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AN UNHEALTHY PREOCCUPATION

With fierce competitive bidding for contracts in places like the UK and Minnesota, the second decimal place in kilowatt hour prices is being given too much significance by the wind industry. In the energy market, price is a matter of debate, not a fixed point, with politics, interest rates, geographical considerations and arguments about external costs all having a significant influence. Whatever the exact figure, wind energy today has reached near parity with the price from conventional technologies when its value on the grid is taken into account. A way to assess this is to compare wind prices with the average price of electricity sold to industry. In Britain this is now roughly equal, while in Germany, wind can be produced for around 20% below the price of industrial electricity. What's more, consumers are apparently willing to pay more for green power. Green pricing schemes could work within a structure of "renewables power pools," although UK experience has shown that a power pool effectively strangles the market signals it is supposed to give. Another and better approach would be to allow customers to contract directly with generators of clean power, paying a charge to the utility for wheeling the electricity to where it is wanted. Instead of setting price targets for wind to hit, a better option would be for wind to operate within target price zones, decided geographically. The article is accompanied by three explanatory graphics on repayment periods, interest rates and wind prices compared to industrial selling prices for electricity in Germany and the UK.

Once upon a time, not very many years ago, the energy business saw wind as an insurance technology; its exact price did not really matter. Now, with fierce competitive bidding for contracts, the second decimal place in kilowatt hour prices is being given a significance by the wind industry probably out of all proportion to market requirements.

The final tenth of a cent was certainly a crucial factor when it came to drawing the line under successful Non Fossil Fuel Obligation (NFFO) bids in the UK this year; and it was certainly the deciding factor when American utility Northern States Power turned its back on its old supplier, choosing a new wind company to provide 100 MW of plant in the single largest contract ever granted (Windpower Monthly, July 1995). But tenths of a cent are not what real world markets are all about. Wind's competitors do not argue at this level and our industry's apparent determination to hoist itself with this petard is an unwise, not to say foolish, preoccupation.

In the latest round of NFFO contracts, wind energy bid prices were low. The average was around $0.065/kWh. In the bidding for the Northern States Power contract, they were very low. The American utility accepted a bid to supply wind plant with an estimated energy cost of "about three cents a kilowatt hour levelised over 30 years." The tendency in the wind community now is to refer to these prices, squeezed to the limit in a fiercely competitive bidding process, as the cost of wind energy today. Here lies a booby trap of frightening proportions.

Over the trap, the wind industry is walking along a tight-rope. On the one hand it wishes to demonstrate its maturity and competitiveness, on the other it is still too small to entirely self-finance its research and development work. The further prices are pushed down, the more dependent it is on government backing. For this reason many of wind's champions meeting in Finland at this month's economics seminar will argue that the only way forward is to push for realistic pricing mechanisms. These mechanisms must acknowledge the entire costs and benefits of all energy sources, enabling fair comparisons in a fair market, comparisons that are rarely possible today.

Yet three factors bedevil assessments of wind energy's competitive position: a wide range of price calculation methods which often fail to take into account all relevant factors; geographical variations in the price of other fuels; and the lack of agreement on methods for assessing the external costs of energy sources, those which occur outside the generation train, such as the costs of acid rain from coal-fired generation, Gulf wars, and clean-up costs after nuclear accidents.

The price of wind

Even within just one technology, wind energy, the basis of price calculation varies widely. Northern States Power's $0.03/kWh is as controversially low as the payments to German wind plant operators -- at about $0.115/kWh -- are controversially high.

In practice the two figures simply cannot be compared. The gap between the American and German prices is narrower than it appears and is largely a function of the different fiscal regimes under which the prices are calculated. It is also worthwhile recalling the adage that "prices are what you want them to be." The NSP figure has been levelised over 30 years, whereas German developers usually secure loans for ten years. This key difference means that German prices will be higher by at least 40% (Fig 1). The interest rates in each case, not public knowledge, also have a crucial effect on wind energy prices (Fig 2). Most importantly, it must be remembered that the German energy payment is a fixed sum, linked to domestic electricity prices and set artificially by government to catalyse a market for wind power. It may or may not reflect generation costs. NSP's price, arrived at through competitive bidding, is nonetheless probably lower in real terms, but not by the huge margin that appears at first sight.

Whatever the exact figure, it is impressive that wind energy today has reached near parity with the price of electricity from conventional technologies during a period when almost every price factor has been stacked against it. The price of fossil fuels has been static or declining in real terms. The move away from state-run utilities towards private utilities or individual developers has also meant the disappearance of "project lifetime" as the depreciation period for wind plant, to be replaced by bank loans repayable over ten to 12 years, or 15 years at the most. The effect of this is, by nature, more pronounced on wind prices than on gas-fired plant (Fig 1), since capital costs account for around 75% of a wind energy price. What's more, interest rates have been rising, partly due to recessional influences, partly due to the moves towards privatisation of the electricity industries. Again, this affects renewables much more than, say, CCGT plant (Fig 2).

A hazardous task

Energy economics are complex and no single method of price calculation correctly reflects everything. To be exact, a pricing method needs to forecast future levels for fuel, operations and maintenance, and interest rates. The crystal ball that can achieve that has yet to be discovered. Fortunately, the immunity of renewables to fuel price inflation is an important advantage, though this has not been seen recently since fossil fuel prices did not continue to rise as predicted in the 1980s. As a result wind's prophesied competitive position was eroded.

Even if fuel prices were predictable, electricity selling prices do not necessarily follow them that closely. Strange things have been happening to UK electricity prices, where even though coal prices fell steadily from 1983 to the present, the price of electricity actually increased between 1990 and 1992. Whether this was due to the generation of higher profits by the privatised utilities, or to providing capital for investment in CCGT plant is unclear. What is clear is that predicting future electricity prices is a hazardous task -- and predicting the price targets wind needs to match akin to chasing quicksilver.

