Wind and solar photovoltaic (PV) electric facilities only account for an estimated 11% of US generation, but they are fast closing on a tipping point where they may outperform conventional generation as an asset class.

Several factors have come together to drive this result, starting with a rapid decline in costs for new renewable facilities, both wind and solar, that has offset the advantage to natural gas generation brought about by abundant and economical supply.

Improved efficiency of renewables also means every facility can generate more power, delivering greater value and revenue to the off-takers. Declining cost and increased output drives a cycle of improving competitiveness and returns when compared to conventional generation.

Supportive economic policies such as Investment Tax Credits (ITC) and tradeable Renewable Energy Certificates (RECs) also provide a source of financial support to green energy, although both are expected to be reduced in the future.

Finally, the progressive restructuring of wholesale electricity markets, while traditionally viewed as providing principal support to conventional merchant generation, has also facilitated the spread of green energy. It has enabled multiple points of interconnection, and broad integration of both the green electricity markets and the markets for their environmental attributes.

The ability to plug into the grid and realize a backstop price and secure marker for value, at a time when per-MWh costs of production are falling, has further allowed renewable projects to proliferate. S&P Global Market Intelligence has examined the revenue generation attributes of wind, solar, and natural gas generation across three major US investment markets to illustrate the respective drivers of value as well as the enormous potential for green energy to disrupt generating fleets well into the future.

Federal subsidy phase-out

Federal subsidies for renewable energy have fluctuated in recent years, with current law phasing subsidies out over the next two years. The current landscape for federal renewable incentives is as follows:

• Solar – The Investment Tax Credit (ITC) equal to 30% of the installed cost of qualified solar panels or grid-scale solar projects that start construction before 2021, and then falling to zero by 2024
• Wind – The Production Tax Credit (PTC) for wind resources was extended to include resources that commence construction by January 1, 2020, falling to zero after that time.

The lapse of federal subsidies will drive up the effective cost of wind and solar facilities beginning in 2021-2022, although some of this increased cost will be offset by falling costs on installation and technology improvements that boost output. Unlike in Western Europe, only about 25% of US electric load in California and the Northeast is subject to taxes on CO2 emissions, and the Northeast program is directed solely to electric sector emissions.

Instead, states increasingly focus on mandates to expand zero carbon generation. In 2018 California followed Hawaii’s lead to mandate 60% of electricity come from renewables by 2030, with a 2045 goal of 100% carbon emissions-free generation.

Many Western US states are introducing similar targets, with Arizona and Nevada pushing a 50% target by 2030. In the East, New York recently issued an executive order bumping its 2030 target from 50% to 70%.

The emphasis on mandates over prior tools such as Renewable Energy Certificates (RECs) and tradeable carbon emission credits reflects a growing consensus on commitment to the infrastructure aspects of the US generating fleet transition, much of which is expressed in early congressional proposals for the “Green New Deal”.

The charts below present 10-year forecast merchant development returns to natural gas, wind, and solar PV in three key US markets: the Electric Reliability Council of Texas (ERCOT); the PJM Interconnection (PJM), and the California Independent System Operator (CAISO). As a whole, low load growth and generation oversupply ensures that none of these asset classes is forecast to achieve a full return (estimated at 9.7%). What is noteworthy, however, is the relative consistency of returns to all classes and the narrowing of spreads between renewable asset classes and new natural gas plants.

ERCOT: King of the hill in energy

If you were going to choose a market with the best odds of success for a natural gas power plant, you could hardly do better than Texas, where industrial-zoned land is cheap, electricity demand is growing, older coal plants have retired, and natural gas produced here may just be the lowest-cost on the planet.

