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Renewable Energy Hedges: Frequently Asked Questions

* What is a hedge?

A hedge was developed as a way for producers of a commodity and users of a commodity to reduce the risk from changing market prices.  Producers are seeking a fair and predictable income. Consumers are seeking a fair and predictable price.  A hedge classically is a mechanism for both producers and consumers to get what income producers need and what prices users need.

Airlines, for example, were able to avoid bankruptcy from escalating jet fuel prices by hedging.  That is, they purchased commodity options or commodity futures contracts, or entered into a contract for differences (CFD) agreements that allowed them to maintain affordable jet fuel prices. Producers through these agreements obtained predictable income streams  in fluctuating markets. 

A renewable energy hedge is the application of risk reducing hedge principles to control user net energy bills and to assure renewable producers a reasonable stream of income.  A removable energy hedge takes advantage of the fact that renewable energy facilities have no fossil fuel costs and therefore their expenses to produce energy do not fluctuate with the price of fossil fuels that determines the market price for electricity.

*What is a hedge fund?

A “hedge fund”, much in the news as speculative investment vehicle, is not, repeat is not a commodity hedge between a user and the producer to reduce risk. A hedge fund involves a usually highly leveraged gamble by an investor that the price of commodity or stock or currency will rise or fall depending on the nature of the speculation.

A renewable energy hedge is a risk reduction mechanism based on agreements between the producer of a commodity and the user of a commodity.  It is not a speculation.  It is not leveraged to maximize gain. On the contrary, a renewable energy hedge is sized reduce risk.

* Is a renewable energy hedge a speculation?

A renewable energy hedge is a way to reduce risk.  It's not a speculation.  A renewable energy hedge is based on a long-term agreement between an energy consumer and a renewable energy generator that benefits both. 

The energy user can change its energy budget from a widely variable cost to a net yearly fixed cost by taking advantage of the fact that renewable energy facilities use no fossil fuels. The renewable energy generator can assure a predictable and long term stream of income and reduce their financing costs and facilitate building more renewable generation.

* What are the basic types of renewable energy hedges?

There are two basic types of renewable energy hedges. The first type, a contract for differences or CFD, requires no capital expands by the energy user.  A contract for differences (CFD) is a time honored risk reduction measure employed by users of a commodity and producers of a commodity to reduce the risk for both parties.  The user with a CFD controls long-term net energy costs, and the producer receives a predictable long-term income stream.

The second type, a capacity income hedge or (CIH) requires a one time capital investment by the energy user. Under a capacity income hedge (CIH), the energy user will receive, on a monthly basis, all the income from the sale of power from a defined amount of capacity from a renewable energy facility for a given number of years.  The user with a CIH can control long-term net energy costs, and the producer receives a discounted net present value payment (NPV) today for the facility’s long-term income stream.

A capacity income hedge (CIH) can be sized to hedge a user's energy costs.  A capacity income hedge can also function as an investment vehicle to generate a profitable  internal rate of return (IRR). As future energy prices rise or fall, the rate of return of capacity income hedge will also rise or fall.

* What can a renewable energy hedge include? What can it do?

First, a renewable energy hedge is a financial mechanism, that is, a financial swap.  It is not a power sale or power purchase.  Is it is based on a financial agreement between an energy user and energy consumer. What is traded and what moves in a financial swap is money between the energy user and energy producer.

A renewable energy hedge is first and foremost from an energy user standpoint a way to control net annual energy budgets. A renewable energy hedge is first and foremost from an energy producers standpoint a way to guarantee annual net income.

Second, a renewable energy hedge can include renewable energy certificates (RECs) that represent the green or renewable attribute of the power generated.  In the voluntary market, RECs can be employed by an energy user to offset partially or fully their green house gas emissions. The cost of the RECs is included in the price of the renewable energy hedge.

Thus, renewable energy hedge can be used to both  control long term basis net annual energy budgets energy budgets and to offset greenhouse gas emissions.

* Why does the renewable energy hedge work?

The renewable energy hedge takes advantage of the fact that renewable plants use no fossil fuel that determines the cost of electricity and natural gas in the marketplace.

When fossil fuel prices rise, the income for renewable energy facilities rises if they sell their energy into the hourly spot market where they are located.  When fossil fuel prices fall, the income for renewable energy facilities falls if they sell their energy into the hourly spot market.

