Energy Finance Report

Hedging with Distributed Renewable Generation Sources in Times of Fossil Fuel Price Volatility

Posted by Joshua L. Sturtevant on 3/11/16 2:20 PM

Volatility_Ahead.jpgCo-author Morgan M. Gerard

Until very recently, mainstream power purchasers have not viewed renewable energy as a reliable hedge against other energy sources, mostly because the costs associated with constructing or purchasing the output of renewable energy systems were very high. However, renewable energy generation systems are increasingly being viewed by large and small consumers alike as a viable hedge against fossil fuel price volatility.

Two main factors have contributed to this. First, recent price declines in both hard and soft costs have precipitated a decline in installation costs. In other words, systems are cheaper to install, making renewables more attractive on an absolute basis. Second, myriad models for both direct ownership and third party ownership have allowed beneficiaries of renewable systems to lock-in long-term pricing certainty. Against this backdrop of profound changes to the cost and ownership structure of renewable energy sources, volatility in natural gas prices has forced power consumers to evaluate the attractiveness of alternatives.

Renewable Energy Prices are Falling

The price of constructing renewable energy projects has dropped precipitously in recent years. For example, according to the Department of Energy (DOE), wind power prices have reached an all-time low, and Power Purchase Agreements (PPA) for wind fell from rates around 7 cents/kilowatt-hour (kWh) in 2009 to an average of 2.4 cents/kWh in 2014. Dramatic price declines have been seen in the solar space as well. For example, between 2008, and 2014, the cost for a PV module declined from $3.57/watt (W) to about $0.71/W. Total install costs declined due to these hardware declines, the reduced soft costs brought about by DOE and industry efforts, and the increase of standardization in contract terms: the total cost of utility-scale PV systems fell from $5.70/W in 2008 to $2.34/W in 2014—a decrease of 59%. Additionally, Deutsche Bank recently predicted that the price of solar would reach grid parity in most states this year. That prediction seems increasingly sound in the face of the extensions of the Investment Tax Credit (ITC) and Production Tax Credit (PTC) late last year.

 Renewables Provide Price Certainty for Offtakers

It is both the decline in costs noted above and the ability of renewable sources to provide cost certainty over long time periods that allow these sources to be utilized in a hedging capacity. Consumers benefit from the output of renewables in two main ways. The first is through direct ownership, also called ‘on balance sheet’ ownership. The second is through a contractual relationship with a third party owner, typically through a lease or a Power Purchase Agreement (PPA). Direct ownership is most prevalent among large, sophisticated entities such as utilities and corporates, while contractual relationships predominate in residential and commercial and industrial (C&I) contexts, though these are by no means hard and fast rules.

Regardless of whether the system is on balance sheet or not, the usefulness of the system as a hedge is simply a function of cost certainty. In the context of an on balance sheet system, there is a known up-front cost and relatively easy to calculate annual costs in the form of insurance and maintenance; once the solar or wind facility is built the owner of the generation source will be able to forecast his fixed costs over the lifetime of the project. In the context of a contractual relationship such as a lease or PPA, the costs are typically clearly known by the consumer as contracts are often set price, or contain an easy to calculate escalator. While obvious, is also important to emphasize what is not a part of the long-term cost structure of renewables; fuel inputs. Given that costs are possible to calculate, the lack of input prices, and the fact that certainty is locked in for the long-term due to long asset lives and contracts terms, renewables provide the best widely available opportunity for long-term energy pricing certainty in existence.

The contrast against traditional sources could hardly be more stark. According to the Wall Street Journal, as natural gas has become an increasingly prominent fuel in the international energy mix, increasingly erratic weather patterns (like El Nino and last year’s polar vortex) have sent commodity traders “scrambling.” Data from BNP Paribas SA shows that realized volatility (a measure of day-to-day price moves) hit an eight-year high for the two-month period covering this past December and January. Additionally, natural gas trading in 2014 “was four times as volatile as the U.S. stock market by that measure, the data shows.”

Renewables May Provide for Future Additional Cost Savings and Revenue Streams

On top of current cost savings and hedging opportunities, renewables have the added benefits of both producing monetizable environmental attributes and helping owners avoid added costs related to carbon production in the future. Environmental attributes already have value in some jurisdictions, and it seems likely that list will grow with the implementation phase of the Clean Power Plan potentially looming and developments such as New York’s Reforming the Energy Vision program underway. Additionally, it has been reported that one of the goals of COP 22 will be the implementation of a “carbon tax”. While it seems unlikely that the U.S. would sign up to a carbon tax regime in the near term, the likelihood of it doing so within 10, 15 or 20 years seems potentially higher. In addition, given that fossil fuel markets are global in nature; additional carbon tax programs abroad could conceivably impact volatility in the U.S., another factor that makes a potential hedge in the form of renewables attractive.


Renewable energy has traditionally been more expensive for the output provided than fossil fuel sources. Additionally, as a result of the energy boom in North America consumers in the United States have paid slightly lower prices for electricity in recent years. On a strictly short-term basis, it is often true that traditional sources are cheaper than renewables. However, the extreme volatility that exists in commodity markets reduces the ability of consumers to effectively account for their fuel costs in the long-term.

In contrast, the price declines in renewable energy sources coupled with the ability to accurately account for long-term costs have made renewables attractive, and consumers have taken notice. Berkshire Hathaway Energy has already adopted renewables as a fuel-hedge for its various portfolios. Additionally, tech players like Google, Apple and Microsoft are all experimenting with distributed renewable energy to take control of their energy consumption regarding both price and source. Big box stores like Wal-Mart, Walgreens, and most recently Whole Foods, have chosen renewables not only as an environmentally responsible energy choice, but a smart fiscal choice as well. Even as the price of traditional energy remains relatively low, a combination of commodity price volatility in that space and price declines in the renewables space have led consumers of energy to find renewables to be an attractive alternative.

Topics: Distributed Energy, Solar Energy, Renewable Energy, Distributed Generaton, Wind Energy, Grid Parity, Natural Gas, Volatility, Natural Gas Volatility, Electricity Price

Sullivan & Worcester logo

About the Blog

The Energy Finance Report analyzes developments in energy finance as well as provides updates and perspectives on market trends and policies.

Subscribe to Blog

Posts by Topic

see all