A New Environmental Era: Managing Renewable Energy Risk

by Jonathan Johns

Environmental impact and climate change related to fossil fuels have put renewable electricity sources—namely wind, solar, biomass and geothermal—at the top of the global energy agenda. A surge of research, education and awareness has led to an increased desire for solutions.

Renewable energy continues to gain momentum within the utility sector through greenfield development, partnerships with renewable energy providers, acquisitions and power supply agreements. Utilities not only consider renewable investment a critical aspect of their supply obligations, but they are also recognizing it as an important part of their social responsibility objectives.

The market has adapted, as well. The U. S. provides a favorable environment for renewable energy development and operation. The American Wind Energy Association reported 5,244 MW of new wind energy capacity in 2007, expanding the nation’s total wind power generating capacity by 45 percent and investing more than $9 billion into the national economy.

According to Ernst & Young’s “Renewable Energy Country Attractiveness Indices,” the U.S. ranked first in the All Renewables Index for the second through fourth quarters of 2007, making it the most attractive country for renewable energy investments and projects. However, delays in renewing the production tax credit (PTC), a key support mechanism for renewable energy, did lead to a three-point drop for the U.S. in the fourth quarter 2007 index.

The competitive renewable energy landscape also includes significant international developments. China, in order to meet a target of 15 percent renewable energy by 2020, will invest more than $250 billion in renewable energy development, according to the China Renewable Energy and Sustainable Development Report. Similarly, leaders from 27 EU countries have pledged to reduce CO2 emissions and other gases linked to global warming by 20 percent in the next 12 years.

Renewable energy investment and development is a relatively new frontier for some U.S. companies. Wise investment requires sound strategy and knowledge of likely competitor activity from existing players, including new, but highly experienced overseas entrants. The following best practices can help to manage and mitigate the associated risks.

Navigate investment decisions

Renewable energy investment requires understanding which renewable resources have a strong, proven performance in a given market. For example, Texas, California, Nevada, New Mexico and Oregon top the Geothermal Index for the fourth quarter of 2007 according to the Ernst & Young “United States Renewable Energy Attractiveness Indices.” A comprehensive analysis must also include technology. Utility leaders must assess the best technology investments from performance and commercialization perspectives. In evaluating conventional sources as a comparison, the risk of a future carbon cost may also need to be considered.

Understand the support mechanisms

Support mechanisms are important for creating strong manufacturing and supply chain capabilities for the industry. Tax incentives and PTCs are two critical considerations. Utility leaders must communicate with regulators regarding the importance of these incentives to the operation and development of renewable assets.

Demonstrate the need for a consistent framework

Renewable energy investment requires a long-term, consistent policy framework to allow for sustainable development. Currently, more than 20 states and the District of Columbia have their own renewable portfolio standards and some states have established their own target levels for emissions from power generation sources. While this can be challenging, several positive regulations support utilities. Tax incentives and tariffs from state legislatures can make renewable asset operation and development more economically viable. Open communication with regulators and policymakers plays a role in this process as they must approve new infrastructure and building costs to be included in the rate base. Addition-ally, it is important to communicate the need for a complementary regula-tory incentive with appropriate infrastructure. Ease of planning and appropriate grid investment can impact a utility’s ability to deploy renewable energy initiatives.

Balance between environment and economics

Environmental regulations and climate concerns, coupled with the call for energy security as demand continues to increase, will only add greater focus on renewable energy—and the utility industry’s actions. Utilities and power generators have an opportunity to lead the movement toward America’s renewable energy future but first they should set a long-term strategy. Ultimately, it must make commercial sense, as confirmed by the activities of a number of companies including NRG Energy and FPL Energy. If the challenge is not taken up, European utilities, oil and gas companies and financial players are prepared to do so, as seen in 2007 with $1 billion in acquisitions or investments by Iberdrola, E.ON and EDP.

Author

Jonathan Johns is a leader in Ernst & Young’s renewable energy group.You may contact him at jjohns@uk.ey.com. The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP.

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