The price of wind energy depends on where you are in the world, since this affects both the method of calculating the relevant prices, and also the prices of other fuels and of plant. Direct generation cost comparisons are also misleading. Where wind loses out in the cost of generation, it wins hands down on transmission and distribution costs because it generates power close to where it is needed. Thus a fairer approach would be to compare wind energy prices with the average price of electricity sold to industry. The price of industrial electricity is close to the value of wind energy on many networks, where "value" includes wind's cost benefits to the network.

Such comparisons are revealing (Fig 3). The price of wind energy in Britain is now roughly equal to the average selling price of electricity to industry. In Germany, a similar comparison shows that wind energy can be produced for around 20% below the price of industrial electricity -- simply because the price of coal supplies to the Germany electricity utilities is very high (almost three times the British price). So despite wind's higher selling price in Germany (mainly due to lower wind speeds than in Britain), it is potentially a more attractive proposition there because expensive German coal pushes up electricity prices substantially. Wind could probably stand on its own feet in Germany if the market allowed it to.

Jokers in the pack

Interest rates, however, could change the competitive position of wind, for better or for worse. A little over ten years ago, a major UK generating utility made a comparison of nuclear and other costs using a test discount rate as low as 2%, simply because this was the rate which had been achieved historically. At the time, the UK treasury ruled that nationalised industries were required to use a rate of 5% for assessing the economics of new plant and this was later raised to 8%. Few private developers, anywhere, currently use such a low rate and the more normal band ranges up to 15%. The effect of these interest rate variations on energy prices are considerable (Fig 2). In the private sector, wind will have a hard job beating gas -- even if interest rates fall substantially. However, it has already undercut nuclear (Windpower Monthly, July 1995).

Another joker in the pack is the external cost of electricity generation, a hotly debated issue. Although real, these costs are extremely difficult to quantify accurately: the financial consequences of a nuclear accident, however unlikely, are mind boggling; the cost of oil spillage and protecting supplies from the Middle East fraught with argument; and the long term cost of acid rain and the greenhouse effect totally unknown.

In recognition of the fact that wind has a role to play in averting environment disaster -- and thus has a value not directly relevant to its cost -- governments so far have used legislation to oblige utilities to buy or develop wind power, or they have introduced a programme of market incentives. Yet there is another approach to the issue of value which short circuits the external costs debate.

Consumer power

Consumers appear to be consistently voting with their feet in favour of green products. They pay price premiums up to 50% or more for organically grown vegetables and bread. They also spend time and money driving to recycling centres where newspapers, bottles and cans can be deposited, although there is seldom any government compulsion to do so. Bottled water, although more expensive and arguably less pure than tap water, also sells in vast quantities.

This mood of social caretaking has also been reflected in electricity consumption. Consumers in the US and the Netherlands are voting with their pockets in some localities and choosing to pay a higher price for being allowed to buy wind energy. In Switzerland, the citizens of Zurich are prepared to pay an electricity price premium to facilitate experiments with solar electricity.

This leads to two possible scenarios. The first is "renewables power pools" in which both suppliers and consumers can sell and bid for electricity. Such a proposal is being discussed by the California Public Utilities Commission (see page 30). This body has suggested that a separate renewables pool be set up, modelled on the UK power pool. The European Union, under the Altener programme, is also funding a study of the prospects for similar pools in Europe.

The UK power pool -- the only one operating for a period long enough to judge its strengths and weaknesses -- has not, however, been an outstanding success. Pool prices have moved erratically, with a limit finally being imposed on them by the electricity regulator. Effectively this has strangled the market signals a pool is intended to give. Most UK energy is now traded via contracts which effectively bypass the pool. This trading, whether it is called third party access, retail wheeling or free market economics, could well hold the key to how renewables will enter the markets of the future. If common sense is allowed to prevail, renewables generators and suppliers will simply enter into firm contracts, avoiding the uncertainties associated with a volatile pool.

This approach needs a clear structure to enable "wheeling" of the energy across the grid to take place, as happens in India. Elsewhere access to the grid for a fee is under discussion; in Germany it would seem to be highly relevant, though monopolistic utilities tend to be wary of what they may see as an erosion of their position. But the drive for clean power has now gathered such momentum that stopping it would seem to be nigh on impossible. If green minded companies like the Body Shop are prepared to tackle the horrendous bureaucracy of the UK's NFFO process and buy into a wind farm in order to gain access to renewable energy, how much more likely it is they will take up the far easier option of buying clean power fed into the grid, even at a premium.

The irrelevance of price

In this clearly uncertain world of energy economics, setting price targets for wind to hit begins to appear decidedly irrelevant -- and scrambling around after the last decimal point a waste of valuable time and energy. The final tenth of a cent might be important when fighting for a single contract, but seen from a global viewpoint, it is overshadowed by other factors. Even in a market as allegedly sophisticated as energy, the West's desire for quality, the hidden agendas of political parties, and the influence of powerful decision makers all have a decisive influence on purchasing decisions. For renewables, an option far preferable to chasing elusive decimal points is available.

Target price zones -- which will vary around the world -- would be more realistic and recognise that the exact (true) costs of energy from competing fuels cannot be pinned down with any great accuracy. A price zone, set to ensure that average electricity prices were reduced, would also mollify economists and governments who refuse to subscribe to the view that green energy should be developed at any price.

* Wind energy costs in this article are calculated using a recommended practice published by the International Energy Agency. Costs are levelised costs using real (i.e. net of inflation) interest rates.

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