Cape Wind: Spreading the Pain

By Lisa Linowes -- December 13, 2010

The headlines were abuzz last month following Energy Secretary Steven Chu’s talk at the National Press Club where he dubbed the global race for clean energy our new “Sputnik Moment” and warned that the U.S. risked falling behind other countries. In this imaginary race, our competition is no longer the Soviet Union, but China, which now leads in the manufacture of wind turbines and solar panels.

The Sputnik analogy is inappropriately applied for obvious reasons. The U.S. space program of the mid-twentieth century was an outgrowth of our military at a time when the United States and Soviet Russia were researching long-range ballistic missiles. The program was a high-cost, high-risk venture that never achieved economies of scale, nor was it intended to. There’s no question the race advanced us technologically and the productization of its research benefited generations of Americans. But, contrary to Chu’s message, it was not a jobs program, its objectives were not imposed on private industry, and its work did not interfere with the lives of everyday Americans.

In the case of energy, we already have a competent and competitive energy market run by the private sector. Its role in not to innovate, but to keep this country reliably powered at a reasonable price so that others can.

Chu’s problem is with the fuels used to power the U.S. and that’s what he wants to change.

He doesn’t hide his agenda to boost wind energy in the United States and he will do what’s necessary to shift the economics in wind’s favor, including sponsoring policies meant to drive up the price of fossil fuels. By teaming up with Interior secretary Ken Salazar, Chu expects to fast-track building hundreds of thousands of megawatts of wind nationwide including the shallow waters just off our eastern seaboard.

The problem for the rest of us is that Chu is an ideologue who, like the department he rules, refuses to publicly acknowledge the cost of his ideas or engage in a fundamental discussion about whether his vision is realistic.

Cape Wind: The Uneconomic Gets More So

While Chu delivered his sermon in Washington, electricity ratepayers in the State of Massachusetts experienced a glimpse of his vision in action. Enter Cape Wind.

Cape Wind is the first offshore wind energy facility approved to be built in the United States. The 468-megawatt project (sticker price: $2.3+ billion) will be erected in federal waters off the coast of Nantucket and its energy sold to utility giant National Grid. With high upfront costs and fewer hours to spread the cost over (given a 39% capacity factor), the power purchase agreement with Grid represents the most expensive in the country.

The Massachusetts Department of Public Utilities (DPU) approved the agreement last month which has Grid purchasing half Cape Wind’s energy for 18.7 cents a kilowatt hour — a price that’s three times the cost of in-region natural gas and at least double the cost of other renewable options. But the numbers are far worse than the press is reporting. The approved 18.7 cent cost does not include 4% paid National Grid as prescribed by State law[1] for agreeing to be a party to the contract or the 3.5% yearly escalator. After the first year of operation, Cape Wind’s energy cost will rise to 20.1 cents per kilowatt. Each year thereafter the cost increases 3.5% until it reaches 31.4 cents in 2027, the last year of the 15-year contract. This price assumes that existing federal subsidies continue throughout the life of the project. If any expire or decrease in that timeframe, the price goes even higher.

The DPU acknowledged that the project will cost National Grid customers between $420 million and $695 million above market prices over 15 years — a figure that we believe to be grossly understated.

But the story doesn’t end there.

The power purchase agreement allocates the entire cost of the project to the delivery side of the electricity bill, and NOT the energy side where it belongs.

Cape Wind’s contract and energy competition

The Energy Policy Act of 1992 allowed states to restructure their electric power industry in order to create more competition. Under deregulation, states with historically higher than average U.S. prices, including Massachusetts and most of New England, enabled customers to choose their electricity supplier. Utilities still provided transmission and distribution (T&D) services.

In Massachusetts, most large industrial and commercial users purchase their energy from competitive suppliers while still paying their utility for T&D costs. By allocating Cape Wind’s energy cost to the T&D portion of the electric bill, all ratepayers in Grid’s service territory would be hit with the bill regardless their energy supplier. This cost allocation flies in the face of electricity deregulation.

