Highlights:

  1. Financial and technological considerations make natural gas, solar, and wind complementary energy sources.
  2. Solar and wind have low marginal costs but high capital costs and intermittent generation.
  3. Natural gas has low capital costs and are dispatchable but have very volatile fuel costs.
  4. Ideal mix of natural gas and renewable energy can meet financial and reliability goals for regional, national, and global electricity mixes.

Introduction

The United States is in the midst of two major energy revolutions – the shale revolution and the clean energy revolution.

On the one hand, the twin technologies of hydraulic fracturing and horizontal drilling have unlocked massive amounts of natural gas and oil, at some of the cheapest extraction prices globally. Large increases in both oil and natural gas production have brought the U.S. to the edge of energy independence, and significantly lowered energy prices across the world.

On the other hand, there is a clean energy revolution resulting from supportive federal/state policies and rapid technological development enabling massive cost decreases for solar and wind generation. From a base of less than 0.5% in 2005, wind and solar are poised to generate 5% of U.S. electricity in 2015, with growth only likely to accelerate in the coming years.

With the future of the U.S. energy system at stake, the rhetorical environment has become very heated, presenting a false choice between natural gas and renewable energy.

In a two-part analysis, I attempt to cut through this rhetorical positioning and focus on an increasingly probable scenario: natural gas and renewable energy make strong allies in achieving an energy system that is low-cost, reliable, secure, and has limited environmental impacts. This is part 1, focusing on financial/economic synergies. Part 2 focuses on environmental synergies.

NG and RE have Distinct Cost Profiles

Economically, natural gas and renewable energy are natural allies in the United States because they have distinct cost profiles. In one sentence:

  • Natural gas power plants have low capital costs but high and volatile marginal costs; wind and solar power have high capital costs but low marginal costs.

A breakdown of EIA’s estimates for plant’s coming online in 2020 clearly illustrate these differences:

Breakdown of Levelized Energy Costs for Different Energy Sources

Cost breakdown indicates natural gas levelized costs are around 70% variable, while renewables are 80-90% capital

Source: Spark Library, based on data from EIA

The fuel costs for natural gas take up the vast majority of the costs to run a natural gas combined cycle facility. Meanwhile, capital costs dominate the profiles of wind and solar. These distinctions directly affect decision making in the power sector. When building a power plant, the first major cost is capital:

  • In 2013, EIA estimated that an advanced natural gas combined cycle power plant had overnight capital costs of $1,023/kW.
  • Meanwhile, EIA estimated in 2013 that wind capital costs were $2,213/kW and a large utility scale solar PV project had capital costs of $3,873/kW.

This means that building a wind or solar power plant could cost 2-4 times the cost of building a natural gas facility. This trend holds true even when accounting for potential issues with EIA’s capital cost numbers.

Renewable Energy Dominated by Capital Costs

Accordingly, a renewable energy developer’s main challenge is figuring out how to finance the primarily upfront capital costs of a project. Build a wind and solar power plant and it will generally produce as much as it can whenever it can – most of the costs have already been spent.

Financial innovation has thus been just as important in driving gains in renewable energy in the U.S. as technological innovation and policy support. Unlike most natural gas facilities, most existing renewable energy capacity in the U.S. has long term contracts. Once a contract is signed and a project is built, a renewable project is past most of its financial risk.

The level of renewable energy capital required to mitigate climate change is truly staggering – even assuming continued cost reductions, one major estimate determined that powering 100% of U.S. energy (not just electricity) with renewable sources would require an upfront capital cost of $13.4 trillion.

Comparison of Financial and Other Risks for Natural Gas and Renewable Energy Projects

The risks facing natural gas (price volatility, fuel supply, policy) contrast with the risks facing renewables (cost-competitiveness, intermittency, transmission)

Source: NREL

Even building enough solar and wind to cover a large portion of electricity demand would be a financial challenge – massive amounts of capital would need to flow into the energy sector rapidly.

Further, as renewable’s share of total generation continues to climb, they begin to significantly affect the function of power markets. By generating very high levels of electricity during certain hours, solar and wind could reduce energy prices during those hours enough to hurt the competitiveness of all energy sources. Although there are ways to limit these impacts, major market restructuring and technological innovation would be required.

Technologically, storage is a potential long term solution to these financial challenges. However, its ability to scale sufficiently in the short-term is uncertain and energy storage is also likely to be a highly capital intensive technology.

Natural Gas Complements Renewable Energy Economics

In the short term, natural gas can mitigate against both the high capital costs required for RE and intermittency/merit-order related issues. Building out natural gas power plants and increasing capacity factors at existing plants while also ramping up renewable energy rapidly can lead to faster declines in coal generation than renewable energy alone can achieve.

In particular, ramping up natural gas in the short term can provide time for building the transmission projects needed to get renewables to their fullest potential. More importantly, low capital costs for natural gas mean they can be easily constructed for use as load following units to balance renewable energy.

While renewable energy lowers wholesale electricity prices during hours in which it operates, ramping natural gas capacity can keep wholesale prices low when solar and wind are not producing at full output.

With low capital costs, a natural gas power plant can pay off its creditors relatively quickly, meaning that it can afford to ramp down its capacity factor and potentially retire earlier than it might otherwise if renewables gain generation share quickly enough.

Finally, with natural gas prices currently below $2.50/MMBtu and likely to remain low for a while, natural gas can also provide lower cost levelized electricity than renewable energy, minimizing overall energy costs in a low carbon system (even acknowledging issues with levelizing energy costs).

