CREDIT: <a href="http://flickr.com/photos/dragontomato/1660139542/">Andrew</a> (<a href="http://creativecommons.org/licenses/by-nc-nd/2.0/deed.en">CC</a>).
CREDIT: Andrew (CC).

Policy Innovations Digital Magazine (2006-2016): Innovations: Renewable Energy Hedges

Mar 25, 2008

The pursuit of sustainability in the 21st century will equate economic growth with ecological improvement, not ecological destruction. The ecosphere is humanity's home, not a temporary hotel that we trash with impunity before moving on. Sustainability means equilibrating human conduct with the health and dynamics of the ecosphere, to maintain conditions favorable for life. Humanity's existence and future depend upon it.

The global goal for sustainability is existential security for all. Sustainability cannot be achieved on the backs of the poor. Sustainability cannot be the good life for the rich living in gated and guarded islands amid an ocean of misery, poverty, and degradation. All of us can live sustainable lives. That is, modestly, but well. According to Aristotle, "The greatest crimes are caused by excess and not by necessity. Men do not become tyrants in order that they may not suffer cold."

Sustainability as a social practice is the pursuit of prosperity, ecological well-being, peace, and justice using the tools of democracy and of markets. We must make the market price system send proper signals to producers and consumers. What's sustainable must cost less. What's unsustainable must cost more. New market rules and ecological consumption taxation to replace income taxation can allow the price system to send clear signals to consumers and producers. Decreases in pollution, depletion, and ecological damage must equate with increases in profit, and vice versa.

A variety of simple tools can allow the price system to support sustainable ends. A carbon tax is one increasingly popular example. But carbon and climate change is not the only ecological challenge we face. Habitat destruction, species extinction, deforestation, desertification, depleting aquifers, devastated fisheries, and air, water, and soil pollution all threaten us. An ecological consumption tax system needs to price in all the externalities resulting from our behavior, not just carbon.

The tools we have at hand, markets and democracy, if properly applied, are consistent with sustainability and prosperity. There are no practical limits on the amount of software bought and sold on a renewably powered Internet; no practical limits on the trade in information in many guises; no practical limits on the growth and elaborations of voluntary human relationships and networks.

Renewable Energy Hedges

Renewable energy hedges are one example of a myriad of innovative practices that, taken together, will amount to an ecological transformation of our civilization. They are a reflection of and response to the escalating economic and ecological costs of fossil fuels. They are not speculations. Renewable energy hedges are long-term financial contracts between energy users and energy producers, benefiting both parties.

In an era of $100-per-barrel oil, renewable energy hedges can help billions of people stabilize their energy expenses, build renewable energy infrastructure, offset carbon emissions, and strengthen communities. Instead of being price takers in an unstable power market, energy purchasers can use renewable hedges to transform their energy purchases into a tool for sustainability.

Renewable hedge arrangements are applicable to both the developed and the developing world, to large purchasers with investment-grade credit, and to small users with limited resources through cooperatives, credit unions, and development banks.

The electric utility system is the largest capital agglomeration and major source of pollution locally and globally. Renewable energy hedges can play a key role in building a sustainable and democratically financed and controlled smart electricity grid. This is a grid using renewable and distributed generation and cogeneration combined with real-time computer-mediated control for high efficiency and minimal ecological damage.

The renewable energy hedge is not a speculation but a contract for differences (CFD), a financial risk reduction mechanism used by both the producers and the users of a commodity. The user buys a commodity at a reasonable long-term cost; the producer receives a reasonable long-term income stream.

Airlines were able to avoid bankruptcy due to escalating jet fuel prices by hedging. They purchased commodity options or commodity futures contracts, or entered into agreements that allowed them to maintain affordable jet fuel prices. Producers, through these agreements, obtained predictable income streams in fluctuating markets.

A wind farm, for example, pays no fuel costs. Its major expense is loan repayment for its capital. Banks and investors that want to finance renewables need assurance of adequate long-term income from the sale of renewable power. But energy market prices for electricity and heat vary widely based on the price of fossil fuels. As the prices of natural gas or other fossil fuels rise and fall, so do the prices of electricity and heat.