National Grid took this unusual action for one reason: to spread Cape Wind’s cost to as many ratepayers as possible. According to National Grid general counsel Ron Gerwatowski, if the cost only applied to ratepayers who purchased their energy from Grid, “everybody would leave the standard offer and we’d have nobody to recover the costs.” In other words, the price shock would be enough for residents and businesses to either leave Grid’s service area or find another energy supplier, one that didn’t include costly wind in its energy portfolio.

Mark Garrett of Garrett Group, LLC filed this testimony before the DPU on behalf of Associated Industries of Massachusetts (AIM) who intervened in the proceedings:

…[National Grid] seeks to impose the above-market costs of this contract not only on Basic Service customers but also on distribution customers purchasing generation service from competitive suppliers. Under this scheme, Basic Service customers would receive 100% of the benefits of the contract, including 100% of the renewable power and 100% of the associated RECS, but would pay only about 50% of the higher costs required to obtain these benefits. Distribution customers taking generation service from competitive suppliers, on the other hand, would receive none of the renewable power and none of the associated RECs under this contract but would be expected to pay about 50% of the higher costs required to obtain these benefits. In other words, about half of the higher costs required to obtain the power and RECs under this contract for Basic Service customers would be paid for by other customers who receive none of these benefits.

The Company’s proposed allocation violates longstanding ratemaking principles that the costs of utility service should be borne by those customers who receive the benefits of that service. The proposed allocation is contrary to public policy in that the cost allocation would create a discriminatory and anti- competitive rate.

It’s no wonder Walmart and AIM objected to the contract and why this decision will likely be appealed. The same goes for independent energy suppliers like TransCanada who argued that forcing Cape Wind’s cost on all National Grid customers, regardless of where they purchased their energy, established a dangerous precedent that would discourage customers from shopping for competitive energy suppliers.

The reaction of business

Walmart will stay in Massachusetts, but may have no choice but to reduce its staff and/or raise prices to cover Cape Wind’s price tag. The same cannot be said for members of AIM. Leaving National Grid’s franchise may prove their best alternative in order to protect their competitive edge. Smaller businesses do not have the same flexibility. Erving paper, a third-generation paper mill in western Massachusetts, told the Boston Herald that Cape Wind will cause its electric bills to spike up to $9,500 a month or $114,000 a year. To offset the cost, the mill’s owner said he’ll probably have to pass along the increase to customers or delay hiring any new employees, adding that “the last thing heavy industrial companies need is higher electric rates in a state with energy costs already among the highest in the nation.”

To emphasize the point, Vermont’s Department of Public Service published the results of a study to evaluate the consequences of adding just 50 megawatts of renewable energy at prices that were higher than market based alternatives — but at prices nowhere near those approved for Cape Wind. The report concluded that “above-market energy costs due to higher electricity prices would have the deleterious effect of “reshuffling consumer spending and increasing the cost of production for Vermont businesses” and that “increased costs for households and employers would reduce the positive employment impacts of renewable energy capital investment and the annual repair and maintenance activities”.

Nothing in the DPU’s public comments suggested the State considered the impact of Cape Wind’s agreement on the State’s economy and jobs outlook.

After nine years of debate, the reality of Cape Wind’s high cost is what caught people’s attention. And this project represents just a fraction the megawatts Secretary Chu expects to see built. Imagine 115 Cape Wind equivalents — 15,000 turbines — located offshore within 10 miles of our east coast, consuming 3,000 square miles of open water. The eastern seaboard from Florida to Maine is only 1,342 miles. The environmental and societal impacts are not even modeled, but Massachusetts offers us some idea of the economic impact.

Dr. Chu told his audience in Washington that his department would continue to “develop and nurture the technologies to help industry go in the right direction.” Frankly, his definition of the “right direction” is highly suspect. And his apparent blind embrace of high-price wind schemes suggests he lacks even a fundamental understanding of how his vision will impact state and regional economies — or maybe he doesn’t care. With the Cape Wind experience in mind, perhaps the best thing the Department of Energy can do right now is emulate NASA by focusing on research, not implementation, and letting competition and private enterprise drive the energy market. Only then will the public have some hope of seeing the best product delivered at a realistic price.

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[1] Massachusetts Green Communities Act of 2008