Natural Gas Dominated by Fuel Volatility

A natural gas power plant developer faces different risks than a renewable energy developer. It can be relatively cheap to build a natural gas power plant, meaning that very large buildouts can happen quickly.  Between 1998 and 2003, installed natural gas capacity in the U.S. more than doubled, increasing by more than 200,000 MW. For reference, all power plants in the U.S. have a combined capacity of around 1,000,000 MW – the buildout in natural gas was thus truly spectacular.

U.S. Total Natural Gas Capacity and Capacity Factor

Between 1999 and 2003, fleet utilization fell more than 30% as capacity more than doubled

Source: Spark Library, based on data from EIA

However, a natural gas power plant’s developer takes a calculated risk regarding future fuel costs. If natural gas prices are high, the plants will be expensive to operate.

Critically, natural gas prices are notoriously volatile. In the last ten years, prices at Henry Hub, the main pricing point for natural gas in the U.S., have varied between $1.63/MMBtu and $15/MMBtu. At these prices, dispatch costs for an efficient natural gas plant would be as low as $18/MWh or as high as $110/MWh. Dispatch costs for a peaking unit can be much higher.

During the mid-2000’s, when natural gas prices frequently broke above $10/MMBtu, utilization of the recently enlarged natural gas fleet was exceptionally low. Fleet wide utilization broke below 20% between 2003 and 2005. Only recently have utilization rates recovered as natural gas prices fell back below $5/MMBtu.

Regionally, price volatility can be even more dramatic. Prices deep in the Marcellus shale, which is pipeline constrained, often break below $1 or 2/MMBtu even as national prices are much higher. Conversely, during the power vortex in January 2014, some regional natural gas prices broke above $100/MMBtu, driving wholesale electricity prices as high as $1,000/MWh or more.

Renewables Complement Natural Gas Economics

For an individual customer and from a systemic perspective, renewable energy can provide a key hedge against this tremendous price volatility.

With current financing methods, renewable energy prices are usually fixed over the term of a contract. This fixed price nature is a perfect balance to the extreme price volatility that periodically dominates natural gas markets.

Generation-Weighted Average PV PPA Prices Over Time by Contract Vintage

Solar prices for long term contracts signed since 2006 actually decline over the 20-25 year lifetime of the project

Source: Lawrence Berkeley National Laboratory

The use of renewable energy to hedge against natural gas price volatility is increasingly recognized – the city of Austin recently prioritized the development of solar at least in part as a hedge against natural gas price volatility.

In addition to hedging against price volatility, renewable energy can also reduce overall natural gas prices by reducing demand. A recent joint study by LBNL and NREL found that renewables used for RPS compliance in 2013 lowered natural gas prices by $0.05-0.14/MMBtu, saving consumers $1.3 to $3.7 billion. As RPS mandates and renewable energy grow in the future, this downwards price pressure on natural gas is only likely to grow.

More broadly, renewables are also attractive financially because they protect against overreliance on natural gas at a regional level. With coal generation in a death spiral, oil generation almost nonexistent, and nuclear stagnant, natural gas generation has made significant gains in the last several years.

Some of the most notable gains have been in the Northeast – between 2000 and 2014, New England’s natural gas generation went from 15% to 44% of overall generation. The region’s grid operator has found that this massive growth has resulted in winter reliability challenges and negative economic impacts.

Renewables offer a prime opportunity to address these challenges in New England and prevent over dependence on natural gas in other regions.

Natural Gas and Renewable Energy Compete in Different Markets

So far, this analysis has focused on how natural gas and renewable energy are economic complements in a systemic sense. However, energy markets in the United States are becoming increasingly complex, as technology changes the number of market participants and their interactions.

This leads to one final argument: natural gas and renewable energy make ideal partners as they have different markets.

Although there are some new builds of peaking natural gas plants, natural gas is primarily competing with baseload power – primarily coal and secondarily nuclear generation. Most of this competition is occurring in the short term in wholesale markets.

The utilization of natural gas power plants are very closely linked to prevailing power and fuel prices. The inherent price volatility of natural gas make long term contracts challenging and rare.

Meanwhile, renewable energy has primarily been purchased on long term contracts and to meet renewable portfolio standards. A large portion of renewable energy is purchased directly by companies and governments. Companies and utilities typically value renewable energy because of its long term fixed price nature.

These two types of markets are largely independent and explain why renewable energy is still growing despite low natural gas prices.

Secondarily, renewable energy credit demand has created a secondary value source that is beyond direct competition with natural gas. The voluntary renewable energy market consists of companies, government agencies, and individuals who value the green benefits of renewable energy. This market makes up a significant portion of renewable energy demand, and while prices are currently low, is a key source of growing demand for renewable energy.

Finally, distributed solar is in its own league entirely. With net metering, the dominant policy supporting distributed power, distributed solar PV is competing against all-in electricity rates. These rates are only indirectly related to prevailing prices in wholesale markets, the primary domain of natural gas.

Read More

  1. Discussion of how wind and solar can be good hedges against natural gas prices: http://www.nrel.gov/docs/fy13osti/59065.pdf
  2. Synergy between natural gas and renewable energy in power and transportation: http://www.nrel.gov/docs/fy13osti/56324.pdf
  3. In-depth overview of natural gas in U.S. wholesale electricity markets: http://www.nrel.gov/docs/fy16osti/64652.pdf