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To evaluate this proposal, four questions need to be addressed: Is the proposal workable? What is its relationship to proposed renewable portfolio standards? Is the proposal a cost-effective way to encourage the growth of green power? What would be the consequences of failure?
The last question merits emphasis. Policy initiatives by definition break new ground, and in most cases their success depends on the not entirely predictable reaction of affected parties. Complete success rarely is assured, and failure is almost always a possibility. All these things are true of the green power price insurance proposal. As discussed below, a major attraction of the proposal is that it offers a strong possibility of encouraging the growth of green power in a highly cost-effective way. However, a further attraction is that its cost to the federal government and the participating states is closely linked to its success. A failure or limited success would be disappointing, but would be unlikely to cost very much.
QUESTION 1: IS THE PROPOSAL WORKABLE?
The insurance program has two important technical require-ments. First, there must be a means to measure changes in the wholesale green premium that is verifiable and that adequately captures the price risk borne by green power mar-keters. Second, the required insurance coverage must not be dissipated on generating capacity that would have been built without the insurance.
Green power price insurance depends on measuring changes in the wholesale green premium. It therefore depends on measuring the wholesale prices of green and conventional power. One alternative for measuring prices would be to use published spot market prices. Such prices exist for conventional power, and the Automatic Power Exchange (APX) now offers spot prices for California green power. APX currently is expanding its operations to other states and also plans to provide separate price quotations for different renewable energy technologies.
Published spot prices offer the advantages of objectivity and public accessibility. There are two questions. First, will the prices continue to be available? The answer is very probably yes. A green power spot market performs a useful role in reducing transaction costs and price risks. In one form or another, it is likely to continue. The second and more difficult question is, would changes in the spread between spot market prices of conventional and green power adequately capture the price risk borne by green power marketers? This question ultimately can be answered only by the marketers themselves, and the answer may not be the same for every green power market. The green power market may be disaggregated by geography, technology, and consumer preference.27 Changes in published spot prices might adequately represent the price risk in some markets but not in others.28
Where published spot prices do not adequately capture the risk, either some alternative must be found or the price risk in those markets will be effectively uninsurable. Probably the strongest assurance that an alternative will be found for major markets is that without its resolution, the insurance companies would have no product to sell.29 There may be a greater risk that no satisfactory alternative would be developed for some smaller markets.
The Energy Information Agency projects that 1240 megawatts of green generating capacity will be added between 2000 and 2005 under existing policies.30 Insuring this “build-anyway” capacity would add nothing to the supply of green power.
The issue is not, it should be emphasized, whether the companies should be permitted to insure capacity that might be built without the insurance. Clearly they should. The issue is whether insuring that capacity should satisfy the companies’ obligations under their bargain with the federal and state governments. Ideally, the answer would simply be “no.” To make that answer completely effective, however, would require precisely identifying the build-anyway capacity. That is not a realistic possibility. A more realistic goal is to identify it with sufficient accuracy that insuring it does not satisfy a large share of the insurance companies’ obligation.
A major step toward that goal would be to exclude capacity built in response to state or federal mandates. This is capacity from which a utility is required to purchase power, or will at least be permitted to recover the cost of the power through its general rates. Such capacity is projected to make up most of the green generating capacity built under existing policies.31
Additional “build-anyway” projects can be excluded by the premium that is charged for the green power price insurance. Almost by definition, build-anyway capacity would generally be the least risky capacity. For the problem at hand, this fact is a two-edged sword. It means that the capacity would be the most attractive market for the insurance companies, since its relatively low risk reduces the likelihood that they would be required to dip into their own capital to meet claims. But it also means that the projects’ developers are likely to see less need for the insurance. A realistic premium thus would tend to exclude projects that have little need for the insurance. It is of course not certain at this point what a realistic insurance premium would be. As noted earlier, that is one of the reasons that government support is needed. The practical point to be made, therefore, is that in the negotiations with insurance companies, the federal and state governments should be at least as concerned with not setting the insurance premium too low as with not setting it too high.32
Even with exclusion of mandated projects and a realistic insurance premium, some part of the insurance companies’ obligations may be satisfied by build-anyway capacity. But the part satisfied in this way is unlikely to be large enough to affect the conclusion that the price insurance is a cost-effective way to encourage the development of green power.33
The green power price insurance proposal rests on assumptions regarding the actions of the firms and individuals involved in the green power market:
These assumptions are supported by the process the has shaped the proposal. That process has involved a year of discussions with representatives of the companies that would be directly or indirectly interested in the insurance. In those discussions, a number of companies have stated a strong interest in participating by offering insurance or buying it.34
Those expressions of interest do not guarantee that insurance companies will sign on to a specific proposal, or that marketers will buy the policies that the companies offer. Companies on both sides will, as one party put it, have to “crunch the numbers.” What the discussions and expressions of interest do indicate is that the proposal is realistically grounded in the industries that it would affect.
QUESTION 2: WHAT IS THE PROPOSAL’S RELATIONSHIP TO RENEWABLE PORTFOLIO STANDARDS?
A renewable portfolio standard (RPS) requires that a certain percentage of the power sold in a jurisdiction be generated by renewable sources, or by some specified set of such sources. Standards setting various percentages and applying to various kinds of renewable energy have been adopted by six states,35 although in all cases with an effective date set some time in the future. An RPS also is included in some, but not all, proposed federal electric restructuring legislation.
