Sunday, November 13, 2016

Quantifying the value of investing in distributed natural gas and renewable electricity systems as complements: Applications of discounted cash flow and real options analysis with stochastic inputs

One energy policy objective in the United States is to promote the adoption of technologies that provide consumers with stable, secure, and clean energy. Recent work provides anecdotal evidence of natural gas (NG) and renewable electricity (RE) synergies in the power sector, however few studies quantify the value of investing in NG and RE systems together as complements. This paper uses discounted cash flow analysis and real options analysis to value hybrid NG-RE systems in distributed applications, focusing on residential and commercial projects assumed to be located in the states of New York and Texas. Technology performance and operational risk profiles are modeled at the hourly level to capture variable RE output and NG prices are modeled stochastically as geometric Ornstein-Uhlenbeck (OU) stochastic processes to capture NG price uncertainty. The findings consistently suggest that NG-RE hybrid distributed systems are more favorable investments in the applications studied relative to their single-technology alternatives when incentives for renewables are available. In some cases, NG-only systems are the favorable investments. Understanding the value of investing in NG-RE hybrid systems provides insights into one avenue towards reducing greenhouse gas emissions, given the important role of NG and RE in the power sector.

• Natural gas and renewable electricity can be viewed as complements.
• We model hybrid natural gas and renewable electricity systems at the hourly level.
• We incorporate variable renewable power output and uncertain natural gas prices.
• Hybrid natural gas and renewable electricity systems can be valuable investments.
Under standard electricity rates and without incentives for solar, the hybrid NG-RE investment would take 14.46 years to payoff (or 6.45 years with incentives). These figures are 12.6 and 4.27, respectively, under a TOU (Time of Use) electricity rate structure and when net metering is available.

Similarly, for the case of a hospital located in Suffolk County, NY, the hybrid NG-RE systems consistently produce positive NPVs (Net Present Values) and ROVs (and generally more favorable outcomes than the single technology alternatives), and the payback periods are much lower than the residential applications given the scale of the investment.... Investing in a hybrid NG-RE system pays off in 4.98 years without incentives (3.25 years with incentives) under a standard electricity rate structure, and respectively, 4.54 years without incentives (and 2.96 years with incentives) under TOU rates and net metering. On the other hand, while the hybrid NG-RE systems are more attractive than their single-technology alternatives with solar incentives, the NG-only system is more attractive when incentives are unavailable. Again, all DG (Distributed Generation) systems are economically favorable relative to BAU, and the same patterns comparing the findings under high NG price volatility relative to low NG price volatility unfold.

Appendix C presents the findings for the applications based in Waco, TX. Consistent results and patterns emerge, however the findings generally do not favor hybrid systems as strongly. This is mostly because of the low non-electric NG load in Texas compared to the high NG load meeting heating needs in regions such as New York
The findings highlight the importance of policy for determining payoff, which has implications for considering mechanisms aiming to increase deployment of hybrid NG-RE distributed systems. Consider, for example, the residential application in Suffolk County facing baseline NG price volatility. Under a TOU rate structure and net metering, the hybrid system’s NPV to investment ratio implies a 9.6% return with no incentives and 36% with incentives. For the commercial system, these figures are 122% and 147%, respectively. One could also consider the NPV to investment ratio to the utility or to government sectors, suggesting that when certain conditions align, these can be win-win policies.
The full paper is currently available free of charge at
by Jacquelyn Pless 1, 2, Douglas J. Arent 1, Jeffrey Logan 3, Jaquelin Cochran 3 and Owen Zinaman 3
Volume 97; October, 2016; Pages 378–390
Keywords: Real options; Project valuation; Energy sector; Renewable electricity; Natural gas
Corresponding author at: University of Oxford, Institute for New Economic Thinking, Eagle House, Walton Well Road, Oxford OX2 6ED.

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