7.5 Energy Price Volatility in CHP Applications

Over the last five years, energy price volatility has become the most significant issue facing the natural gas industry and energy companies. Natural gas, electricity, crude oil and oil product markets have all exhibited price volatility over some portion of the period. Price volatility has contributed to a climate of uncertainty for energy companies and investors and a climate of distrust among consumers, regulators and legislators.

Energy price volatility creates uncertainty and concern in the minds of consumers and producers, who may delay decisions to purchase appliances and equipment or make investments in new technologies. Such delays may result in lost market opportunities and inefficient long-run resource allocations.

This section briefly summarizes the way a potential CHP investor might try to address the risks associated with uncertain and volatile prices.

7.5.1 Risks and Hedging Mechanisms

There are a variety of ways to hedge or reduce the risks associated with volatile prices. Various financial engines can be used to mitigate exposure to price volatility. For example some manufacturers and project developers offer Power Purchase Agreements (PPA’s). The manufacture or developer assumes all capital risk, while monetizing any incentives and or credits. The host customer is charged a fixed or variable $/kwh for every kwh produced by the CHP system. In some cases the thermal energy is provided at little or no cost. Other financing mechanisms include operational or capital leases.

Another way to hedge risk is to engage in the various financial instruments to manage the fuel costs. These include futures contracts, price swaps, options, and forward contracts, all with attendant advantages and disadvantages. Using such instruments requires market intelligence and expertise. For a small CHP investor or for an owner/operator firm whose core competencies do not encompass this type of intelligence or expertise, the need to engage with these financial instruments could easily discourage investment. An ESCO, on the other hand, if it is already in the business of commodity acquisition, would have this type of expertise as part of its core competencies, and thus is expected to engage in these financial instruments.

In the case of a small CHP investor or a firm that does not have core competency in futures instruments, the investor can either secure long-term gas and electricity contracts or a contract with an ESCO to operate its energy system. This will insulate their operations from the volatile movements of gas and energy prices.

Finally, a CHP plant may itself represent a physical hedge against volatile electricity prices.

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