Wednesday, September 28, 2005

Practices for Sustainability Emerge: A Wind Hedge as Financial and Social Innovation

Guest perspective/Roy Morrison
Today, the fundamental challenge we must face at first appears daunting. In the 21st century, economic growth must mean ecological improvement, not ecological destruction.
The news, unfortunately, is not of constructive change, but of war and disaster inextricably linked to the political and ecological consequences of our fossil fuel use.
We must ask: Can the market system heal, not destroy? Can liberal democracy endure? Can we as citizens, as businesspeople, as administrators, as workers transform a self-destructive industrial order to a prosperous and sustainable ecological civilization?
Implicit in these questions is the understanding that sustainability is not just a lofty goal, to be sacrificed to the demands of more pressing matters, but a necessity for our future prosperity and security.

A Wind Hedge
A wind hedge is a new financial means to connect energy users to renewable energy developers for their mutual advantage. It empowers energy users to facilitate and benefit from renewable energy development. It can be a powerful tool removing institutional barriers to building the renewable energy infrastructure.
The wind hedge allows renewable developers and energy end users to negotiate mutually beneficial agreements. The wind farm gets an assured and reasonable long term price for power generated; the energy user gets stable and affordable long term energy costs; society gets more renewable development, a stronger economy, and a decline in fossil fuel use and pollution. It's a win-win-win arrangement.
A wind hedge, at bottom, is an expression of the economic, social, and ecological consequences of fossil fuel use that is bringing forth healing responses to the excesses of an empire of oil. By itself, a wind hedge is not the answer to our problems. It is one manifestation, of many to come, of economic and social forces that are catalyzing a movement toward sustainability from business and pollution as usual.
A wind hedge will do more than fatten quarterly balance sheets. It improves the triple bottom line of sustainability: the financial, the social, and the ecological.
A wind hedge is a good example of the practice of sustainability representing the emergence of financial and social innovation.

A Hedge
A hedge is a means of protection. A Contract for Differences (CFD) hedge is a tried and true financial way both producers and uses control their costs.
Classically, a hedge lets a farmer in Iowa and a baker in Boston negotiate a win-win deal so both can stay in business.
The farmer can pay her mortgage if she can sell her wheat at $1.00 per bushel. The baker can pay his mortgage if he can buy wheat at $1.00 per bushel. They agree on a $1.00 strike price for 1000 bushels. The farmer sells her wheat in the Iowa market. The baker buys his wheat in the Boston market.
In the first year, there's a frost in Iowa. Wheat is $1.50. The farmer earns $1500. The farmer sends $500 to the baker. The farmer's net income is $1000.
The baker meanwhile has paid $1500 for his wheat in Boston. But he receives $500 from the farmer. His net cost is $1000.
Next year, there's a bumper crop. Wheat is 50 cents a bushel. The farmer earns just $500. And the baker pays only $500 for his wheat. The baker sends $500 to the farmer. His net cost is $1000. The farmer's net income is $1000. Over the two years, the farmer has an average income of $1.00 per bushel; the baker has an average cost of $1.00 per bushel. It's a win-win relationship.

Wind Hedge Details
A wind farm pays nothing for fuel, some money for maintenance, and a lot to bankers for their capital investments. Wind farms earn money from power sales, typically into wholesale markets. To clear the financing hurdle, a wind farm must earn enough money to cover their 20-year mortgage for capital costs.
But electricity prices vary widely. The spot market for electricity sometimes peaks at 50 cents per kilowatt-hour, and other time's falls to 2 cents. Renewable developers, to satisfy financiers, have been forced into negotiating long term power purchase contracts with utilities or other large marketers at less than favorable prices. The wind hedge, by stabilizing long term energy costs and income allows both users and developers to prosper.
The basic mechanics of the wind hedge are straightforward. The two parties agree on a quantity of power to be hedged, a strike price, and a term of years. Power generated by the wind farm is sold into its local spot market.
Each month, if the average price received by the wind farm is above the strike price, the wind farm sends a check to the energy user. If it's below the strike price, the user pays the wind farm the difference. If there's no sale of power, there's no payment by either party.
As long as the two separate markets--the wind farm's local market and the buyer's local market--behave in a similar fashion, the hedge works well. In the Northeast, for example, natural gas prices determine the market clearing prices for electricity. When natural gas prices rise or fall on the NY Mercantile Exchange, natural gas prices and electricity prices also rise or fall both in New England and in New York State. A wind hedge thus, in principle, is valid for a wind farm in New York and an energy user in New Hampshire.
Since a wind hedge is a financial arrangement only, and not a power purchase contract, the wind hedge is not limited to wind farms in the user's back yard. The user continues to buy power from its local supplier at the best price obtainable. The hedge provides economic protection.
In the U.S., large wind developers have successfully used hedge agreements with companies like Goldman Sachs, Constellation New Energy, and Morgan Stanley. Now, hedges are being actively negotiated between wind developers and businesses, universities, and governments. Completion of the first round of developer-end user wind hedges is expected shortly.

Wind Hedges and Sustainability
As a practical expression of sustainability, a wind hedge should help catalyze an ongoing ecological transformation from the ground up. This is transformation not imposed upon us by law, government, or fiat, but arising from civil society, from the actions of businesses, institutions, organizations, unions, local governments, communities, and, of course, individuals.
Sustainability, like democracy, is a social practice that, at bottom, is a matter of ongoing social innovation and renewal, of practical creativity.
Necessity means that sustainability must become an emerging characteristic of how we work, how we organize ourselves, how we measure and account for what we do.
Sustainability is an idea whose time has come. It is in response to necessity that moves us to action in accord with underlying social dynamics.
These include the creation of healing responses to excess, of the earth finding a way, and the tendency to help solve intractable problems through an increase in scale and complexity, in this case through the growth of new extensive networks between renewable power producers and power users.

Sustainability in the Market
Sustainability, in part, means smart businesspeople seeking competitive advantage in rapidly expanding markets. There's real money to be made.
Sustainability now counts. And counts big time.
General Electric President Jeffrey Imhelt, for example, has embraced "ecoimagination" and is aggressively pursuing markets for clean energy, efficiency, and clean water.
But sustainability is more than just new product development. Sustainability is, at bottom, a matter of addressing our fundamental challenge: how do we make things better in the future, not worse; how do we unleash the forces of growth in service to sustainable prosperity, strong communities, and healthy eco-systems?
We can no longer realistically choose between profit and a healthy environment. We must choose both, or we will have neither. In the 21st century we have moved from an either/or to a both/and world.
For businesses and institutions, the conduct of sustainability has become much more than rote acceptance of The World Commission on Environment and Development 1987 definition in Our Common Future (the so-called Bruntland
Report) that defined sustainability as meeting "the needs of the present without compromising the ability of future generations to meet their own needs."
Today, we are seeing flesh put on the bones of principle.
Roy Morrison is a writer and energy consultant involved in wind hedge development. His next book, forthcoming, is "Ecocivilization 2140." For more info see his Web site and click on power point and wind hedge section.

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