The Economic Value of Renewable Resources: Intrinsic, Extrinsic and External

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by Tanya Bodell, FTI Consulting

Support for renewable resources continues to vary by state with minimal harmonization expected from the federal government. California recently passed a renewable portfolio requirement of 33 percent by 2020 and is scheduled to implement a carbon program in 2012. In contrast, the New Hampshire House of Representatives voted to rescind participation in the Regional Greenhouse Gas Initiative, the first cap-and-trade system to control greenhouse gases. Although such disparate policies seem to be driven by politics or ideology, they also might reflect differences in underlying assessments of economic value.

Intrinsic Value

With electricity capacity exceeding reserve margins and natural gas prices hovering around $4 per million British thermal units, renewable resources appear to be an above-market option for meeting U.S. energy needs. Levelized costs for building and integrating most renewable resources into the system are more than double wholesale electricity prices. The intrinsic value of renewables within the current market appears to be out of the money. So how are advocates and policymakers justifying policies that support them? Externalities and extrinsic value also must be considered.

Externalities

Renewable resources provide value beyond energy. Fossil fuel-fired generation produces air emissions, and clean air can be considered an input to production. Air emissions create negative externalities that are not incorporated into production and purchase decisions. Cap-and-trade programs and taxes on emissions attempt to price this externality to rationalize the production of power using fossil fuels. In the absence of such policies, renewable resources appear to be much more costly than alternatives–an unfair comparison.

Renewables also create positive externalities that should be considered in an economic valuation of their broader benefits. Resources such as wind and solar are close to zero marginal cost; placing them in the supply stack shifts the entire supply curve out, resulting in lower wholesale electricity market prices for all consumers as more expensive fossil fuel peaker plants, and even traditional base load natural gas facilities, are displaced by greater levels of renewable resources in the market. Such price suppression can extend beyond energy and capacity markets to oil and natural gas as a result of lower demand for fuel from displaced fossil fuel generating units. Lessening dependence on foreign oil also generates national security benefits–another positive externality.

Politicians tout economic impacts, such as green-collar jobs, as another benefit. Although an economist can argue that deadweight losses from the taxes required to support such economic development will offset temporary job increases, such investment may be worthwhile if it creates an economically viable industry over the long term. As alternative generating resources become commercial, investment today can fuel innovation and industry tomorrow.

Extrinsic Value

Renewable resources also have extrinsic value beyond a proper accounting of externalities. Extrinsic value is a term normally used in the context of options to measure the difference between the option price and the difference between the strike price and market price of the underlying security. In the context of renewable resources, extrinsic value is the additional value beyond the difference between the levelized cost to build and market prices and includes diversification benefits.

Renewable resources diversify the nation's generation portfolio away from fossil fuels. Although incorporating costly renewable resources into the generation portfolio might increase the expected cost, the volatility of the underlying fuel source is lower. The value of decreased volatility is a well-established concept in finance first proffered by Harry Markowitz as part of his portfolio theory and introduction of the efficiency frontier. Adding a fixed-cost source of electricity to the generation portfolio should allow for decreased volatility of the total power production cost.

Conclusion

The economic value of renewable resources extends beyond the intrinsic value calculated under existing market conditions. Informed business and policy decisions require quantification of these benefits. Yet even a proper measurement of the true value of alternative resources by region can result in disparate policy recommendations because of differences in the economic value of renewable resources vs. available alternatives.

Author

Tanya Bodell is a managing director at FTI Consulting and co-founder of the Electricity Consulting Group. Reach her at tanya.bodell@fticonsulting.com.

"Not only will atomic power be released, but someday we will harness the rise and fall of the tides and imprison the rays of the sun."
Thomas Edison

 

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