COC S-P-Report-July-20-2011.pdf

Of Water, Wind, And Wires: Credit
Implications Of Renewable Energy For The
Pacific Northwest Power Markets
On April 1, 1998, a British newspaper reported that, to integrate the U.K. 's traffic patterns with the rest of Europe,
all traffic would drive on the right. However, the report continued, to ensure a smooth implementation of this major
initiative, the change would be phased in--for the first six months the regulation would apply only to buses and
trucks. Of course, the report was an April Fool's Day prank. But it highlights the importance of taking each and
every variable into account when restructuring long-established complex patterns.
The U.S. is currently undergoing a restructuring of its power markets to incorporate more renewable energy sources.
But with the evolution of electric renewable and transmission policy stateside the process can get tricky, as it has in
the Pacific Northwest. The region has been experiencing exceptionally strong hydro runoff conditions (see note 1 ),
significant wind development, and also a languishing economy. As a result of surplus generation and limited
transmission to take it elsewhere, wholesale prices have gone down and even become negative during some off-peak
hours--meaning producers have actually been paying buyers to take their power. And these incidents have been . . mcreasmg.
Overview
• The highest snowpack runoff in years has led to a glut of hydropower in the Pacific Northwest.
• This is causing low--even negative--prices in the power markets.
• Wind farm operators have curtailed generating due to the hydro glut and because they still don't have enough new transmission
lines.
• These factors may weaken the longer-term credit quality of regional power generators.
Yet, past behavior would indicate that lower Northwest market power prices are limited to spring. Episodes of zero
or negative market prices have occurred in six of the past 11 runoff periods. Power generators have usually hedged
their production in the short-to-medium term, which enables them to ease this spring runoff effect. However, the
development of significant intermittent generation--wind--and the absence of adequate transmission wire capacity to
take the power to where customers need it could put more pressure on long-term regional wholesale electric market
prices. The magnitude and frequency of negative off-peak power price excursions have increased. At some point, this
is likely to weaken the longer-term credit quality of regional power generators, especially those with "dispatchable"
coal-fired and gas assets (wind and run-of-the-river water generation units are not dispatchable; they have to
generate when the resource [i.e., water or wind] is available).
"Aqua"-sition--Hydro Takes Over
Snowpack levels in 2011 are 30% to 50% higher than they were last year at several locations in the Northwest. In
its June 2011 update, the Northwest River Forecast Center said it expects river flow for interior parts of the
Standard & Poor's I Research I July 20, 2011 2
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Northwest Hydroelectric Power Output
• 2006-2010 max. • 2011
Gigawa11 hour$
450
400
350
300
250
200
150
100
50
0
�--
"' .,., N 0, .,., N 0, c c N N D � � .. .. c c c ., D D .., .., .. .. .. u, ., ., .., .., .., u, u,
Sources: U.S. Anny Corps of Engi.neers; Energy Information Administration.
C Standard & Poor's 2011.
Of Water, Wind, And Wires: Credit Implications Of Renewable Energy For The Pacific Northwest Power Markets
Renewable Mandates Drive Wind Additions
Developers continue to add wind capacity at a rapid clip in the Northwest to meet increasingly stringent renewable
portfolio standards (RPS) that individual states have established. Table 1 presents some major wind generation
owners in the Bonneville Power Administration (BPA; AA/Negative) region, the major power system in the
Northwest. Several characteristics of RPS resource development cause lower wholesale electric market prices (which
is somewhat ironic given their generally high capital costs). First, current RPS targets and financial incentives tend to
result in the growth rate of qualifying energy production exceeding load growth until the final RPS target is met in a
state. Second, RPS resources usually must operate to produce the qualifying energy so that operators can claim
production tax credits (PTC). Finally, the variable costs of resource operation are typically low. As a result, we
would expect market prices to be lower than they would be absent RPS resources, all else being equal.
Table 1
Top 10 Wind Capacity Owners In The Bonneville System
Megawatts Rating
Iberdrola Renewables Holdings Inc. 1,055 A-/Negative/--
Portland General Electric Co. 450 BBB/Stable/ A-2
EDP - Energias de Portugal S.A. 300 BBB/Negative/ A-2
Canon Power Group 262 Not rated
NextEra Energy Inc. 247 A-/Stable/--
Summit Power Group 204 Not rated
Puget Energy Holdings LLC 157 BB+/Stable/--
Tuolumne Wind Project Authority 136 A+/Stable
Energy Northwest 95 A-/Stable
lnvenergy LLC 72 Not rated
Source: SNL Energy.
