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A Prudent Green Purchase

In an excerpt from the new book The Business Case for Renewable Energy: A Guide for Colleges and Universities, the authors describe how renewable energy certificates can be used as a price hedge.

By Andrea Putman and Michael Philips

When Concordia purchased its long-term, fixed-price contract for wind power, local utility Austin Energy set the price of wind slightly higher than its average retail electricity price because it cost more to acquire wind-generated electricity. Concordia started out paying more for its wind power than it would have for conventional electricity. Less than three years later, the situation has reversed and the university is making money every year in the form of lower utility bills.

The university’s contract guarantees the green power fuel price for 10 years at 2.85 cents per kilowatt hour for all of the 5.5 million kWh of electricity that it uses annually. The charge for a traditional contract beginning in January 2006 is 3.63 cents per kWh, a difference of 0.78 cents per kWh. Based on 2005 usage and similar weather, operational, and occupancy patterns, Concordia would spend $50,600 more in 2006 without this contract.

The budget predictability is a very appealing aspect of the long-term contract. Concordia can now plan without concern about electricity price increases because the electricity costs remain constant until 2011. The president, faculty, staff, and students view the green power purchase as something that supports the university’s mission, which includes the stewardship of the Earth. “Preserving our planet and improving the quality of life are a point of emphasis throughout our educational process,” said President Thomas Cedel in announcing the renewable energy purchase.

Concordia’s green power purchase eliminates nearly 8 million pounds of carbon dioxide emissions a year—the equivalent of taking 700 cars off the road or planting more than 1,000 acres of trees.

Buying RECs As a Price Hedge

Concordia’s contract serves as a hedge against price volatility in conventional fuels. One advantage of renewable energy sources like solar and wind is that they have no fuel costs and thus can be counted on to generate electricity at a stable price over time. However, utilities and other green power marketers do not typically pass on this price stability to their customers. Instead, the marketers simply charge a premium for green power and it is added to whatever utility charges the customer already pays. In these cases, even if a college or university purchases 100 percent of its electricity from renewable energy sources by buying renewable energy certificates (RECs), its electric bills will nevertheless increase like everyone else’s as the prices of conventional fuels rise.

Concordia’s contract is an example of a way to purchase a type of REC that serves as a hedge against the volatility of fossil fuel prices. These RECs are structured in such a way that if the college or university enters into a long-term fixed-price contract for, say, 100 MWh worth of RECs per year, then those 100 MWh of its annual electricity usage will not be subject to fossil fuel price volatility. If the college or university enters into a contract to purchase 100 percent of its estimated future electricity consumption in this manner, it will completely insulate itself from fossil fuel price shocks and volatility for the duration of the contract, as Concordia University did in 2003.

To date, this approach has been used mainly for wind power. The wind hedge gives the institution a stable price for electricity. It will cost more than conventional electricity at first, but over time as conventional fuel prices increase, the wind hedge is a better deal. If fuel prices decrease, the college or university ends up losing money. Thus, there is some risk with wind hedges, although most buyers think it is a good gamble to bet on traditionally generated electricity prices increasing rather than decreasing. Hedge products usually have terms of 10 years or longer.

Austin Energy is one of the few electric utilities that offer wind hedges. The utility entered into its own long-term fixed-price purchase contract with local wind farms, enabling it to pass on similar contract terms to its customers. Only an electric utility like Austin Energy can guarantee that a university’s wind hedge will keep its electricity bills stable, at least for those megawatt hours of consumption covered in the hedge contract. If an institution decides to go 100 percent wind, then the utility guarantees that the generation portion of the college’s utility bill (per kilowatt hour) will not increase for the duration of the hedge contract.

Conversely, non-utility REC suppliers have no control over utility bills and cannot guarantee a fixed price for electricity. What they can do is reimburse buyers for electricity price increases by offering a financial hedge against price increases in the form of a contract for differences. This is an instrument that is already in use by some colleges and universities for the purchase of conventional electricity.

Contract for Differences

A contract for differences is a purely financial forward contract (as opposed to a contract to buy electricity) in which a college or university can insulate itself from the volatility of conventional electricity prices for a contract period of 5 to 10 years or longer. Also known as a fixed-for-floating swap, a contract for differences involves an institution entering into an agreement with an electricity supplier wherein the two parties pay each other as conventional electricity prices fluctuate.

