It will not surprise most of our readers that the mix of fuels used to keep America’s lights on has changed considerably over the past decade. Whereas coal dominated the power landscape 10 years ago – accounting for nearly 50% of U.S. generation – it has now fallen to just 30%, and its market share is likely to continue to dissipate. Meanwhile, abundant natural gas is picking up the slack, rising from 22% of power generation in 2007 to 32% in 2017. Gas will likely continue growing its share of the pie; domestic production growth has shown no signs of slowing down, despite taking a short break in 2016 as low prices discouraged production increases. While the shift away from coal toward natural gas is no surprise, the emergence of increasingly competitive renewable sources – including solar and wind – tell the rest of the story, having nearly doubled their share of the U.S. power mix between 2007 and last year to approximately 16%. The story of the power market over the past decade has not been the fall of coal, the rise of natural gas or the arrival of renewables – it has been diversification, with many sources playing an important role.
The diversification of energy sources and increasing energy independence of the U.S. has been a major deflationary force for the country’s consumers. Wholesale power prices in Texas, for example, have fallen more than 50% since 2011 – largely a result of almost 7,000 megawatts (MW) in new wind capacity installed since the end of 2014. Total installed wind capacity in the state is now 21,044 MW. This diverse energy base has far-reaching implications: a more stable grid and an expanding market share from environmentally friendly energy sources, an auspicious backdrop for the U.S. economy.
The Rise of Gas
The natural gas side of the equation is familiar to most, reflecting the free market at work. The combination of horizontal drilling and hydraulic fracturing technology has unleashed a torrent of new gas production. With domestic production rising from 19.4 trillion cubic feet (Tcf) per year to 28.3 Tcf annually over the past 10 years, new supply has outpaced new demand, pressuring price to an average of $3.31 per MMBtu over the past five years compared with $6.31 per MMBtu over the previous five. Lower prices, in turn, spurred investment in new gas-fired power generation capacity. According to Industrial Info Resources, 180 utility-scale natural gas-fired projects valued at more than $91 billion are in the making. This will likely continue to pressure coal demand as cheap gas transforms the power landscape and becomes the largest, if not dominant, source of generation capacity in the U.S.
Even if prices remain low, production costs continue to fall for gas producers. According to recent reports from Chesapeake Energy, fully loaded production costs in certain areas have dropped to $2.00 per MMBtu. The economic incentive to grow gas production will likely persist, which could spell low prices for years. Given the lead time on new investment for gas-fired power as well as other sources of demand for gas – including transportation, liquefied natural gas exports and industrial/manufacturing uses – it may be some time before the demand environment is robust enough to absorb this new supply. Meanwhile, gas will continue to grow its share of the pie, with some projecting a rise to 40% of U.S. generation capacity by 2040.
The Renewable Renaissance
If the rise of gas is a story of technological innovation combined with private capital and free market forces, the growth in renewable energy as a power source – particularly wind and solar – is a more complicated tale.
Looking back just a decade, renewable sources were hardly a material element of the U.S. power supply mix. However, as concerns over greenhouse gas emissions and climate change have grown, the public sector has responded with subsidies designed to increase renewable energy’s share of the country’s power. Public support has taken various forms, ranging from loan guarantee programs and direct grants to lucrative tax credits. State-level incentives, some of which predated federal legislation, have also underpinned the rise of renewables.
Federal support, which began in earnest in 2005 with the Energy Policy Act, has played an important role in attracting investment to the renewable sector. Since the policy was enacted, installed wind capacity has increased almost eightfold to over 82,000 MW.
Solar, meanwhile, has trailed wind but now boasts approximately 45,000 MW of installed capacity. Solar will likely continue to grow in importance as hardware costs fall, and the Solar Energy Industries Association projects more than a doubling of installed capacity between now and 2020.
Federal tax policy provides stable, predictable inflation-adjusted tax credits for wind and solar energy investments through the renewable energy production tax credit (PTC) and investment tax credit (ITC).1 For example, the solar ITC offers a 30% tax credit on the solar system installation cost for the system owner through 2021. This ITC will settle at a permanent 10% for commercial and utility credits when the extension ends, providing market certainty for companies interested in developing long-term investments in the solar industry. While the wind industry has its own ITC, federal law also allows owners of qualified wind power projects to receive a one-time direct payment worth 30% of the eligible cost of the wind facility from the Treasury in lieu of tax credits. For tax-exempt entities, the Department of Energy also offers incentives through clean renewable energy bonds (CREBs), qualified energy conservation bonds (QECBs) and other grant programs or loan guarantees to finance eligible renewable energy projects.
In addition to tax policy and funding, recent federal regulations for systems operators have made substantial progress in improving wind and solar energy transmission funding and operation efficiency, increasing production and profits for grid owners. The modified accelerated cost recovery system also allows businesses to recover investments in certain renewable energy property through depreciation deductions, including a 50% bonus provision for eligible systems acquired and placed in service before January 1, 2012.
