TODAY’S STUDY: NEW NUMBERS ON NEW ENERGY GRID PARITY

Journey to grid parity; Three converging forces provide a tailwind for US renewable power

November 2015 (Deloitte Center for Energy Solutions) Executive Summary

In the US, the debate about when renewable energy will achieve “grid parity,” or the ability to compete on equal footing with conventional sources of generation, generally assumes the continuation of at least some state and federal subsidies for wind power and utility-scale solar photovoltaics (PV). This analysis, however, takes a different tack. Here, subsidies have been purposefully excluded from the assessment of grid parity in order to provide a different, and perhaps more relevant, perspective on the competitiveness of the renewable energy sector.

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Key Findings

1. Renewable power generation reaching grid parity without federal or state subsidies is not imminent, except in certain markets possessing the most robust renewable resources and having relatively high wholesale power market prices. Indeed, without dramatic cost declines and improvements in efficiency and utilization, it is unlikely that some parts of the US can reach grid parity without federal or state incentives within the next 10-15 years.

2. Onshore wind is more likely to reach grid parity before utility-scale solar PV, under a wide range of assumptions.

3. While it is widely accepted that the continuation of the federal Production Tax Credit (PTC) for wind and the federal Investment Tax Credit (ITC) for solar would allow the renewable generation sector to reach grid parity faster, the extent of the acceleration—by as much as a decade—is more pronounced than one might expect.

4. Lowering the cost of capital—by adding project-level debt at the outset of the project for instance—advances grid parity timing by around five years across most markets for onshore wind and solar PV.

5. Three trends are converging, which are collectively pushing renewable energy development forward: forecasted rising natural gas prices, wholesale power market rebalancing, and ongoing improvements in renewable technology. Whether or not these trends continue and to what degree will affect the timing of grid parity.

6. While there are many uncertainties, the pace of innovation across technology, processes, and financing is the big wild card. While it is difficult to include in an economic modeling exercise such as this, innovation should be acknowledged as a factor that could shorten the journey to grid parity to a great extent.

This analysis was performed by Deloitte MarketPoint. A detailed discussion of the methodology used in the analysis, along with sample calculations, can be found in Appendices A and B.

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Introduction

At present, many states and countries provide targeted and sometimes significant incentive schemes to engender new renewable energy project development. In the US, these are chiefly in the form of the federal PTC for wind, which currently provides a 2.3 cents per kilowatt hour subsidy over the initial 10 project years to eligible technologies; the federal ITC for solar, which presently provides a 30 percent tax credit for solar generators; or tradable Renewable Energy Credits or Certificates (RECs), which provide a stream of additional income to developers as part of some statesponsored Renewable Portfolio Standards (RPS) programs. Additionally, many states offer other programs such as job credits, research and development incentives, and sales and use and/or property tax exemptions for renewable property.

Herein, the term “compete” means that revenue earned from regional wholesale power markets alone would cover capital investment for renewable energy projects, along with operating and financing costs, including profit on a going-forward basis. Notably, although many renewable energy projects are at least partially contracted using Power Purchase Agreements (PPAs) and do not earn revenue directly tied to wholesale power market prices, rapidly advancing project economics and changing market conditions could impact future renewable energy development and the availability and terms of PPAs.

The following analysis, which uses four different models, along with power price projections from Deloitte MarketPoint’s North American Integrated Market (NAIM) Reference Case outlook, investigates six wind and six solar US market regions—all of which have active renewable energy project development or a large installed base of generation capacity.1 The results of this analysis provide a differentiated perspective on the grid parity debate, since potential timelines are often based on the continuation of subsidies as opposed to their absence.

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The confluence of three trends

The grid parity analysis performed by Deloitte MarketPoint indicates the confluence of three trends, which taken together provide evidence that in the foreseeable future renewable energy may be able to compete on a level playing field with conventional generation sources. These trends are:

1. Forecasted rising natural gas prices

2. Wholesale power market rebalancing

3. Improvements in renewable technologies

In order to identify and better understand these trends, the analysis examined natural gas markets over a 25-year horizon. It also considered the natural gas supply in the US, including capital development costs to meet gas demand for power generation as well as demand for residential, commercial, and industrial uses. It additionally explored how the abundance of shale gas is reshaping the supply picture, including the potential impact of liquefied natural gas (LNG) exports on the natural gas supply-demand balance and market prices.