A couple of other factors have contributed to the accelerated growth of wind energy resources in Bonneville's
system. Developers are building more wind energy farms than RPS standards require in the Northwest because
California utilities now have a greater ability to use tradable renewable energy credits/certificates (REC) (see note 2).
There is some concern that the sale of unbundled (see note 3) RECs from Northwest wind projects to serve
California's RPS requirement will result in the region's having to develop even more renewable resources to meet its
own RPS laws: California is laying claim to the credits that much of the region's renewable energy development
generates. Second, the ability of developers to claim investment tax credits (ITC) instead of PTCs is also contributing
to more wind construction than the market anticipated (see note 4). To claim PTCs, wind projects have to generate
electricity; however, project sponsors merely have to make the investment to start claiming ITCs.
Moreover, because wind output tends to be disproportionately higher in off-peak periods, it typically correlates
poorly with the overall system load. This increases the variability of demand on the rest of the system. As the lowest
variable-cost power generation resource, wind generation is always dispatched first. This tends to shift the load
curve downward (i.e., as an exogenous resource, wind reduces demand for the rest of the system because net
demand becomes "total demand less wind generation"). The larger ratio of peak to off-peak demand causes higher
cycling of other generation resources, which must ramp up to meet the peak loads and then ramp down during
off-peak periods. This greater cycling generally raises the system's overall generation costs and can cause reliability
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879927 I 300642892
Of Water, Wind, And Wires: Credit Implications Of Renewable Energy For The Pacific Northwest Power Markets
issues given the unanticipated wear and tear on the coal and gas plants. One of the reasons that operators have
installed more than 3,000 MW of wind in the region since 2005 is that during other seasons, the hydro system has
ample balancing reserves that variable wind generation requires.
Water, Water Everywhere
High wind and unexpectedly high hydro runoff can lead to more frequent "excess energy" events. They happen
when the available water and wind energy can't all be used to generate electricity because of a lack of matching
demand. In fact, operators have had to spill water over the dams instead of running it through the turbines. Yet
federal law restricts the amount of spilling that protects certain endangered fish species. Spilling churns the air and
water, which increases the concentration in the water of dissolved gases, including nitrogen. High levels of dissolved
nitrogen can kill fish (see note 5). Therefore, to comply with spillage restrictions, operators must send water through
the turbines into a system that has no demand for the resulting electricity.
The BPA owns about 21,000 megawatts (MW) of mostly hydro resources. In its role as the electric system operator
of the Federal Columbia River Power System, BPA must balance electric supply with demand. This large resource
presents BPA with a dilemma: should it continue to purchase wind power when significant amounts of cheap
hydropower are available on its own system? To address the oversupply, BPA has developed an environmental
"redispatch protocol" under which it can curtail thermal and wind generation when regulations limit how much
water it can spill. However, BPA first reduces coal-fired generation before it curtails gas-fired and wind generation.
The situation has become contentious because wind generators earn PTCs and RECs only when their turbines are
spinning. With practically no variable costs, wind generators could generate electricity even under negative pricing
because the combined value of the REC/PTC benefits make it economical to do so (PTCs alone currently average
about $22 per megawatt-hour [MWh]). These economic disincentives for wind project operators to curtail
production result in negative pricing excursions (see note 6). In fact, in anticipation of an oversupply situation,
incidents of negative off-peak prices have increased in frequency and magnitude. Therefore, wind generators need to
be paid to shut down production. When snowpack runoff began in earnest, BPA sold the surplus at negative prices
to induce wind generators to back down as more water ran through BPA generators. However, BPA in short order
decided that its mission does not include giving effect to the Internal Revenue Code's PTC provisions and curtailed
wind generators with no compensation. It has provided replacement power to the system at $0 per MWh, but will
not sell at negative prices.
