Technology
Is Renewable Energy a Fungible
Commodity?
R. Kenneth Skinner
E
arlier this year, the Energy Information Administration (EIA) published its Annual Energy Outlook.1
The EIA projects that in 2009–35, renewable
electricity generation will account for nearly onequarter of the growth in electricity generation (Exhibit 1). Wind power is projected to nearly double
its share of total generation. Likewise, solar energy
is expected to dramatically increase its share of total
generation. This dramatic growth in intermittent
renewable energy will be largely driven by state and
federal renewable energy standards and tax credits.
Although the increase in these clean energy sources
is good for the environment, several problems have
been written about. Typically others have talked about
the impact to system reliability, the higher cost of renewable energy, and its impact on rates, its usefulness
as a peak-day resource given its uncertainty, and other
reasons. In this column, we discuss the tradability of
intermittent renewable energy and ask if renewable
energy can really be a fungible commodity.
Over the past decade, a number of environmental commodities have been created, including carbon offsets and Renewable Energy Certificates (RECs).
A carbon offset is a reduction in emissions of carbon
dioxide or greenhouse gases made in order to compensate for or to offset an emission made elsewhere.
Renewable Energy Certificates are tradable, nontangible energy commodities that represent proof that
R. Kenneth Skinner (kenneth.skinner@integralanalytics.com, phone [513] 762-7621) is vice president
and chief operating officer of Integral Analytics.
october 2011
Natural Gas & electricity
electricity was generated from an eligible renewable
energy resource. The owner of a REC can effectively
claim to have purchased renewable energy.
In order to be fungible, a commodity must be
able to be traded or substituted for an equal amount
of a like commodity, usually to satisfy a contract.
Although RECs are traded commodities, is that as
far as we can go to make renewable energy fungible? What about the energy and ancillary services
markets? Can energy from intermittent renewable
sources be effectively traded in the OTC (over-thecounter) or bilateral energy markets?
Heavy Risks in Hedging
Typically, contracts written in bilateral energy
markets require the buyer and seller to specify a
notional quantity. For example, an OTC contract
may specify that 50 megawatts will be delivered at a
specified date and location for a given price. Other
contractual terms include “make-whole” provisions
in the case of nondelivery. If the 50 megawatts are
not available on the specified date, the contract may
require that the 50 megawatts be delivered from the
spot market at the prevailing spot market price. The
problem with this structure is that the price of spot
market energy is unknown up to the time of delivery. And an unknown price is very risky.
The problem with this structure is that the price of spot
market energy is unknown up to the time of delivery.
Generators face a similar problem, referred to as
unit-contingent delivery risk. If a generator trips offline due to a mechanical failure, make-whole proDOI 10.1002/gas / © 2011 Wiley Periodicals, Inc.
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Exhibit 1. Nonhydropower Renewable Electricity
Generation Capacity by Source, 2009–35 (GW)
visions would require that the energy be purchased
and delivered from the spot market at the prevailing
spot market price. An interesting energy structuring
department problem is to find an effective way to
hedge unit-contingent delivery risk.
It is not an easy problem to solve. One solution is
to purchase an insurance policy written to cover the
positive difference between the contract price and
the spot market price. But what about the case of
intermittent renewable energy, when make-whole
spot market energy purchases are the norm rather
than the exception? The make-whole provision in
this case represents enormous risk.
To date, the risk associated with make-whole
purchases of intermittent renewable energy has effectively prevented these generation resources from
participating in the traded OTC and bilateral markets. Thus, there is not an effective way to trade
intermittent renewable energy as a like commodity
with firm energy and ancillary services in the OTC
and bilateral markets.
Intermittent Renewable Energy and
Storage
One solution to the problem of trading intermittent renewable energy lies in the development of costeffective storage technology. Conceivably, wind or
solar electric generators coupled with storage would
create a firm energy product that could potentially
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© 2011 Wiley Periodicals, Inc. / DOI 10.1002/gas
be traded in the OTC or bilateral energy markets. In
Exhibit 2, intermittent renewable energy is combined
with storage to provide a fungible traded commodity.
