Renewables Are Lowering Price of Electricity For All in Ohio

Contrary to “conventional wisdom” renewable energy is causing downward price pressure on Ohio wholesale markets

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The Public Utilities Commission of Ohio (PUCO) has recently released a report that concludes that the addition of large scale renewable energy is having the effect of causing price suppression. For people who pay electric bills price suppression is a good thing.

Since renewable are a no-cost addition to the grid, once installed, they are called upon first to deliver electricity. This lowers the overall wholesale rate of electricity delivered into Ohio.

From the report:

Price suppression is a widely recognized phenomenon by which renewable resources produce lower wholesale market clearing prices. The economic theory that drives price suppression is
actually quite simple. Renewable resources such as solar and wind are essentially zero marginal cost generators, as their “fuel” costs (sunlight and wind) are free. As such, they will always be dispatched first by the grid operator, thereby displacing units with higher operating costs. This
results in lower wholesale market clearing prices than would have been experienced in the absence of the renewable resources.
— Public Utilities Commision of Ohio

The report goes on to say that there are no issues with grid integration of these technologies in Ohio.

No severe congestion issues or emergency curtailments were observed, even after incorporating all approved projects, which suggests that the electric grid in Ohio is sufficiently robust to support the continued development of utility-scale renewable projects.

— Public Utilities Commision of Ohio

The other compelling thing about this report is that the PUCO is not a biased party.

Net Present Value- Solar Development Basics

Understand the Financials of Solar Project Development- NPV

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One of the keys to developing successful solar projects is to understand how to measure and communicate value. We need to frame the value conversation with our customers.

Several days ago we talked about how payback is not a good measurement for conveying the value of solar to a customer. 

We covered how using the simple payback method is not effective with projects that have very long useful lives. It overemphasizes the short term and does not convey the total long term value of the system.

Two better ways to consider the value of a solar project:

IRR and NPV

IRR= Internal Rate of Return

NPV= Net Present Value

IRR and NPV are two measurements that are very often used in capital budgeting to measure and compare the profitability of investments. They are terms that take the total return on investment into consideration.

We will spend today discussing what NPV is and how it works.

Net Present Value

Simple Version:

NPV is a way to assess whether the cash flow of a project is positive while taking into account the time value of money. In its simplest form it means that a dollar today, is worth more than a dollar tomorrow.

Why?

Because of three factors:

  • Opportunity Cost- what you couldn't do with that money, like invest it.
  • Inflation- that dollar will have less purchasing power tomorrow.
  • Risk- are you really going to get that dollar tomorrow?

So NPV is a way of factoring the time value of money into project cash flows in the future.

In general if a project has a positive NPV that means it will make money over the time analyzed and is a “good investment”. So we want to see a positive NPV on our solar projects.

Deeper Explanation

Let’s first understand what present value means.

Pretend you are presented with these two options:

  1. Someone offers you $100 today.
  2. Someone offers you $100 one year from now.
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Which would you choose? As a sensible person you'd pick Option 1.

If you received $100 today, you can invest it, and in a year from now you might have $105 if your investment has a return of 5%.

In addition, inflation would steal part of your $100, so in a year from now, the same bill might buy you only $97 worth of products. We prefer to get money sooner rather than later, so you’d need some form of compensation to get the money later.

So Present Value is the value today of an amount of money in the future.

How about this choice:

  1. Someone offers you $100 today.
  2. Someone offers you $105 one year from today.

You get options like this often in everyday life, like the option to pay upfront for a year instead of making monthly payments.

So, which option would you choose? Basically, you are offered a 5% return that needs to reimburse you for the loss of investment (i.e. you can’t do anything else with $100), the risk involved (will you actually get the $105 in a year from now?), and the expected rate of inflation.

These factors, opportunity cost, inflation and risk are used to set something called the Discount Rate. The Discount Rate is key in calculating NPV and can change the calculation dramatically based on the discount rate chosen. (Note: Working with your customer to understand their Discount Rate is important)

Let’s assume you could put the money in the bank and would receive 3% interest. Inflation is currently rather low, let’s say 1%. The person is creditworthy so the risk of not getting paid is extremely low. With your 3% investment, you’d have $103 in a year. Given 1% inflation, the $103 would be worth only $101.97. 

So if you’d take the $100 today, you’d have 101.97 in a year. Option 2 would be favorable, as you would get $105.

The NET portion of the term simply refers to all the cash flows over the term of the project. If you apply the Discount Rate to ever years cash flow and add them all together you get the Net Present Value.

To Sum Up:

  • Net Present Value is a way to value an investment that takes into account the time factor of money.
  • The Discount rate used has a tremendous impact on NPV
  • A positive NPV means that the project is worth considering
  • A negative NPV means the project will loose money
  • NPV is a good way to screen projects but is not a great tool for prioritizing projects because a the size of the project will impact the NPV
  • Engage your customer in a discussion of what the right discount rate to use.
  • The higher the discount rate the lower the NPV

Helpful Links:

How to Calculate Net Present Value 

How to Use Excel Formulas to Calculate NPV

Bonus:

David Roberts at Grist has an excellent piece on how setting a discount rate has tremendous impact on modeling climate change economics.

 

 

Why We Need Edward Snowden in Solar and The Market for Lemons

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 So before this turns into a debate about patriot vs. traitor let's just say that he was someone who exposed information that only a few people knew.

So why does this matter for solar? Because of an economic principle called quality uncertainty. This was first publicized in a Nobel Prize winning paper called 

"The Market for Lemons: Quality Uncertainty and the Market Mechanism"written by George Ackerlof.

In this famous paper he discussed information asymmetry, which is a situation where the seller knows much more than the buyer. 

This creates an imbalance of power in transactions which can cause the transactions to go awry, a kind of market failure. 

It is this issue that gave rise to the phrase "Buyer Beware" 

"The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence."- George Akerlof.

A recent GTM  article highlights a recent example of this. These issues are few and far between and represent   The Tragedy of the Exception in which one bad apple can spoil the bunch.  (Not to be confused with  Tragedy of the Commons which those of us in sustainability normally worry about).

 The implication for solar is clear. Solar projects, at all stages have a degree of complexity that the average buyer most likely does not understand. There are all sorts of ways to play on information asymmetry in this market. And it doesn't only apply to the end customer. It can apply to equipment manufacturers, financiers, developers and installers.

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How good is the panel?  How much are the transaction fees for this deal? Can you really install for that price or are there a bunch of change orders right around the corner? Are we really going to be able to find an off-taker for those SREC's? Is the production estimate done by industry best practices? These are all cases where information asymmetry can become an issue.

And as Akerlof makes clear this is not only a problem on the individual transactions, it becomes a market problem. If you can't tell who is above board then every transaction becomes riskier. In this case bad actors can drive good actors out of the market.  

So back to the provocative headline...The more that we educate every level of participants in the solar market and the more transparent we make the buying process the stronger the marker becomes as a whole.  

I'm glad to see things like Mercatus Single Point of Truth, TruSolar's uniform credit screening, Energy Sage's consumer research and Principal Solar Institute's PSI ratings. These can all serve useful purposes,  in the same way the used car industry has Kelly Blue Book, Edmunds.com and Carfax these are all ways to decrease information asymmetry. 

We will spend more time in the future on some of the services listed above as well as how individual players can reduce their exposure to information asymmetry.