For homeowners and businesses, most states offer additional tax credits or cash rebates for installing a residential or commercial solar system, which can reduce solar system costs by between 10% and 20%. Today, 29 of 50 states and Washington, D.C., have established a renewable portfolio standard (RPS) that sets binding targets for renewable energy in the near- and long-term future to diversify the U.S. electricity generation mix. Through the RPS, states legally require utilities to generate a certain percentage of their electricity from renewable sources, such as wind and solar. In addition, any solar power system in a state with an RPS will generate solar renewable energy certificates (SRECs) from the state for the amount of electricity produced. One SREC is earned for every 1,000 kilowatt-hours (kWh) produced. System owners can sell these SRECs to utilities to be put toward meeting the utilities’ renewable generation requirement. As a result, SRECs can bring in hundreds of thousands of dollars per year in income for a system owner, depending on a state’s SREC market. In addition, some states or utilities offer performance-based incentives (PBIs), which pay solar energy system owners a per kWh credit for the electricity their systems generate. Unlike SRECs, PBIs don’t have to be sold through a market, and incentive rates are determined upon system installation.
State-level renewable policy is a challenging maze to navigate – New York alone has 116 potential policies, grants and loan programs – but public incentives are clearly driving an impact.
Are Renewables Self-Sustaining? Looking at Renewable Economics
While government programs helped to lay the groundwork for the renewable renaissance, the free market may keep these power sources competitive over the long term. Starting with solar, the installed price of solar energy has been steadily declining in recent years as policy incentives, technology improvement and market forces have attracted more investment capital to the sector. The National Renewable Energy Laboratory recently reported that solar installation costs fell from $7.06 per watt to $2.93 per watt between 2013 and 2016, a staggering 60% decrease. Falling costs can be attributed to a steep decline in silicon prices (a key raw material in the photovoltaic panels that absorb the sunlight), increased competition among international equipment manufacturers and more efficient installation due to improvement in rack design.
Wind, too, has become more efficient. The wind turbine itself can represent 70% or more of the cost of a land-based project. As wind towers grow taller and longer, blades lighten and manufacturing costs fall, wind is becoming extremely competitive in its own right.
Power Prices – A More Stable Grid
As discussed in our December 2016 article, “The U.S. Electric Power Market: A More Stable Grid,” the diversification of our energy sources has profoundly affected the long-term economics of power generation in the United States. Wind in particular is an increasingly important piece of the American power mix, and as it grows in importance, it has in many ways helped to stabilize the inherently volatile electricity market. In the ERCOT 2 or Texas market, price volatility has been nearly cut in half as wind has eclipsed nuclear and closes in on coal as the state’s second largest electricity source after natural gas.
Is Texas a microcosm of the U.S.? And will renewable sources continue to grow if and when government subsidies eventually leave the marketplace? It appears that as costs continue to fall – particularly for solar – renewables are poised to capture an increasing share of the American energy pie. How big that share becomes and how quickly it happens will be a function of both free market economics and Washington policy. Increasingly, it will be a function of the former.
If the federal government’s 2005 passage of the solar ITC was a pivotal moment in the history of renewables, it was the state-level legislation that set the path in many ways. Texas, which now gets more than 10% of its electricity from wind and is the largest producer of wind power in the U.S., devised policies that produced a real impact. The rest of the country seems to be following a similar route.
This publication is provided by Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) to recipients, who are classified as Professional Clients or Eligible Counterparties if in the European Economic Area (“EEA”), solely for informational purposes. This does not constitute legal, tax or investment advice and is not intended as an offer to sell or a solicitation to buy securities or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code or for promotion, marketing or recommendation to third parties. This information has been obtained from sources believed to be reliable that are available upon request. This material does not comprise an offer of services. Any opinions expressed are subject to change without notice. Unauthorized use or distribution without the prior written permission of BBH is prohibited. This publication is approved for distribution in member states of the EEA by Brown Brothers Harriman Investor Services Limited, authorized and regulated by the Financial Conduct Authority (FCA). BBH is a service mark of Brown Brothers Harriman & Co., registered in the United States and other countries.
© Brown Brothers Harriman & Co. 2019. All rights reserved. 2019.PB-03214-2019-11-27
1 More details on the PTC and ITC can be found on the World Resources Institute’s website: http://www.wri.org/publication/bottom-line-renewable-energy-tax-credits.
2 ERCOT: Electric Reliability Council of Texas.
3 Hurlbut, David. “A Look Behind the Texas Renewable Portfolio Standard: A Case Study.” Natural Resources Journal 48, no. 1 (2008): 129-161. www.jstor.org/stable/24889202.
4 “Renewable Generation Requirement.” Department of Energy. https://energy.gov/savings/renewable-generation-requirement.