By themselves, these portfolio standards have two significant limitations. One is their coverage. The existing standards cover only a few states, and where they do exist, they do not cover all renewable technologies. A federal RPS would have broader coverage, but there is no assurance that federal restructuring legislation will be adopted or, if it is adopted, that it will include an RPS.
The second limitation is that an RPS is directed only at the demand side of the market. It establishes a demand for green power. It does not do anything to bring forth the supply of green power needed to meet that demand at a reasonable cost.
This problem may be aggravated by the discontinuous nature of the demand created by an RPS. Immediately before an RPS goes into effect, demand for green power rests on consumer preferences; it then rises immediately to the level established by the RPS.
Green power price insurance would tend to compensate for these limitations. It would be available for all renewable technologies and at least in all major markets. It is designed to reduce the cost of green power, and it should add continuously to the growth of green power over at least the five years that the insurance companies would be required to offer the insurance.36
QUESTION 3: IS THE PROPOSAL COST EFFECTIVE?
The cost effectiveness of the proposal can be measured by comparing the additional amount of green power likely to be generated with the amount of federal and state funds expended. It is assumed here that least 1,000 MW of green generating capacity would be insured and that 310 megawatts of that is build-anyway capacity. On these assumptions, the program would result in the construction of 690 MW of additional green generating capacity. At a projected 55% load factor, that additional capacity would generate 67 billion kilowatt- hours of green power over a 20-year period — green power that would not have been produced without the insurance . (The load factor is calculated from projected capacity and power production in documents supporting this proposal, posted at http://www.realliance.org/insurance/>; other assumptions and their bases are set out in Appendix C.)
As discussed earlier, it is assumed $5–10 million of the $50 million contribution of the federal and state governments is paid to the insurance companies as a fee and that the remaining $40–45 million is held by the insurance companies to meet insurance claims in excess of premiums. All of the latter amount would be refunded to the federal and state governments if claims could be satisfied from the premiums on the insurance. The total long-run cost of the program to the federal and state governments thus would be between $5 million and $50 million. At the upper end of this range, the cost would be equal to less than 0.1¢ for each additional kilowatt-hour of green power generated as a result of the program; at the lower end, it would be equal to less than 0.01¢ per kilowatt hour.37
These amounts are small because federal and state funds would cover only a small part of the cost of the green power. Most of the cost — perhaps 99 % — would be borne by consumers who wished to purchase green power and were willing to pay a premium price for it. The federal and state contribution is critical; without it, there probably would be no insurance until some unknown future time, and without the insurance, much of the capacity probably would not be built. But its role is that of a catalyst, not a major source of funds.
As already noted, the amount of in-state green power capacity preferentially insured would be proportional to a state’s share of the total commitment. The above calculation of the overall ratio of benefits to costs therefore would be approximately applicable to each participating state.38
There are, in addition, two arguments for the proposal’s cost effectiveness that are relevant to the participating states in particular. The first is that the program would permit a state to achieve economies of scale in developing the insurance that it could not achieve on its own. The second reason relates to the system benefits charge — a charge levied on all electric sales by some states that are unbundling their retail electric markets.
The system benefits charge is used to fund activities that previously were supported through utility regulation. In some cases, those activities include discounted rates for poor customers and funding for energy conservation programs. They also can include promoting renewable energy.
The system benefits charge therefore poses the question of cost effectiveness in a concrete form: How can the state achieve the largest impact on renewable energy with the funds that the charge generates for that purpose? Under that criterion, participation in the price insurance program should rank at or near the top of the list of alternatives available to a state.
QUESTION 4: WHAT WOULD BE THE CONSEQUENCES OF FAILURE?
The proposal might fail in various ways. Most obviously, it might fail because little or no capacity was insured. This might occur because insurance companies declined to participate in the program, or because marketers declined to purchase the insurance that was offered. In either case, under the terms of the proposal discussed here, the contribution of the federal and state governments would be reduced accordingly.
There also is another kind of potential, “invisible” failure. In this case, insurance companies participate and marketers buy their insurance. The federal and state governments therefore make their agreed contribution. Despite this activity, however, the proposal, in fact, accomplishes nothing. Companies would have offered similar insurance without the government support, or the capacity that was insured would have been built without the insurance. The proposal in fact would have accomplished nothing.
This kind of invisible failure is the downside of the proposal because it involves the contribution of federal and state funds in return for nothing. It is unlikely to occur, however. Insurance companies have said that they would not offer the green power price insurance at this time without some government support. They give plausible reasons for that position. However, the strongest reason for accepting the companies’ statements is that to reject them would imply that the companies are acting collusively to stay out of a profitable market in order to obtain government support under a program that has not yet been adopted — a far-fetched supposition.
On the other hand, it is likely that insurance companies would satisfy some part of their obligations by insuring capacity that would have been built without the insurance. The question is whether so much of their obligation would be satisfied in this way that the proposal would have to be counted a failure. As discussed earlier, that seems unlikely if mandated capacity is excluded and a reasonable premium is charged.
The proposed price insurance might not reach all its goals. If it fails, however, this is unlikely to be costly to the participating governments. And the risk of failure is outweighed by the potential for creating an institutional basis for consumer-driven expansion of the green power market.
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