The renewable energy hedge is a financial swap.  The renewable energy generator trades the income from rising fossil fuel prices to be sent to the energy user, in exchange for payments from the energy user if fossil fuel prices decline. Both the energy user and the energy generator benefit.  The user controls long-term energy costs.  The generator guarantees a reasonable long-term income stream. 

This kind of renewable energy hedge is called a Contract For Differences or CFD.

* How much capital do I have to invest to buy a Contract for Differences (CFD)?

There is no capital investment, repeat, no capital investment required for a user to enter into a CFD.

In exchange for supporting the maintenance a level stream of income for the renewable facility, the energy user receives the benefit of a substantial capital investment by the renewable developer.

For example, a Contract for Differences of 10,000 MWh per year renewable energy hedge based on the output of 3.3 MW of wind means the user takes advantage of about $67 million of capital investment by the energy developer.

An investment grade energy user has no additional credit requirements to enter into a renewable energy hedge.

If an energy user has less than an investment grade rating, additional credit support may be required.

* How do I know how large a renewable energy hedge I need? How to I predict renewable energy hedge performance?

We work with energy users to size and optimize their renewable energy hedge portfolio.  An energy user can decide to hedge some or all of their energy use to meet their specific needs to reduce risk, offset carbon emissions, enhance or protect their competitive position.

The amount that's hedged removes that portion of your energy budget from market risk.  A hedge portfolio can be constructed with hedge agreements added over the years in response to market forces and user needs.

Eco Power Hedge LLC has developed sophisticated analytical software that uses data from the specific hourly performance of renewable energy facilities, spot markets, and user energy consumption.  We size renewable hedges. We model renewable energy hedge performance under a wide range of future energy price change scenarios ranging from low to probable to high.

Based on this data, we determine the net projected annual energy budget expense that users will expect to pay for energy under the hedge. We also determine the monthly and yearly hedge performance under low, probable, and high future energy price scenarios.

* How to I verify renewable energy hedge performance and payments?

Equal Power Hedge LLC will act as buyer’s verification agent. Each month, we examine the complete audit trail of energy generated by the renewable facility and sold into the local spot market, the hourly spot market price received, any applicable capacity credits received, and any payments due either user or generator.

* Why is a renewable energy generator interested in a hedge agreement?

Since a renewable energy facility, a wind farm, for example, uses no natural gas or other fossil fuel, its cost for producing electricity remains constant based on capital cost and maintenance.

The renewable energy hedge is a better and fairer deal for the energy generator as well as the energy consumer.

The investment bankers, who finance renewable energy facilities, require an assurance that the facility can pay its capital costs over 15 to 20 years based on the income received from energy generated by the facility.  Until recently, renewable energy generators had only the option to negotiate a long-term Power Purchase Agreement (PPA) with utilities and power marketers.  Under retail competition, utilities typically no longer purchase power and power marketers purchase power for resale at a profit.

 Usually, these Power Purchase Agreements with power marketers are at prices considerably lower then the strike price negotiated with energy consumers.  Energy consumers are interested in controlling their energy costs, not in reselling power for our profit.

* It is the renewable energy hedge a power purchase?  How do they get the power to me?

In a renewable energy hedge is a financial swap, not a power purchase.  Under the financial swap, the energy user receives payment from a renewable facility when energy prices rise above the strike price; the energy generator receives payment from the energy user when energy prices fall below the strike price.

A renewable energy hedge is not a contract to buy electricity.  It's a way for energy users to control their net annual energy budget over a long-term.

* What about my existing electricity purchases?  Do I have to get a new energy supplier if I have a renewable energy hedge?

A renewable energy hedge is not a power purchase.  It's a financial swap only.  It has no affect on your choice of energy suppliers.

You can continue to purchase electricity from your current supplier if you choose.

If you have a renewable energy hedge, you may not be interested in a long term fixed price contract with an energy supplier sends the hedge is designed to protect you from market risk and market fluctuation.  By attempting to time the energy market, that is, by buying long when the price is low, you sometimes are rewarded if the price rises, and sometimes are punished when the price falls.

A renewable energy hedge is a way of reducing the risk  of both market timing and market price fluctuation.

* What's the strike price?

The strike price is the tipping point negotiated between an energy user and energy generator in a renewable energy hedge. Average income received by the energy generator above the strike price is sent to the energy user.  If the average income received by the energy generator is below the strike price, the energy user sends the energy generator the difference.