Concerning power market rebalancing, the analysis considered the current and future conditions of regional power markets. Each market has its own resource characteristics, seasonal load shape, and expectations for future demand growth. Furthermore, markets vary in terms of overall supply-demand balance with some experiencing significant oversupply conditions and others greatly depending upon imports. In addition, several high-profile regulatory developments have recently come into play, including policies to reduce carbon and other emissions, which could force further plant retirements, particularly coal, thus affecting the supply picture.

Along with the evolution of natural gas prices and power markets, the analysis further examined how renewable energy is reshaping the power market landscape as it enters the mainstream as a highly technological and efficient source of generation. Furthermore, as the sector has matured, overnight construction costs have dropped, precipitously in some instances, while technological advances have led to better operating characteristics. This combination is instrumental in bringing renewable energy closer to grid parity with conventional sources of generation.

With this background in mind, the following sections explore each of the three aforementioned trends in greater depth…

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Conclusion

Grid parity is not imminent but may be reached sooner rather than later

The purpose of this report was to examine the timing of reaching grid parity without state RECs and without federal tax incentives, such as the PTC for onshore wind and the ITC for utility-scale solar PV.

The research indicated that reaching grid parity is not imminent, except in certain markets possessing the most robust renewable resources and having relatively higher wholesale power market prices. Overall, the results show that onshore wind is more likely to reach grid parity before utility-scale solar PV, under a wide range of assumptions. Indeed, without dramatic cost declines and/ or improvements in efficiency and utilization, it is unlikely that some parts of the country will reach grid parity without federal or state incentives within the next 10-15 years. While it is widely accepted that the continuation of PTCs and ITCs would allow the renewable energy sector to reach grid parity faster, the extent of the acceleration—by as much as a decade—is more pronounced than one might expect.

In addition to regional wind and solar resource characteristics, the research identified three converging factors that will affect the timing of grid parity. These are rising natural gas prices, wholesale power market rebalancing, and improvements in renewable technology. Together, these converging forces will likely provide a tailwind for renewable energy development, pushing it to become competitive with fossil fuels, without subsidies, over the 25-year forecast horizon across many regional power markets.

In summarizing the findings of the analysis, it should be noted that the future pace of innovation cannot be predicted based on market fundamentals or historical data; therefore, it was not included in this analysis. Nonetheless, it could accelerate or delay the timing of grid parity to a great degree. For instance, an improvement in wind technology that facilitates a 500 basis point increase in operating capacity factor (e.g., 40% to 45%) could advance grid parity timing by about five years in most regions.

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Open questions include: construction costs have declined substantially, can this continue or will the pace of reductions slow? The literature suggests solar-plant costs might decline further and faster than for wind based on recent evidence, but this is not a given. Also, overnight construction cost estimates vary widely, due in part to the use of different equipment and regional variations in labor and material costs, as well as when the plants were commissioned. The difference between the low and the high ends of the range can impact grid parity timing greatly—by as much as 10 or more years in some instances. Will these cost estimates drop and will their range narrow as the renewable energy sector expands and matures across regions? The answer, again, is unknown, but yet material to the grid parity discussion.

Finally, financing also deserved mention. A lower cost of capital, attained by accessing lower cost debt and levering project balance sheets, can advance grid parity timing considerably, by as much as five years in the scenarios examined. Over the past couple of years, financing innovations, such as YieldCos, green banks, and securitization, have generally made capital more accessible and affordable for developers. Ongoing access to such funding may likely help to spur renewable development and expedite the journey to grid parity. It would also make solar and wind projects less reliant on traditional tax equity financing, which is dependent upon the continuation of federal tax incentives.

Although the results clearly show that solar PV and onshore wind are not immediately economic without federal tax incentives or state RECs, they do indicate that under the right conditions grid parity could occur within the next decade in some regions for wind and somewhat later for solar. If utilization and/or operational efficiencies increase or construction costs decrease further, as has been witnessed over the past decade, the timeline could be shortened considerably. The results also acknowledge that the door is open for other factors not directly included in the analysis, such as the Clean Power Plan, state regulatory reform, or declines in financing costs, to provide an additional boost for the renewable energy sector on its journey to grid parity.

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