Jan

13

PREVIOUS PARTS

Google Part 1: Framework (January 2, 2014).

Google Part 2: Google Goes Underwater (January 5, 2014).

INTRODUCTION

I apologize. I realize an additional discussion is needed. Without understanding renewable energy, Google’s strategy may be difficult to understand. Unfortunately, renewable energy has acquired baggage in the media, some of which is undeserved. Nevertheless, that baggage clouds objective discussions about energy, environment and policy.

This part may disabuse some of their preconceived notions about renewable energy. It will describe markets few know exist. What may disrupt many is the prime mover is not the federal government.

Most renewable energy connects into the nation’s infrastructure at the distribution level. It is intrastate commerce. As such, most renewable energy is not regulated by the federal government. It is regulated by individual states.

STATE MARKETS

Each state developed unique programs to create, market, and consume renewable energy. No two states have the same program. A renewable energy program in one state may be slightly different from a renewable energy program in a nearby state. In addition, states are reluctant to share renewable resources with one another.

While this may sound odd, most states’ objective is to force their constituents to consume renewable energy certificates. The consumer is generally unaware because most of the process is hidden, but not secret. The state’s energy service providers, not the consumer are the principals who are responsible to assure consumers receive and consume certificates. Motivating energy service providers (load serving entities or local distribution companies) are financial penalties should they fail to deliver enough certificates.

Some may wonder why states focus on certificates, not renewable energy. It turns out, states are interested in renewable energy per se, they are primarily interested in native-born renewable energy. Certificates are evidence that renewable energy consumed by state’s consumers was produced within the state.

In the future, this focus may change. However, there are practical reasons why states have a parochial view of renewable energy. One is jobs. They want new jobs associated with a state’s renewable energy program to remain within the state.

While jobs are important, states’ biggest driver is a concern over their natural capital. States are finding what was once plentiful is now in short supply.

Natural capital is air, land and water. For decades, states limited access to their natural capital through the permitting process. If a new business needs to dump their emissions into the water or air, they need a permit. If they need to dispose of waste products, they need a permit.

Up until recent times, permits were relatively easy to acquire. Governments, companies and individuals saw natural capital as a free economic good.

As populations and economies expanded, states’ natural capital became depleted. Concerned about oversaturating their native environment, states were forced to limit new permits. They found too much pollution was bad for their constituents, their politics and their economies.

In addition, constituents became more informed about chemicals in the air, land and water. As they learned more, they became more concerned. In addition, as medical technologies advanced, the connections between chemical exposures and health outcomes became better understood.

States can no longer issue new permits in or near counties that exceed health standards. They cannot issue permits in or near counties that are nearing those limits. States should not want to issue new permits that will cause neighboring states to incur liabilities.

There is a good reason why states should be concerned about neighbors. Encroached states have and will sue other states. One such case is currently pending at the Supreme Court (http://tinyurl.com/l3wxx8k). This issue is about cross-border pollution. Specifically, the air in some states may meet environmental standards. However, pollutants from their power plants and refineries drift across state lines, preventing neighboring states from meeting their obligations.

No matter how the Court decides, states’ problems will persist. While they have a wide range of options, most will use a smart combination of renewable energy and the newly formed power markets. That combination will automatically displace some of the state’s bad actors.

CORRELATION EVERYWHERE

Here is how it works. It turns out; everything appears correlated. The most polluting sources of energy are typically the most inefficient sources. Inefficient facilities are gas-guzzlers; they require large amounts of fuel to produce small amounts of power. That combination causes them to be technically and economically inefficient. They become economically inefficient because they consume large amounts of fuel to produce small amounts of power. If they consume large amounts of fuel to produce small amounts of power, they must also generate more pollution per unit of energy.

The numbers are huge. In fact, a typical power plant’s primary product is waste. Its secondary product is energy. Incredibly, modern coal and nuclear plants waste 70 to 75 percent of the fuel they use to produce electricity. These are considered the nation’s most efficient plants. Older coal and gas plants can waste up to 90 percent. That difference has to go somewhere. A lot is lost to waste heat. In the case of coal and natural gas, a lot is physical waste. Most of that physical waste consumes the state’s natural capital.

Pollution and efficiency are correlated. Environmentally inefficient plants have high production costs. Therefore, another correlation appears. Environmentally efficient plants tend to be cost leaders. Cost leaders always win in the nation’s power markets.

Many confuse production costs with levelized costs. Levelized costs were important in the old scheme, where utility assets were regulated. Power markets do not care about capital, overhead or other fixed costs. All they care about is the direct costs needed to produce the product, or the unit’s production costs.

This may help explain why investors are interested in renewable energy assets. Renewable energy is a clean source of power and it has very low production costs. In fact, the production cost to produce power from a solar panel or a wind turbine is near zero. That means renewable energy’s gross margins are the highest in the market.