These contracts can be entered into without involving renewable energy. They simply hedge the price of conventional electricity. Under a green hedge, the college or university can receive RECs as part of the deal. In this case, the supplier would be a green power provider such as a wind power marketer or broker.

A Renewable Energy Certificate Primer

Customers pay a premium for the green power products their utilities offer. This power has been generated or purchased by the utility, usually at a higher price than electricity from conventional sources. The customer doesn’t actually “receive” the green power.

Once the green power plant feeds its electrons into the power grid, the electrons are not differentiated from the electrons of other kinds of power plants. Instead of trying to ensure that each green buyer receives only green electrons, the utility measures the amount of electricity (in kilowatt hours) fed into the grid by the green power generator and then assigns them to green power purchasers who have agreed to pay the premium price for them. Although green power customers do not receive any more green electrons than any other consumers, the premium helps pay the extra cost of building the green power plant.

For example, if power generation in a given region costs 3 cents per kWh on the wholesale market and the cost of generating wind power in that region is 4.5 cents per kWh, then the wind farm owner needs to find a way to cover the incremental cost of 1.5 cents per kWh. The owner does this by passing on the cost to customers willing to pay a green power premium.

The premium represents not only the incremental cost of green power but also the environmental improvements afforded by the green power plant through reduced power and emissions output at coal-fired power plants. Think of a green power plant as generating two items: normal electricity and environmental benefits. The normal electricity is sold to all consumers. The environmental benefits are sold to the payers of the green premium, who thus “own” the environmental benefits.

The commodity being purchased with the green premium is known as a renewable energy certificate (REC). It is also known variously as a green tag, a tradable renewable certificate, and a renewable energy credit. RECs are denominated in kilowatt hours or megawatt hours, not in tons of emission reductions, because the calculation of exactly how much emission reduction is taking place is extremely complex and often inexact.

Buying and Selling
RECs are sold to customers who may or may not be consumers of the electricity produced by the green power plant. In fact, while the green plant’s electricity is sold to nearby customers, its RECs can be sold to customers anywhere in the country.

The green power marketers play a similar role to utilities, but they are not limited to operating in a given service territory like distribution utilities. While electric utilities can purchase both electricity and RECs from green power plants and sell them to their customers, the green power marketers and brokers enter into deals with green power plants to purchase only the RECs, which they then sell to interested customers. REC marketers also sell to electric utilities, particularly in states where utilities are required to buy a portion of their electricity from renewable sources. The renewable energy sources that can be bought from utilities and marketers include wind, biomass, landfill methane, low-impact hydropower, municipal solid waste, and sometimes solar energy.

All contracts for differences are based on the wholesale price of electricity. To enter into a contract with a green electricity supplier, the two parties agree on a “strike” price for electricity. The strike price is a wholesale price and is the reference point for determining which party pays the other as wholesale electricity prices fluctuate. It is often set at a premium above the current wholesale price. Once the parties sign the contract, the supplier pays the college or university the difference between the two prices any time the spot wholesale price goes higher than the strike price. Whenever the spot wholesale price drops below the strike price, the institution pays the supplier the difference.

For example, assume that a college is paying 7.5 cents per kWh for its retail electricity. Retail prices will tend to track wholesale prices. Assume that the wholesale price is 6 cents per kWh. The green electricity supplier and the college might agree to a strike price of 7 cents per kWh. They also agree that the contract for differences will apply to a certain number of kWhs over a certain number of years. Those kWhs will represent the RECs the college will take title to, although the price of those RECs will vary as wholesale electricity prices vary in relation to the strike price. If at some point the spot wholesale electricity price rises to, say, 8 cents per kWh, the renewable energy supplier will reimburse the college at the rate of 1 cent per kWh. In the event that electricity prices decrease to, say, 6 cents per kWh, the college will pay the supplier 1 cent per kWh.

In the example in Figure 1, the college agrees to a strike price of $50 per megawatt hour (or 5 cents per kWh) for wind power. When conventional electricity exceeds that price, the wind marketer pays the college within the darkly shaded areas above the 5-cent line. When conventional electricity drops below 5 cents, the college pays the marketer within the lightly shaded area.

