This commentary originally appeared in Real Clear Energy on August 4, 2016.
The International Energy Agency (IEA) recently released a report agreeing with the renewable industries’ dual claim that even though technologies like wind and solar power are now cost-competitive with conventional energy sources, governments should continue to subsidize them. This rhetoric suggests that American taxpayer dollars should continue to prop up the profitability of select companies compared with what the free market would objectively and more efficiently determine.
In other words, the IEA implicitly confirms that by removing government support, many renewable energy companies would collapse like a house of cards because they aren’t competitive without it. Further, the report concludes that without government subsidies for renewable companies, investors would not be comfortable investing private capital.
Why then would the U.S. government want America to put all of her eggs in a renewables basket? Warren Buffet, billionaire and major investor in wind energy, has admitted that wind isn’t all that it’s cracked up to be. “The only reason to build them [wind farms]” is the subsidies; “They don’t make sense without” them.
Assertions that renewables are not a profitable investment without taxpayer dollars are based on the industry’s cost structure. Since the bulk of the costs for renewable projects are fixed, the profitability of new projects are dependent on current and future fiscal and regulatory environment.
The IEA report confirms that renewable energy technologies depend more on government action than fossil-fuel based investments. Unlike renewables, coal and natural gas producers can respond to market signals by adjusting their output and operating costs.
Texas is at the center of this debate over preserving renewable subsidies because the state leads the nation with 18.2 GW of combined installed wind and solar capacity. The Texas Renewable Portfolio Standard’s (RPS) goal of reaching 10,000 MW by 2025 was met in 2010, 15 years ahead of schedule. The Texas Legislature now faces a dilemma of whether to increase the costly RPS after long meeting its goal.
Renewable supporters’ strong resistance to Senate Bill 931 in 2015 suggests that the industry is well aware that subsidies are necessary to be competitive. This bill would have eliminated the Texas RPS and make the purchase of renewable energy credits by utilities voluntary. This would promote a return to a more market-oriented approach to renewable energy production rather than one mandated by government. Unfortunately, the bill eventually died in the Texas House.
Since the RPS was not increased or made voluntary, renewable energy credits for new projects have become even more scarce than they were during the boom of projects in the early 2000s. Despite this, Texas has reached 16 GW of installed wind capacity since the boom and now produces roughly 20 percent of the nation’s wind-powered electricity generation.
Given the scarcity of renewable energy credits, how did Texas renewables achieve this growth?
According to the IEA, about one-third of the 4.8 GW of wind power installed in Texas in 2014 was financed using “synthetic power purchase agreements,” also known as hedges. Under these agreements, the power producer sells its electricity directly into the wholesale spot market and receives the prevailing market price. To compensate for the unpredictability of market prices, however, the power producer signs a contract for a financial product known as a “hedge” to provide protection against volatility and increase the stability of future cash flows.
These agreements effectively enable project developers, in combination with federal tax incentives, to secure debt and equity financing required to finance their projects.* Extensive, unregulated use of hedging was blamed for the 2008 financial crisis, though government was also to blame for creating the financial market boom that would eventually bust. Given the incentives in place, financial companies purchased vast insurance against risky markets that ultimately collapsed, followed by the government bailing out many financial firms and over-regulating them through Dodd-Frank.
Regarding renewables, producers are hedging their bets on production with synthetic power purchase agreements to ensure profitability despite receiving government subsidies. All this to finance energy that cannot be produced when it’s not windy or sunny outside.
As with the financial sector, renewables have had a boom led by government intervention and hedging that may ultimately bust as markets can’t efficiently work. This would not only threaten the reliability and price of electricity, but it would also come at the expense of taxpayers. Further, the IEA’s assertion to subsidize renewables to keep them cost-competitive makes the strongest possible statement against subsidizing them.
It’s time for Texas to take a closer look at the effect of increasing renewable generation and steer the competitive electricity market away from growing subsidies for unreliable energy sources. Once Texas, the nation’s leading energy producer, starts to move the dial, other states and the federal government should follow to allow free markets to work instead of contributing to a boom and bust cycle.
Ph.D. Economist at the Texas Public Policy Foundation. Blog posts are publications by the author.