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Thermal And Wind Curtailment On The BPA System
• Hydrogeneration • \l'v1tld generation • Thermal generation
(Gigawatts)
18
16
14
12
10
8
6
4
2
0 12:00 0:00 12:00 0:00 12:00
May 27, 2011 May 28, 2011 May 29, 2011
0:00 12:00
May 30, 2011
0:00
Source: Energy Information Adnini:stration, based on Bonneville Power Administration data.
Cl S1andard & Poo,'s 2011.
Of Water, Wind, And Wires: Credit Implications Of Renewable Energy For The Pacific Northwest Power Markets
transmission operators to treat power from other generators the same way they would treat their own power.
BPA transfers generation in excess of its system demand to neighboring regions as off-system sales. Wind generators
have also argued that the protocol dispatches BPA's hydrogeneration ahead of nonfederal wind and thermal
generation without compensation during periods of surplus energy. In doing so, they argue, BPA lowers its costs by
protecting the value of its nonfirm excess generation at the expense of nonfederal generation.
Not so, counter hydropower customers. They argue that instead of lower wholesale spot market prices, the focus
should be on the high fixed capital costs of wind energy, which operators also have to recover from ratepayers. They
argue that wind power is being built not to serve the region's anticipated needs, but rather to export RECs to
California. Moreover, they claim that the "dumping" of excess variable generation on the Northwest system results
in greater cycling of the system's resources and higher costs for maintaining the system's reliability.
Because of the large number of legal issues raised in the complaint, BPA has requested additional time to respond.
The FERC has extended the response date to July 19, 2011.
A Transmission Buildout Should Allow More Wind On The System
Developing renewable energy in the Northwest for export in the absence of new transmission capacity also depresses
wholesale electric market prices. This happens since either the energy associated with the renewable generation
facility is dumped in the Northwest market or it displaces energy from thermal generation units that would
otherwise have been exported, causing that energy to remain in the Northwest market. Thus, it will take additional
transmission to allow more variable wind capacity on the system, in our opinion.
Some of the buildout is already underway. BPA has identified and proposed two transmission line upgrades, one
each in Washington and Montana. These are the Northern lntertie Reinforcements, which would increase BPA' s
interconnection with Canada, and the Colstrip upgrade project, which will increase interconnections between
eastern Washington and Montana. Together with four new high-voltage lines (see table 2) already under
construction or under National Environmental Policy Act review, these upgrades could deliver more than 3,200
MW of additional energy by 2015 (see note 7).
Table 2
High Voltage Overlays On The BPA System
Cost (mil.
Miles Substations $) Current status Energization
1-5 Corridor 500 kV project 70 500 kV at Castle Rock. Wash. and 342 NEPA review Oct. 2015 Troutdale, Ore.
McNary-John Day 500 kV line 79 175 Under construction Feb. 2012
Big Eddy-Knight 500 kV line 28 500 kV Knight sub-station 115 NEPA review Feb. 2013
Central Ferry-Lower Monumental 500 40 99 NEPA review July 2013 kV line
kV--Kilovolt. NEPA-- National Environmental Policy Act.
The completion of these projects will allow BPA to provide transmission service to wind projects throughout
Montana and not cause congestion in high wind development corridors. At this point, most wind projects are
concentrated in the Columbia Gorge and nearby regions. More geographical diversity makes electrical load
balancing easier. Also, as a short-term measure, BPA is allowing wind generators to supply their own balancing
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Of Water, Wind, And Wires: Credit Implications Of Renewable Energy For The Pacific Northwest Power Markets
reserves. Iberdrola Renewables, TransAlta Corp., and Grant County Public Utility District have responded to the
pilot program and have reduced BPA's required reserves by 300 MW through 2013.
The Credit Impact On Market Participants
Historically, subject to transmission constraints, BPA has transferred excess generation above its system's demand to
neighboring regions as off-system sales. Public power utilities (see note 8) buy hydrogeneration from BPA at fixed
low rates, and then receive credits paid from off-system revenues when BPA sells the excess power. As wind
generation increases, BPA's nonfirm power sales decline, resulting in higher costs for these public power entities.
Given that lower prices also result from adding generation that may not be dedicated to serving the native
Northwest electrical load, it's no surprise that public power interests are concerned about protecting the value of
hydrogeneration. On the flip side, lower market prices benefit utilities that have native load obligations but have a
net short generation position and must buy power from the wholesale market.
