This section discusses the green power market that has begun to develop in states that have unbundled their retail electric market: the firms and individuals that participate in it, the transactions among them, and the price risk associated with the sale of green power. That price risk is the principal obstacle to the construction of new green power generating facilities on the basis of the retail green power market.

Four types of firms and individuals participate directly or indirectly in the green power market:

• Lenders, who typically provide 60–70% of the funds for constructing the green power generating facilities.

• Developers, who build and operate the generating facilities. A developer generally specializes in one renewable energy technology. For example, Enron Wind Corporation specializes in wind; CalEnergy specializes in geothermal.

• Marketers, who purchase power from developers and resell it to consumers as a green power product.

• Consumers, who willingly pay a premium price for green power.

The participants commonly are linked by a chain of transactions. The developer borrows money from the lender and sells power to the marketer. The marketer resells the power to consumers. Variations are possible. A developer might seek equity as well as debt financing and might sell power directly to consumers; one marketer might sell power to another, who might in turn resell the power to consumers. But the structure described here — lender to developer to marketer to consumer — will serve to illustrate the dynamics of price and price risk in the green power market.

The dynamics of price and price risk are heavily influenced by the capital-intensive nature of renewable energy.¹⁴ Its capital intensity means that its cost is significantly affected by the terms on which lenders provide funds.¹⁵ Low-cost power requires a reasonable interest rate and amortization term. To obtain a reasonable rate of interest, the developer must offer firm assurances that principal and interest will be paid.

To obtain a reasonable amortization term, the assurance must extend sufficiently far into the future. Most developers cannot themselves provide that assurance: their assets are too small. Any assurances must principally rest on expectations regarding the price at which the developer can resell its power. Those expectations largely determine the terms on which the developer can borrow money.

Some of the contracts under which developers sold green power to utilities provided the assurances needed for low-cost financing. Under retail unbundling, however, utilities may no longer purchase power. Instead, it would be purchased by power marketers. Green power marketers are unlikely to sign long-term power purchase agreements; even if they did, the assurances of future income nominally given by the agreements would not be credible to lenders.

One reason for green marketers’ presumed reluctance to sign long-term purchase agreements is the nature of the contracts under which they in turn resell power to consumers. The term of the contracts rarely exceeds two years and generally is one year or less. This does not mean that most consumers abandon a marketer in a year or two. A marketer may reasonably expect to retain a consumer for several years on average, and that expectation might in turn support a power purchase agreement term as long as five years. It would not, however, support the 10-year power purchase agreement that is considered necessary in order to obtain financing on reasonable terms.¹⁶

A power purchase agreement of that length must be supported by revenues from new customers. Getting new customers is not the problem; if all else fails, a marketer can resell the power into the conventional power spot market — or the running market for short-term power sales. The problem is getting new customers who will pay a price that permits the marketer to meet its obligations to the developer. Existing customers may stick with a marketer out of loyalty or inertia. To gain new customers, the marketer is likely to be forced to meet the prevailing green power market price. The fundamental risk faced by the marketer is that this market price will decline.

The retail market price for green power can be thought of as having two parts: the retail price of the conventional power with which green power competes, and the retail green premium that some consumers are willing to pay because the power is green. The green power market price might decline because of a decline in either the price of conventional power or the green premium.

There is nothing exceptional about the risk of a decline in the price of conventional power. It is borne by marketers of both conventional and green power. The risk of a decline in the green premium is unique to green power, and it is that risk that would be reduced by green power price insurance.

The risk has two sources. One is uncertainty regarding the future demand for green power. That demand depends on consumer attitudes — the number of customers willing to pay a premium price for green power and the size of the premium they are willing to pay. It also depends on the rules that permit customers to choose between green and conventional power. Neither future attitudes nor future rules are certain.

The other source of risk is the continuing decline in the cost of the renewable energy technologies used to generate green power. In a market that is competitive and expanding, price generally is determined by the cost of the newest facilities.¹⁷ If the cost of green generating facilities declines, the market price of green power will decline as well.

These factors create a price risk for green power that is greater than the one borne by developers and marketers of conventional power. The next section discusses the proposal to use insurance to reduce that risk.

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