For example, a strike price of $70 per megawatt hour (equivalent to $.07 per kilowatt hour) was negotiated as the basis for a renewable energy hedge. In January, assume 1,000 megawatt hours of electricity were generated under the renewable hedge. The average income received was $75 per megawatt hour, $5 per megawatt hour above the strike price, for a total income of $75,000.  The generator will send $5,000, that is, $5 per megawatt hour X 1000 megawatt hours, to the energy user at the end of January.

In February, assume 1,000 megawatt hours of electricity were generated under the renewable hedge. The average income received was $65 per megawatt hour, $5 per megawatt hour below the strike price, for a total income of $65,000.  The user will send $5,000, that is, $5 per megawatt hour X 1000 megawatt hours, to the energy generator at the end of January.

The renewable energy hedge works to keep net energy costs for the energy user flat and to keep income for the energy generator stable.

* Can I offset my carbon emissions with a renewable energy hedge? 

Renewable energy hedges can be used to offset a user’s carbon emissions in the voluntary market through the use of Renewable Energy Certificates (RECs) combined with the renewable energy hedge.

A user can purchase RECs, included in the strike price negotiated with the generator, equal to the amount of energy hedged. These RECs may or may not be associated with the facility generating the electricity that is the basis of the hedge.

The value of RECs varies widely.  For example, RECs from a New England renewable facility may be $50 per megawatt hour, while RECs from a Midwest facility may be worth $2 per megawatt hour.

The value of RECs is widely expected to increase as national REC standards are adopted as part of efforts to reduce global greenhouse gas emissions.

RECs associated with a particular hedge may or may not have very substantial future value.  All RECs can be retired, however, by users interested in offsetting their carbon emissions in the voluntary market and assist sustainability efforts, socially responsible conduct, and marketing efforts.

Eco Power Hedge LLC can calculate user carbon emissions & is hedge program to offset some or all of a user’s carbon emissions in the voluntary market.  RECs can also be sold into rapidly emerging REC markets.

* What about energy efficiency? Does a hedge interfere with my energy efficiency efforts?

A renewable energy hedge works very well with energy efficiency programs.  A renewable energy hedge, in fact, focuses your attention on reducing your energy budget by becoming more efficient, instead  of attempting to control energy costs by timing your energy market purchases.

Under a renewable energy hedge, when prices rise, the dollar effect of your efficiency savings is somewhat magnified.  When energy prices fall, the dollar effect of your efficiency savings is someone reduced. 

For example, you have a renewable energy hedge with a wind farm based on 1000 MWh a month, sized to fully hedge your electricity use, at a strike price of $75 per megawatt hour. You reduce your consumption to 800 MWh per month through efficiency:

1. In January, if electricity prices rise to $80 per megawatt hour, you would still receive $5 per megawatt hour ($80-$75) x 1,000 megawatt hours or $5,000 from the wind farm.

2. Your net January bill with efficiency would be 800 MWh x $80 per megawatt hour = $64,000 minus $5,000 = $59,000.

3. Without the renewable hedge, your January bill would have been $64,000 or $5,000 more.

4. In February, if electricity prices fall to $70 per megawatt hour, you would still pay five dollars per megawatt hour ($75-$70) x 1000 MWh or $5,000 to the wind farm.

5. Your February bill with efficiency would be 800 MWh x $70 per megawatt hour = $56,000 plus $5,000 = $61,000.

6. Without the renewable hedge, your February bill would've been $56,000 or $5,000 less.

* Is the renewable energy hedge too good to be true? Is the renewable energy hedge a free lunch? 

The renewable energy hedge takes advantage of the high price of fossil fuel energy in the marketplace.  It's an outstanding example of the emergence sustainability as a market force.

Renewable energy hedge is not a free lunch.  If energy prices decline below the strike price, the user has to make payments to the generator. 

Energy prices, as we have seen, have escalated very substantially since the 1970s.  They are expected in the long run to continue to do so.  Many believe that $100 a barrel oil is just the beginning.  But energy prices also fluctuate widely and often substantially decline from previous highs. 

The renewable energy hedge is meant to stabilize long-term energy budgets at an affordable annual price.  If energy prices fall, an energy user will pay more with a renewable energy hedge than they would have without the hedge.  The hedge is designed for users to maintain the predictable and affordable price for energy based on the amount hedge.