Monday, May 14, 2007

Value of cost certainty

In thinking about renewable energy plants one has to remember that they provide both energy and a hedge against volatile fossile fuel prices. I wrote an article about this last year in Public Utilities Fortnightly. I was reminded of this while posting a comment over at Energy Outlook.

If one considers (fossil) fuel price volatility, wind power is much cheaper than it looks. Upon installing the wind turbine you know (within a couple %) what it will cost to produce power in 20, 30, even 40 years. Try that with fossil fuels!

Every wind turbine provides an energy price insurance contract (long term call option) in addition to a stream of electrons. The embedded call option is theoretically worth 1-2% (depending on your belief about future fossil fuel volatility) of the turbine purchase price PER YEAR the turbine will operate.

Another way to think of this cost certainty is to compare wind turbines to treasury bonds and fossil fuel turbines to junk bonds. You pay more per $ of interest for treasuries because of the added certainty of receipt. Experienced investors know that junk bond returns are more risky, i.e. volatile. In the same way, the cost of running a fossil fuel turbine is more volatile (or risky--especially if we consider the cost 20,30, and 40 years from now) than the cost of running a wind turbine.


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