Until now the only choice for most developers was a long-term, wholesale Power Purchase Agreement (PPA) with a utility or power marketer at a price typically much below the retail market. With a renewable power CFD, developers can offer users reasonable long-term fixed energy prices thorough a financial swap, while assuring their own long-term income stream closer to market prices, which facilitates financing and reduces finance costs.

In a renewable energy hedge contract for differences, the user and the developer agree upon a strike price, say 7 cents per kilowatt hour of electricity, for a quantity of energy needed by the user. For example, a town using 250,000 kilowatt hours per month can hedge the total output of a 1 megawatt wind turbine that averages production of 250,000 kwh/month. The producer sells the renewable energy into the local hourly spot market where it is located and receives the hourly spot price. This hourly price varies depending on the price of fossil fuels and the level of local electric demand.

Each month the hedge settles. If the average price for energy the producer receives in a month is above the strike price, the producer sends the difference to the user. If the amount is below the strike price, the user sends the difference to the producer. If energy prices soar, the user maintains a constant net annual expense. If energy prices plunge, the producer maintains a constant net annual income. The user has achieved net annual energy price stability with no capital outlay. The hedge is not a free lunch. If energy prices drop, the user will pay more than they would have without the hedge.

The renewable hedge has additional advantages as a financial swap, not an energy purchase. It is an agreement that can be made between producers and users who are far away from one another. The hedge works as long as energy prices in both markets rise and fall along with the price of natural gas or other fuel on the margin. Thus hedges could be negotiated between a wind coop in Denmark and a town in New England. In both markets, natural gas is the fuel on the margin that determines spot prices.

A renewable energy hedge is not a contract to buy electricity. A renewable energy hedge is a financial swap, not a power purchase. The user can continue to purchase electricity from its current supplier or a new competitive supplier of its choice.

Building the Smart Grid

Renewable energy hedges are an early step along the sustainable road where cooperative- and community-based and -controlled capital and ownership emerges as an economic norm and where market price signals make pollution, depletion, and ecologically damaging goods and services more expensive. The renewable hedge tool can be wielded by cities and towns on behalf of their residents, by credit unions and development banks targeting low-income people, and by Chambers of Commerce in support of businesses.

In a smart electric grid system, individuals are both buyers of electricity from the smart grid and sellers of electricity into the smart grid from their own small renewable generation and cogeneration. Meanwhile, the net cost of purchased energy is controlled by financial hedge agreements of various kinds made by users with renewable energy developers.

That the electric utility system can be transformed to one characterized by broadly democratic forms of finance and ownership in sustainable technologies is no small step on the path toward sustainability—supported by given market rules, price signals, and relevant financial instruments. Renewable hedges are a good example of people building the road toward a sustainable future as we travel down it.

No More Business As Usual

The limits and challenges we face, I believe, are not primarily technical. We have the ability to use renewable resources to completely transform our energy systems. Nontoxic materials can supplant the poisonous chemical stew. But to say that we can get the prices right and be sustainable does not prove that we will.

Industrial business as usual is anything but sustainable. For everyone to produce and consume like Americans, it will require four or five earths—but we have only one. That is the current global development path. The self-interest of business as usual is for sustainability to become more a marketing tool than a description of transformative social and ecological practice.

Where I live in central New Hampshire, it's not just that winter comes late and spring early. I've gone lake kayaking on Christmas instead of skiing, and warm mid-winter drizzle is redolent of spring evenings. On a south-facing rise in the Mink Hills, I was able to dig with my hands in February, past a soft frost, finding friable soil instead of winter earth frozen rock hard at least four feet deep.

Sustainability is not just what should be done, it is emergent social behavior resulting from two converging trajectories. First is the pursuit of economic growth. Second are the inescapable ecological consequences of our actions.

Defenders of the unsustainable status quo and its unsustainable profits call sustainability an unaffordable luxury, a new Luddism. This is what philosophers call a category error. Sustainability is not voluntary. It is a necessity for civilization. Ultimately, sustainability is about the transformation from industrial to ecological civilization.


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