Could California host a hydropower renaissance?16 April 2019
Michael Ferguson, director, Sustainable Finance, S&P Global Ratings explores how California’s decision to move towards a 100% renewable energy grid can be a boon for hydro generators
Against a backdrop of diminishing environmental standards at the federal level, America’s states are taking the baton. In September, California’s outgoing governor, Jerry Brown, signed into law a mandate requiring the state to derive all its power from renewable energy sources by 2045. Brown at the same committed California to achieving total “carbon neutrality" by the same year. In doing so the Golden State is creating a new gold standard for US decarbonization efforts.
Though the mandate was met with widespread praise, even its most ardent supporters have acknowledged the many challenges ahead in implementing it. For one, experts fear that operating exclusively from intermittent resources, such as solar and wind, may prove unreliable – harming the grids ability to meet baseload demand or causing it to rely on battery storage, which is currently prohibitively expensive for mass deployment.
So how might the reliability gap be bridged? The grid’s incumbent hydropower capacity could offer a partial solution. Hydropower is generally closer to baseload, more reliable and, importantly, will contribute to California’s renewable goal of 100% by 2045. Before intermittent sources can prove consistent, hydropower may see some upside. This, we believe, is more likely to come in the form of favourable contracts with utilities rather than new projects – which remain costly and time-prohibitive.
The US hydropower renaissance
The US hydro fleet, despite experiencing flat growth in total capacity since the 1970s, is experiencing a renaissance. It isn’t only in California, but across the country – with some of the nearly 2200 facilities commanding substantial earnings before interest, tax, depreciation and amortization (EBITDA) multiples in recent transactions, owing in part to their renewable characteristics but also to their very long asset lives; this, too, leads to these assets being more financeable on a standalone basis.
What’s causing hydropower’s resurgence? It has been partly driven by the low-power pricing environment, which has in recent years weakened the fortunes of merchant generators. This atmosphere has somewhat weakened the case for building greenfield generation in unregulated power markets, which in turn has placed greater emphasis on the maintenance of incumbent plants. And because hydro assets can remain profitable far longer than conventional generation and because they have predictable, relatively smooth capital spending patterns, they are in prime position to benefit.
Also, hydropower’s economic staying power is generally matched by its operational longevity. In fact, America’s largest generating facility, the Grand Coulee Dam, Washington, is over 70 years old. Longer asset lives allow hydro assets to survive weaker commodity cycles – providing price insulation to ratepayers, and providing a guard against refinancing risk to investors.
For California, too, longer anticipated asset lives should complement the ambitious mandate. Even assets with lifespans of 50-or-so-years can be prolonged thanks to a healthy diet of maintenance spending. Unlike a full repowering of a solar or wind project, which may be likely given the current age of existing generating facilities, this spending can be gradual.
Ensuring a reliable grid
As California’s energy mix changes, the grid’s load bearing ability – absent changes – could also fundamentally reduce. Coal generation has ceased (its last nuclear plant is slated for closure in 2024), and gas-powered generation faces headwinds. Retiring these energy resources will bring California closer to its goal, but finding a suitable replacement for these non-renewable assets could prove challenging.
Solar and wind assets look set to significantly benefit from the state mandate, but their dependence on ever-changing weather conditions mean they are inherently intermittent. While energy storage could provide the long-term solution, substantial technological advancements and an estimated 200-fold increase in batteries may first be necessary. Barring such improvements these assets may prove an unreliable alternative – a critical issue that requires a solution.
It is likely that these shortcomings will play some role in the more favourable conditions for hydro assets in the Golden State. For one thing, these assets are closer to baseload, meaning that resource risk is not nearly as problematic as for wind and solar. As variable generation comes online, the ability of hydro facilities to adjust their production and offer load following services is becoming invaluable. This flexibility can help ensure any unexpected spikes or troughs in demand can be met without disruption to the grid.
And while other resources are likely to depend on external storage to operate reliably, hydropower comes with its own battery. Currently, this energy storage capability distinguishes hydro from other renewable solutions – meaning they will likely accrue the most substantial benefits.
Of course, hydropower’s renaissance is not to be overplayed: the capital costs and time associated with permitting and building new hydro assets remain prohibitive, at least for the foreseeable future. Though hydro assets may generate power without carbon emissions, the construction phase can be much more environmentally disruptive than some alternatives (solar assets, for instance). It’s our view, therefore, that without considerable – and not to mention unforeseen – incentives, any growth to hydro capacity would be restricted to incremental uprates.
There are practical limitations, too. Much like other renewable resources, hydro generation can also be subject to volatility, with secular changes to hydrology resources a contributing factor. Droughts in California have led experts to question whether enough water will always be available, or whether there is such significant season-to-season variability that its reliability would be called into question. Of course, the lack of confidence in long-term water levels can undercut hydro assets most substantial benefits – their tremendous economic and operational endurance.
That said, hydropower could yet play a complementary role in completing California’s mandate. Put simply, the removal of large high capacity hydro units would, absent another solution, inevitably lead to new fossil fuel generation, which under the long-term mandate would seem untenable. And given that an uptick in battery storage is likely needed to sure up the reliability of intermittent sources, hydro power, despite some lingering risks, may have a role to play.