Here is a trick that investors, policymakers and consumers love. Whenever a wind plant or a solar panel produces power, it will always become the market’s cost leader. As cost leaders, solar and wind power will always displace the most expensive producer. As mentioned discussed, the most expensive producer is usually the market’s most polluting producer. Consequently, when dispatched, renewable energy not only reduces market-clearing prices, it reduces pollution at the same time.

Think about this from point of view of the state. If the state offers investors incentives, the state and its constituents will see immediate returns. Those incentives will cause the power market to deliver lower wholesale energy costs. The market will sideline the worst actors in the market, giving the state cleaner air, water and land. The state should see increased economic activity. The state should have happier and healthier constituents. The state will also avoid costly lawsuits from neighboring states.

In fact, the net costs of the state’s renewable energy credits could be zero. It could even be negative. One point is certain; the net cost of renewable energy certificates has been overblown.

As more states think about the possibilities, they are more likely to consider options that include renewable energy. However, each state has unique needs and requirements.

The nation is in the early phases of renewable energy. Huge amounts are already planned. Because the programs are young, it is not a surprise each state might take a slightly different approach. Nevertheless, most states have been using a common feature of renewable energy certificates.

Renewable energy certificates are fungible derivatives of various sources of renewable energy. One big difference between states is their portfolio. Some states prefer more wind. Others prefer other renewable sources. Many really prefer solar.

SPECIAL CASE: SOLAR POWER

Some states carve out special certificates. A favorite for 16 states and the District is a special carve out is for solar power (other states offer additional incentives). These certificates are commonly called solar renewable energy credits, or SRECs.

There is a practical reason why states prefer solar. It is about another correlation. It turns out a state’s economic activity is roughly correlated to the sun’s position. As the sun rises and sets, the state’s economic activity rises and sets. As economic activity increases, so does demand for power. Since the sun’s position is directly correlated to solar power production, solar power production is naturally correlated to daily demand curves, making solar a natural peaking asset.

Historically, peaking generators are the least efficient power plants in the fleet. While their capital costs are low, their production costs are high. When dispatched, they set [high] market-clearing prices. They are also the nastiest units when it comes to environmental impact.

If solar is naturally correlated to the grid’s need to dispatch peaking units, solar ends up displacing the dirtiest of plants. Solar also displaces the most costly of plants. Thus, solar power shaves off market-clearing prices while it cleans the air. As wholesale market clearing prices drop, so do consumers’ retail prices for electricity.

When it comes to solar, it seems everything is correlated. The state wins. The economy wins. Consumers win. The environment wins. Taxpayers win. That is the point of view of states. It is an important point of view because they, not the federal government, control the playing field.

Of course, there are losers. Solar has a significant impact on oil, coal, nuclear and natural gas units. By shaving of market-clearing prices, solar reduces gross margins for all market participants. For the marginal generators, solar removes revenues.

FEDERAL ROLE

There are no federal programs, which create, manage or regulate renewable energy certificates (credits or tags). There have been Congressional attempts to create a national standard. There have been Congressional attempts to create a national product. However, all attempts failed.

What did not fail was Congress’ desire for federal facilities to mimic state programs. Under Section 203 of the Energy Policy Act of 2005 (42 USC 15852), Congress requires federal agencies to use renewable energy as part of their supply of electricity. Each year, the Act ( http://tinyurl.com/7r3l3ct) increased the amount of renewable energy needed by federal agencies until fiscal year 2013. At that point, most agencies were required by statute to use a minimum of 7.5 percent renewable energy. On average, the executive branch met the mandate on time.

At this point, the federal program could seem a little confusing. If no national renewable energy credits exist, if no national standards exist and all states offer different programs, how does the federal government buy renewable energy? The answer is they do it badly.

Good or bad, the federal government is in a pickle. Federal agencies, including the Department of Defense, are reluctant to transgress on states’ environmental policies. As such, most agencies will go to great lengths to avoid adding new pollutants to states’ air, land and water resources.

On a macro basis, it appears the nation is using up natural capital. As populations and economies expand, there is less room for new pollution sources. If the federal government or any other outsider pollutes a host state, arguments will flow. It is about money. It is about local economies. It is about states’ rights.

NEXT: GOOGLE FIGURES IT OUT

Google understands the big picture and regional pictures. Their energy strategy is about energy markets and infrastructure. However, their primary focus is connecting their use of energy use with company infrastructure.

As will be discussed in the next part, Google will become renewable energy’s biggest winner. While it will take years to complete, Google is quietly building a competitive advantage. Google's competitors may find this advantage difficult to beat. Better, Google is creating a barrier to entry that some competitors cannot overcome.


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