Because water is also a variable resource, owners of large, dispatchable thermal (i.e., coal- and gas-fired) resources
get hurt the most by increasing variable generation. Hydro-rich utilities aggressively market surplus hydropower
during high runoff periods by offering power at low prices, making it attractive for thermal plant operators to
curtail operation to save fuel costs and substitute hydropower to serve their loads. PPL Montana LLC is a good
example to assess the impact of the excess energy event as its generation gets equally split between coal/gas ( Colstrip
units 1-4 and Corette) units and 11 hydro assets. We estimate that in 2011 through May, PPL Montana's coal-fired
production is down one-third compared with 2010 generation. Despite an estimated 25% increase in production
from the hydro assets, we estimate that gross margins would have been down by one-third in 2011 compared with
2010 if the project had sold generation in the spot power market. PPL Montana has a practice of hedging its
economic generation on a rolling basis in the forward market and is heavily hedged through 2013.
On a separate, yet related point, wind capacity cannot be counted in plans for peak loads. This is because wind
requires additional resources to balance its variable output (called firming). The downward pressure on market
power prices can discourage the development of such ancillary gas-fired and coal generation units, necessary not just
to maintain reliability but also to provide firming services for intermittent wind energy resources.
An Issue Of Efficiency And Equity
The combination of water and wind resources and the lack of wires has proffered unintended results. The issue of
excess energy events can be separated into questions of efficiency (i.e., the lowest-cost method of achieving an
outcome) and questions of equity (i.e., the fairest way to achieve the outcome). On the issue of efficiency, the extent
of additional Northwest wind power development to serve the California RPS will depend on the Northwest's and
California's evolving RPS policy. To remedy the problem, industry experts suggest that RPS provisions could include
energy efficiency as a qualifying resource. Similarly, current California RPS policy that only requires the equivalent
of REC-associated energy to be imported within the calendar year provides little incentive for California utilities to
support expanding transmission line capacity. Perhaps policies requiring the transfer of associated energy as it is
produced would provide an incentive to expand transmission intertie capacity.
Also, significant changes to any economic system raise equity issues. This may require solutions such as crediting
substitute hydropower as an RPS and PTC qualifying resource for curtailed wind generation. Other, shorter-term
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Of Water, Wind, And Wires: Credit Implications Of Renewable Energy For The Pacific Northwest Power Markets
market-based solutions that industry participants have suggested include region-wide displacement auctions whereby
the system offers to pay auction-determined prices to wind generators for shutting down ahead of expected surplus
energy periods. BPA could also, some industry experts say, establish a volumetric charge applied to all generators
that contribute to surplus energy events to recover negative wholesale prices paid to customers to bring supply and
demand into balance.
Notes
(1) Runoff: That portion of the precipitation that flows over the land surface and ultimately reaches streams to
complete the water cycle. Important sources are melting snow and surface water that move to streams or rivers
through any given area of a drainage basin.
(2) RPS mandates: California, 33% by 2020; Montana, 15% by 2015; Oregon, 25% by 2025; and Washington,
15% by 2020.
(3) RECs can be transacted as a) fully bundled: delivered with the associated energy; b) partially bundled: the
associated energy can be delivered within a specified time; or c) fully unbundled: marketed separately from the
associated energy.
(4) Owners of projects completed in 2009 and 2010, or under construction as of the end of 2010, are reported to
have taken the option of converting to the federal business energy investment tax credit or U.S. Treasury grant as
provided in the American Recovery and Reinvestment Act of 2009. Moreover, not all renewable energy projects
receive the PTC. The amount of credit varies by type of resource and has a limited life.
( 5) A disease similar to II the bends. 11
( 6) Although the increased frequency of zero or negative price episodes corresponds with the rapid growth in
Northwest wind capacity, other factors are also at play, including runoff patterns, and declining loads due to the . . economic recession.
(7) After the $600 million Hemingway-Boardman 500 kV line project sponsored by Idaho Power these four are the
largest transmission projects in the ColumbiaGrid 10-year plan through 2021.
( 8) While all of BPA' s customers benefit from robust water years, it is principally its II slice-of-the-system II customers
that reap this benefit. The II slice II customers also take on the risk of dry years with low sales.
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The McGrow·Hi/1 Companies I-