Financial vulnerability of the electricity sector to drought, and the impacts of changes in generation mix

Abstract:

Electric power utilities are increasingly cognizant of the risks water scarcity and rising temperatures pose for generators that use water as a "fuel" (i.e., hydroelectric dams) and generators that use water for cooling (i.e., coal, natural gas and nuclear). At the same time, utilities are under increasing market and policy pressure to retire coal-fired generation, the primary source of carbon emissions in the electric power sector. Due to falling costs of renewables and low natural gas prices, retiring coal fired generation is mostly being replaced with combined cycle natural gas, wind and solar. An immediate benefit of this shift has been a reduction in water withdrawals per megawatt-hour and reduced thermal impacts in surface water systems. In the process of retiring older coal-fired power plants, many of which use water intensive open-loop cooling systems, utilities are making their systems less vulnerable to water scarcity and higher water temperatures. However, it is not clear whether financial risks from water scarcity will decrease as result of this change. In particular, the choice to replace coal with natural gas combined cycle plants leaves utilities financially exposed to natural gas prices, especially during droughts when natural gas generation is used to replace lost hydropower production. Utility-scale solar, while more expensive than natural gas combined cycle generation, gives utilities an opportunity to simultaneously reduce their exposure to water scarcity and fuel price risk. In this study, we assess how switching from coal to natural gas and solar changes a utility’s financial exposure to drought. We model impacts on retail prices and a utility’s rate of return under current conditions and non-stationarity in natural gas prices and temperature and streamflows to determine whether increased exposure to natural gas prices offsets corresponding gains in water use efficiency. We also evaluate whether utility scale solar is an effective hedge against the combined effects of drought and natural gas price volatility—one that increases costs on average but reduces exposure to large drought-related losses.