Thanks to burgeoning unconventional oil production, especially that coming out of West Texas, the supply of natural gas that comes along for the ride has expanded faster than generators (or anyone else) can use it. But Texas is also blessed with high levels of wind, be it from the wide flat plains of the West or from the steady coastal breezes. Texas is also at a favorable latitude for solar resource. Furthermore, the Electric Reliability Council of Texas (ERCOT) market only pays for peak generating capacity on an hour-to-hour basis, a situation independent merchant power developers have long decried. With last year’s improvement in prices, Market Intelligence estimates spark spreads sufficient to deliver returns to generation equity owners this summer, with growth into the future as the market stays tight on generation.

Compare the struggle for returns of a gas-fired combined-cycle (CCGT) plant in ERCOT to a new solar facility. Although solar facilities can’t avail themselves of hour-to-hour capacity payments, solar PV drives value during the peak times of the day, receiving arbitrage between the fluctuating price of coal and natural gas and their own marginal cost of zero. Solar PV plants also receive at least a nominal contribution from ERCOT’s REC market. While low power prices in ERCOT mean solar PV owners must accept less than a full 9-10% return on capital, Market Intelligence estimates superior returns to solar than those for natural gas.

Wind clean spreads look better still. With modern wind turbines operating close to 45% of the year, the long-cited deficiency in summer peak contribution becomes less relevant. Wind captures more value in winter months than solar PV does, driving a higher overall estimated return.

Pennsylvania: Renewables close in on gas

If the Permian Basin of West Texas produces the cheapest natural gas on the planet, the Marcellus Shale centered in western Pennsylvania, eastern Ohio, and West Virginia may come in a close second. Combined with a more stable revenue stream for generating capacity via the PJM Interconnection’s capacity auctions, this region has been targeted for merchant CCGT investment.

Market Intelligence estimates 16.7 GW of new CCGT capacity will come on-line 2018- 2020, offsetting the impact of recently retired coal and nuclear capacity. Together with a robust capacity payment, Market Intelligence estimates that a new CCGT will generate a solid return, exceeding that of ERCOT gas plants, over the next 10 years.

But states in the PJM region also support renewable facilities, using Renewable Portfolio Standards (RPS) backed by tradeable RECs. Utilities in Pennsylvania, Maryland, and New Jersey in particular can contract with green facilities or purchase RECs created by a facility potentially anywhere within PJM’s 14-state footprint. As in ERCOT, typical wind plants in PJM generate substantial value for their owners, with REC contributions driving comparable returns for wind compared to those estimated for a natural gas plant.

California: Gas out of favour

In efforts to modernize its natural gas generation fleet, California has mandated replacement of once-through cooling systems with zero-discharge water towers. Many plants are instead opting to decommission. At the same time, the aggressive build out, especially of solar PV, both distributed and wholesale, has depressed power prices substantially and will continue to do so.

This is essentially the wholesale price version of the infamous ‘duck curve’ for hourly load, resulting in very low prices when solar PV generation is highest. As a result, a new CCGT stands out as a higher-performing asset in our forecast than wind or solar, as the state’s enthusiasm for these resources saturates the market. Importantly, however, the hourly wholesale electricity market supported by CAISO has expanded to cover multiple states of the Western US, allowing developers to site plants in areas less picked-over and still serve California’s RPS standard. While total returns in California appear low, stronger returns are achievable elsewhere in the Western US.

Bottom line: Tilting towards renewables

The revolution in US shale gas seemed destined to drive most future generation investment toward natural gas power plants. And indeed it did – for a few years. As costs have fallen for wind and solar PV facilities, Market Intelligence forecasts indicate returns are converging with new natural gas, even in markets where natural gas competes best.

This begs an important question: how competitive is green electricity today in parts of the world where fossil supplies are lagging? With just modest additional improvements in technology, we could see capital begin to tilt even further towards renewable energy, and further away from conventional generation.

This article has been republished from the S&P Global Platts’ Insight Magazine and blog, The Barrel. The latest issue, released ahead of the S&P Global Platts Global Power Markets conference in Las Vegas, April 8-10, 2019, presents a series of articles on the global and US electricity sectors.