The changes brought about by evolutions in renewable energy technologies, and in some cases aggravated by the impacts of COVID-19, are likely to up-end traditional relationships between different forms of energy and the customers that use them. These changes are significantly impacting not just competitors, but their contract counter-parties, the risks they face, their credit-worthiness and their customers.
Renewable generation equipment’s cost continues to decline. Output from solar and wind is available at $0 short-term incremental dispatch cost. Battery research is identifying ways to lengthen the duration of output from that form of storage, and to lower its cost. But the location of renewable assets is not necessarily the same as the location of conventional thermal generation facilities, which typically have been located adjacent to sources of large amounts of water. Hence the transmission system built around conventional generation usually will not suffice in a market where renewables play the kind of role envisioned by states’ renewable power standards; wind and solar will be in entirely different locations. The result will be the stranding of electric transmission assets. Moreover, because renewable sources have no cognizable variable costs of being dispatched, conventional generation resources will experience reduced demand, and some will simply not be economical in competing with renewables. Similarly, gas pipelines that transport volumes to be burned in power plants will experience de-contracting, reducing use of their systems and revenues. These various forms of stranded costs will, to the extent regulated (e.g., in bundled electricity retail markets, for generation; in all cases for electric transmission costs; and more or less on pipelines, depending on both the degree of under-subscription and the proportion of a pipeline’s capacity subject to negotiated rates) contribute to increased costs for conventional generators.
Moreover, the financial dis-location of the COVID experience has depressed demand for, and price of, oil and petroleum products significantly, contributing to further risk for contract counter-parties to hydrocarbon exploration and development companies (e.g., pipeline transporters; oil field services companies; and consumers depending on their suppliers’ long-term commitments). Renewable developers now include enterprises with higher market capitalizations than even some of the major exploration and development companies.
The dis-advantaged posture of conventional resources may hasten their downfall. Higher unit costs for conventional resources in the generation stack relative to renewables with no incremental dispatch costs means that renewables will come out on top in hours where an incremental dispatch cost of $0 causes them to be taken first, and possibly to the exclusion of conventional generation. If conventional generators respond to reduced demand by relinquishing firm gas transmission capacity in favor of interruptible service, the result will be the addition of another incremental cost (the interruptible transportation rate) to each hour of generation from such a source.
The upshot is that costs all along the supply chain will become skewed under at least existing rate design principles, and the economic viability of a number of market participants will be de-stabilized, with significant financial consequences to many contract counter-parties of energy industry participants.
These issues are discussed as part of Sheppard Mullin’s Nota Bene podcast series, hosted by Michael Cohen. For greater detail in an accessible format, listen to Michael and Mark discuss these challenges on Episode 97 of Sheppard Mullin’s Nota Bene podcast.