Wind Power: A Case Study

by: QuandaryFX

Within the United States, no other state surpasses Texas in wind power production. Texas currently has an installed capacity of over 10,000 MW of wind turbines, accounting for around 7% of electricity production within the state. The demand for wind resources has led the state to increase its wind capacity by over 5,000% in the past 10 years.

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With such rapid growth and glowing media reports of renewable energy reshaping our society, the contrarian-minded individual can't help but ask: what's the catch?

Wind and ERCOT

The majority of Texas is part of the Electricity Reliability Council of Texas (ERCOT), which serves around 85% of the state's population. ERCOT is a very interesting region in that it is essentially an electrical island. This means that there are very few ties between ERCOT and the rest of the United States. Basically, the majority of electric demand must be met by generation within ERCOT. This allows the analyst a wonderful opportunity to examine how renewable energy sources impact an electrical operating system and ultimately consumers.

The rudimentary idea of wind power is that instead of using fossil fuels to create steam that turns turbines, allow nature to supply wind which turns a turbine, creating electricity. The huge benefit of wind power (and all renewable) is that no harmful emissions such as carbon dioxide are emitted into the environment. This is a wonderful idea in theory, however many individuals, lawmakers, and lobbyists fail to examine the basic building block of this power source - wind. There seems to be a pervasive belief that by simply building a wind power infrastructure, wind will show up to the party when needed.

Reliability

An additional issue with wind as a source of energy is that it typically does not arrive when most needed. The power markets think of things in terms of "peak demand" and "off-peak" demand. This is fairly straightforward in that peak hours are when demand is highest (during the day) and off-peak is when demand is lowest (during the night). Within Texas, wind is strongest during the night. These strong winds lead to higher levels of wind production, but unfortunately the market simply doesn't need the excess power. Below are two charts showing the typical load profile on a summer day in Texas as well as the normal wind output forecast.

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Note the timing of the peak and trough of these two charts. Wind output is typically the least when demand for electricity is greatest. It behaves exactly opposite of how the market desires it to behave!

Subsidies

With so much wind power hitting the grid at times when it simply isn't needed, electricity prices in Texas frequently become negative. This means that power plants are actually paying to sell their power. In a normal market environment, this would lead to plants cutting back production to allow for profits equal to a plant's marginal cost of production. The renewable power market is anything but normal, however. The United States government currently gives wind power a tax break for every megawatt produced in the range of $19 / megawatt hour of production. This means that even if prices are negative, wind turbines can produce at a potential profit.

Grid Integrity

Sustained negative pricing has massive ramifications for the electric grid. When prices are negative, it means that any plant exposed to the real-time price of electricity is rapidly losing money. For example, if prices are -$50 / megawatt hour and a plant is producing 500 megawatts per hour, it is losing $25,000 per hour before any expenses are accounted for. This type of environment leads to plants either closing or hedging their production for long periods of time.

Unfortunately, the plants facing these decisions are base-load units, or units which are required for daily system reliability. As these plants begin to shut down, the grid finds itself in a bind - it desperately needs electricity to meet demand or it will have to institute blackouts. To get this extra production, ERCOT is attempting to send a price signal by recently raising the price cap for electricity to $4,500 / megawatt hour. However, what type of company is going to make a massive capital investment to create a power plant when power prices gyrate so dramatically? This question is yet to be answered.

Where do we go from here?

The short of it is this: wind power is a great idea on paper but it is unreliable, mainly there when you don't need it, subsidized to the point where it destroys essential generation, and creates an environment where investors are rethinking investment in new plants.

The backbone of wind power is government subsidies. If these fall, the viability of wind power as an energy source could face very stiff hurdles. The strategic investor should be poised to capitalize on this opportunity if it were to arise. Considering the current political environment and the record deficit, cuts must be made on some front. If energy subsidies happen to be slashed, this will lead to wind turbines facing the real-time price of power and eventually a cutback in production and the viability of many renewable companies will be questioned.

By simply observing this market, the alert investor can quickly glean an investing strategy. In Texas, wind energy simply isn't working and can't stand on its own without government subsidies. With a potential fiscal crisis approaching, the government must cut back spending in some industry. Should renewable subsidies be curtailed, this industry will be forced to stand on its own feet. If that happens, the simple laws of supply and demand show that this industry cannot yet sustain itself.

With the government support removed, producers of wind power turbines will face decreased demand and power providers who have wind in their fleet will face decreased profits due to a decrease in government tax breaks.

By doing the preemptive research now, an investor can locate companies which rely on wind and prepare to position themselves accordingly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.