About the Book

Growing numbers of colleges and universities are switching to renewable energy. And some are not only saving money—they’re making money on their renewable energy purchases. The Business Case for Renewable Energy: A Guide for Colleges and Universities, written by energy consultants Andrea Putman and Michael Philips and published this month by NACUBO, the Association of Higher Education Facilities Officers (APPA), and the Society for College and University Planning (SCUP), outlines the process of evaluating the various technologies, ownership options, relationships with utilities, and financing strategies.

While the bottom line is a top consideration, higher education institutions are choosing renewable energy for many reasons, such as its reliability during emergencies and power outages. Many institutions wish to demonstrate their commitment to environmental stewardship. Such initiatives engender strong support from students, faculty, and community members. These institutions often link their renewable energy initiatives to environmental and energy-related curriculums. Citing numerous, in-depth case studies in higher education, this text shares the innovative solutions that have worked for colleges and universities around the country.

Wind? Biomass? Geothermal energy? Once the decision has been made to explore renewable energy, how does an institution decide which energy source to purchase? And how can your institution take advantage of available funding options, such as government grants and incentives? This book guides you through the process—from making the decision to setting up a plan. Graphics, case studies, and practical appendices ensure that even those who are new to the subject will walk away with the necessary knowledge to move forward with a renewable energy initiative.

Thanks to the book’s generous sponsors—the New Jersey Higher Education Partnership for Sustainability, the U.S. Department of Energy, the International City/County Management Association, Chevron Energy Solutions, the American Council on Renewable Energy, and the National Wildlife Federation—NACUBO member institutions will receive a complimentary copy. Additional copies of the book, Item No. NC3073, can be purchased at www.nacubo.org.

 

Calculating Environmental Benefits

Calculating the financial benefits of RECs with a price hedge or contract for difference is easy. Many colleges and universities also are interested in quantifying the environmental benefits of green power purchases. Generally, a marketer will provide the calculations as part of its proposal. Common metrics include:

  • emissions prevented in pounds per year for carbon dioxide, sulfur dioxide, nitrogen oxides, and mercury,
  • the carbon dioxide equivalent of planting x number of trees,
  • the equivalent of x number of miles not driven, and
  • the equivalent of x number of cars taken off the road.

The National Renewable Energy Laboratory of the U.S. Department of Energy has a Renewable Energy Converter that quantifies displaced emissions that result from a renewable electricity purchase. The calculator is set up for biomass, concentrating solar, geothermal, photovoltaics, and wind. It converts to metrics that include:

  • annual household electricity needs met,
  • tons of carbon monoxide, coal, nitrogen oxides, and sulfur dioxide reduced, and
  • cubic feet of natural gas displaced.

Emission factors for various power plants are reported to the EPA’s eGRID, a searchable database that reports on air quality. The eGRID also shows generation of electricity by fuel type and the fuel mixes in different regions. EPA’s Power Profiler lets the user know how a particular region’s fuel mix compares to the national averages; compares emission rates of the area to national averages; and calculates the emissions that can be attributed to a business or facility based on ZIP codes.
With the price of a barrel of oil at record levels, buying green can potentially lower the risk of volatile fuel prices by providing stability and long-term pricing. Colleges and universities have an incentive to diversify their energy sources to lower the financial risk that results from rising prices.

Buying and Selling

RECs are sold to customers who may or may not be consumers of the electricity produced by the green power plant. In fact, while the green plant’s electricity is sold to nearby customers, its RECs can be sold to customers anywhere in the country.
The green power marketers play a similar role to utilities, but they are not limited to operating in a given service territory like distribution utilities. While electric utilities can purchase both electricity and RECs from green power plants and sell them to their customers, the green power marketers and brokers enter into deals with green power plants to purchase only the RECs, which they then sell to interested customers. REC marketers also sell to electric utilities, particularly in states where utilities are required to buy a portion of their electricity from renewable sources. The renewable energy sources that can be bought from utilities and marketers include wind, biomass, landfill methane, low-impact hydropower, municipal solid waste, and sometimes solar energy.

ANDREA PUTMAN is president of Green Innovations, Arlington, Virginia. MICHAEL PHILIPS is principal, Energy Ventures International, LLC, Tacoma Park, Maryland.