The U.S. uses very little oil to generate electricity, but our energy sectors are inextricably connected , so changes in one often affects others. For example, we are starting to see the rumblings of how the price of oil might affect wind indirectly through natural gas prices.
On Thursday, July 26, 2018 the Public Utility Commission of Texas (PUCT) dealt what turned out to be the final blow (see video Item 4) to the Wind Catcher Wind Project, which, had it been built, would have been the biggest (2,000 MW) wind farm in the U.S. Shortly after Texas said no, the main backers pulled the plug on the project altogether.
The levelized cost of Wind Catcher was estimated to be below $19/MWh. That is very, very low.
Texas regulators ultimately turned down the project partly because of a perceived lack of direct benefits to Texas ratepayers for an Oklahoma wind farm with a dedicated power line servicing Tulsa. Much of the discussion at the PUCT, however, revolved around the underlying natural gas prices in the project proponent’s economic model, which raises an interesting point about the future of wind project economics in a low-cost natural gas world.
Wind farms receive payments from two different sources, the Production Tax Credit (PTC) and contracted Power Purchase Agreements, or PPAs. The PTC provides wind farm owners, or their equity partners, a tax credit for every megawatt-hour of electricity they produce. Most wind PPAs are virtual, in which a third party, usually a utility or corporate customer, guarantees the project owner a certain price for the energy they produce. This PPA price is then compared to wholesale electricity market prices at a certain point in the grid, often a hub, as specified through a “contract for differences.”
If the price at the set location is higher than the PPA price, the wind farm owner pays the difference to the PPA holder. For example, if the PPA price is $25/MWh and the hub price $30/MWh, the wind farm owner would pay the PPA holder $5/MWh. However, if the hub price was $22/MWh, the PPA holder must pay the wind farm owner $3/MWh. Thus, the PPA is a financial vehicle that both reduces the upside and risk for the wind farm developer, depending on electricity prices.
Having a PPA in place is usually a requirement for lenders to invest in a wind project. But Wind Catcher was different from the start – project proponents were asking for permission to rate base the project, i.e., add the cost and some profit directly to customers’ bills. In this scenario, project owners – a utilities that serve Oklahoma, Texas, Arkansas, and Louisiana – a needed to prove that their wind farm would offset the increased rate based cost by sufficiently lowering overall electricity costs.
Proponents argued that rate basing the project offered $685 million dollars in additional benefits over a PPA strategy, partly because the dedicated transmission line would allow the project to avoid congestion in the existing transmission system. Commissions in Oklahoma, Arkansas, and Louisiana approved the deal, but it was not enough for Texas regulators to get on board.
A significant part of the Texas discussion focused on the underlying natural gas prices in the proponents’ economic model. To make their case, they used the Reference Case from Energy Information Administration’s 2016 Annual Energy Outlook.
Natural gas price assumptions are important because natural gas prices are the main drivers of wholesale electricity prices. The 2016 EIA Reference case forecast has gas increasing to about $5/MMBTU in 2025 and flatlining thereafter. This roughly corresponds to electricity prices increasing to $43/MWh. In this case, lower marginal cost wind power, like Wind Catcher, would clearly provide benefits to the system.
However, if gas prices are lower, wind can have a harder time competing because, given the way the Texas market is structured, PPA prices must compete with the average marginal generator in the wholesale market when wind is online. The lower gas prices are, the tighter that competition gets because the marginal generator is often a natural gas plant burning cheap gas.
The 2018 EIA Reference case has gas prices below $5/MMBTU all the way out to 2050, and the High Oil and Gas Resource scenario flatlines at about $3. Sustained natural gas prices this low would keep electricity prices between $25-40/MWh, long-term. (For reference, ERCOT average annual electricity prices have fluctuated between $21-36/MWh since 2012.)
Once the PTC expires, wind developers will have to capture all of their costs through either the market, or their PPAs. If Wind Catcher, which was already a historically-cheap source of electricity, was to deliver power at $19/MWh, including the PTC ($22/MWh) and subtracting transmission costs (assumed $5/MWh, levelized), puts their full costs at roughly around $36/MWh.
A PPA at $36/MWh is going to be a tough sell to anyone in this market. A 12-year PPA signed in 2020 will likely have to compete with, on average, $32/MWh electricity prices or lower over its lifetime, assuming the 2018 EIA Reference case price of natural gas holds true – or even less if something closer to the High Oil and Gas Resource scenario prevails.
So what does oil have to do with all this? Actual natural gas prices have been lower than the EIA Reference cases. In fact, they have been closer to the High Oil and Gas Resource scenarios, partly due to increased efficiency and must-drill contracts. But high production also is being driven by increased tight oil associated with gas production – natural gas that is a by-product from oil wells. This has become a significant driver of low natural gas prices.
Tight oil production is booming, particularly in Texas. As a result, the associated gas production is depressing prices below the break-even point of some dry gas producers. However, the oil drillers economics’ are based on oil production, so their break-even costs of gas could be very low, or even negative.
Beyond the Wind Catcher project, what does this mean for future wind farms? Post PTC, the economics of wind might start to get tough, and cheap gas isn’t helping. Meanwhile, reduced oil project investment could keep oil prices relatively high, which will only keep the cheap gas flowing.
Solar might be less affected by low gas prices. Solar prices have been falling faster than wind and solar also has the benefit of producing electricity closer to higher peak price times. However, some locations with high concentrations of solar, like California, are experiencing solar-driven wholesale electricity market price depression.
For this dynamic to change, either capital costs for wind will need to fall, the price of natural gas needs to increase, the PTC will need to be extended, or a combination of cheap batteries and retirements must add flexibility and room in the markets. Also, a CO2 price of about $25/ton would bring non-PTC wind back within striking distance of current market prices. The wind industry is far from dead, but some gas-heavy grids, like Texas, could become more challenging.
[rest of article available at source]
Joshua D. Rhodes, PhD is a Research Fellow at the Energy Institute and the Webber Energy Group at the University of Texas at Austin.