Wednesday, February 26, 2014

The Economics and Panic Behind Wind Energy

Every now and then Michael Skelly says something that resonates.  It sticks in the back of my head until it’s understood, and right now someone at CLEP is thinking “Oh no.  What did he say now?”

Last November a video of Skelly giving a presentation at Harvard surfaced.   He explained that in spite of conventional wisdom, those who sign long term power purchasing agreements with wind energy companies do it at times of peaks in energy prices. 

Why?  Why do organizations like the Illinois Power Agency with the pushing of Governor Quinn feel the need to buy wind energy at the high in the market?  I believe Skelly and his statement is an inarguable fact.  I don't think he was fudging when the made this statement.  It was probably one of the most candid statements made by Michael Skelly.  

I think I understand why and hope to successfully explain it.

When energy prices are high, it is often caused by high demand for energy ( as opposed to a low supply).   There is also a high demand for the fuels to create electricity, coal and natural gas.  If the economy is good, manufacturing is good.  Manufacturing consumes electricity, plus coal and natural gas.  Combined, a strong manufacturing market increases the price of electricity.

As we are experiencing right now, the low price of natural gas causes this form of energy generation to be economical (cheap).    Manufacturing is also lower as we stagnate along in this economy.  Therefore, the price of coal and natural gas as inputs to making electricity are also driving the price of electricity downward.    Long term forecasts are not indicating natural gas prices will increase dramatically.

Wind on the other hand, does not have this variable cost.  Wind energy’s cost has the ability to stay more constant.  While wind isn’t "free", the cost of wind energy production is not dependent on the fluctuating cost of the major input.   When the cost of energy created by coal and natural gas are high, wind energy appears to be more competitive.  Unfortunately for wind energy, it is difficult to compete with lower priced coal and natural gas generation.  Now that the cost of electricity created by natural gas is low and driving the market down, wind energy is absurdly overpriced and noncompetitive. 

Companies like the former Horizon Wind Energy feed off politicians and bureaucrats who do not understand the energy market.  Politicians like Governor Quinn panic when prices are high and believe the contracts they are signing are a good deal at the time.  They fail to consider historical trends but look at the short term trend lines.  In their panic, they believe the price of energy will continue to rise and they are doing a good thing locking in a price.    Unfortunately, the Governor Quinn’s do not realize they are in the midst of a market peak and not the start of an uptrend like they believe.  

In a panic market it is often believed the supply of inputs are limited.  For instance, the notion that the do not make more land so you better buy what you can now has proven to be a myth.  The same is true for coal, natural gas, or oil.  It's never been proven we have a finite supply that will run low in the near future.  New supplies are found.  

The opposite of this phycology is also true.  Today we have low energy prices.  There is not a panic to lock in a price and sign a 20 year Power Purchasing Agreement.  Organizations like the TVA can afford to shop around and compare for the most economical priced form of energy generation.  

It’s going to be interesting is the TVA actually signs on with Clean Line Energy Partners for the Plains & Eastern Clean Line.  With the TVA closing 18 coal generation stations, hundreds and hundreds of people will be laid off.  The TVA is going to have a difficult time explaining why these jobs are being outsourced to Oklahoma. 

For this to work, Clean Line Energy will have to prove to the TVA energy in Oklahoma and transmission will cost less than building new natural gas generation stations within the TVA’s region.    The TVA already purchases over 1,500 MW of wind energy.  Much of it comes from Illinois. 

If the TVA contracts 100% of the Plains & Eastern 3,500 MW’s, this project would be an actual cost allocation for a Merchant Transmission Line where everyone in the region will pay for a privately owned powerline. 

Will this really happen?

Lay off hundreds of people, outsource the energy to Oklahoma, and probably, pay more for the energy than it would cost to generate locally doesn’t sound like a wise action plan.  If this was the pre-2008 economy, this could work.  Few would look critically at this business plan when unemployment was that low, but the post 2008 economy is a fact.  Natural gas is cheap.  Unemployment is high.  Wind energy is comparatively expensive and energy buyers are not in a panic.

The Plains & Eastern Clean Line business plan is in trouble. 

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