Several companies are currently using storage to
firm intermittent renewable supply. Several electrochemical battery makers are using grid-scale batteries to help firm wind and solar generators. For
example, Xtreme Power has deployed grid-scale
storage with Maui Electric Company, Kaua’i Island Utility Cooperative, and others in Hawaii to
manage wind and solar resources.
Thermal storage technologies are currently used as
distributed peak-shifting resources to manage peakhour demand uncertainty. For example, Ice Energy
produces rooftop air conditioning systems that use
electricity at night, when demand is low, to make ice.
The ice is then used to cool buildings during the day.
The system effectively stores electricity made the night
before, often from excess wind generation that is otherwise wasted, and then uses it to reduce electricity demand on hot afternoons, when the generating system
is maxed out. The Steffes Corporation grid-interactive
renewable water heater controller and thermal brick
space heating systems provide utilities with an affordable and effective way to integrate renewable generation into the grid while providing uninterrupted hot
water and space heating to the consumer.2
Smart grid applications are likewise positioned to
help integrate renewable energy into the grid. Recently,
by using Integral Analytics’ IDROP software system,
Duke Energy demonstrated how residential end-use
demand can be choreographed with intermittent renewable energy to manage uncertain variation in supply and demand.3 Today, utilities manage variation
in renewable supply by dispatching more fossil generation. IDROP was designed to proactively “micro
dispatch” hundreds of thousands (someday millions)
of individual distributed-demand-side resources in
response to intermittent variation in renewable and
other grid-connected resources.4
How to Value Renewable
Intermittency
Financial engineering tools can be used to value
the cost of intermittency. The value is similar to a
short call option where the strike price is equal to
the contract price and the underlying variable is the
spot energy price.
Unfortunately, this is not a simple vanilla option to evaluate for (at least) two reasons. First,
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october 2011
Exhibit 2. Providing Fungible Energy From a Renewable Source
the intermittent resource is likely to generate some
fraction of its obligation during any hour. Thus,
the amount of energy needed from the spot market
is unknown.
Second, spot electricity prices have been shown to
exhibit characteristics inconsistent with the underlying assumptions used in the Black-Scholes equations
used in calculating the value of the option. Specifically,
the risk may be correlated to extreme weather conditions. During these times, the underlying energy price
is better explained with extreme value theory rather
than the simple Gaussian distribution underlying the
Black-Scholes equation. Although Black-Scholes is
not appropriate for this problem, Monte Carlo techniques can be used to accurately value the option.
It is interesting that in addition to valuing the risk
of intermittency, the value will also give us an indication of the net present value of colocating storage
with intermittent renewable resources for the purpose
of creating a firm resource. It is the business case for
grid-scale storage. The use of storage to firm renewable
energy is well understood as a reliability benefit.
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Using the firmed energy as a fungible commodity
in energy and ancillary service markets is not discussed as frequently. However, as renewable energy
supply becomes a bigger percentage of a utilities
total resource portfolio, the issue will become increasingly important in managing intraday balancing energy purchases and sales.
NOTES
1. US Energy Information Administration. (2011, April). Annual
energy outlook 2011 with projections to 2035. Retrieved from
http://www.DOE.EIA.gov.
2. Steffes, P. (n.d.). Grid-interactive renewable water heating: Analysis of the economic and environmental value. Retrieved from http://www.steffes.com/LiteratureRetrieve.
aspx?ID=72241.
3. Duke Energy Carolina, LLC, Residential Energy Management
Systems Pilot Measurement, Verification, and Evaluation Report, Docket E-7, Sub 906 filed before the N.C. Utilities Commission, January 13, 2011.
4. Berst, J. (2011, January 4). Is IDROP the forgotten engine for
next-generation demand response? Retrieved from http://www.
smartgridnews.com/artman/publish/Technologies_Demand_
Response/Is-IDROP-the-forgotten-engine-for-next-generationdemand-response-3407.html.
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