Management of Uncertainty in the Renewable Energy Market

Daniella Rough, Matriculation #3359562

Introduction Uncertainty, or lack of knowledge of future outcome(s), is an inevitable factor of life that we deal with every minute of every day. From seemingly trivial activities such as walking across the street, to investing in a business, there lies an element of unpredictability, and the variability of the possible outcomes is related to the magnitude of uncertainty. The tricky question rests, as uncertainty by definition involves unknown factors, how can one manage something that they arent aware of? How can one prepare for a 3-headed monster attack when they dont even know 3-headed monsters exist? We are constantly weighing the possible outcomes of a situation (subconsciously or consciously), and acting in ways which minimize the risk of consequences, while achieving the best perceived outcome given our predefined priorities and/or objectives (Atkinson et al., 2006). With increased knowledge and history, the relative likelihood of future alternative outcomes can be evaluated, and thus pro-active actions can be taken to limit the window of possible consequences (Hans et al., 2007). This process is called management of uncertainty, and can be applied to any decision making process in life, business, projects, etc. A good illustration of management of uncertainty is riding a bike from point A to point B. There are a number of uncertainty factors that may be taken into account in order to achieve the objective (getting from A to B) in the most efficient way with the least risk of consequences. Priorities to reach this objective could be minimizing time, cost of the bike, comfort of journey, etc. and these known factors can be managed by making calculated decisions from cost/benefit analyses. However, the risk of possible consequences due to unknown factors (uncertainties) such as getting hit by a car, hitting a bump, a large object falling from the sky, the tire popping, etc., can only be minimized by evaluating all of the possible foreseeable uncertainties and taking preventative actions to mitigate them. In the case of the bike, these might include riding slower, looking both ways before crossing roads or buying a higher quality more responsive bike. These pro-active calculated risk mitigation decisions to minimize the probability of future unknown consequences are examples of how uncertainty can be managed; although, in reality, they can be significantly more dynamic and complicated and thus harder to predict (Kauffman and Carter, 2006, Hans et al., 2007). While the concept of uncertainty can be applied to all fields and businesses, this paper considers management of uncertainties from the renewable energy management perspective. Six categories

of uncertainty are considered and discussed in terms of specific examples and ways that they can be managed. These include: 1) Resource, 2) Technological, 3) Infrastructure, 4) Market, 5) Economic, and 6) Regulatory uncertainties. Resource Uncertainty All products or services are limited in terms of their lifespan and/or availability. Uncertainty of an agricultural product or resource could be related to the product rotting, being stolen, or taken over by disease. These uncertainties could be managed by using preservatives that extend their longevity and resistance to degradation or using security measures to increase protection of the resource. Renewable Energy is sourced from nature and therefore comes with inherent variability and uncertainty of resource availability. Some days the wind doesnt blow and the sun shines less intensely. These uncertainties cannot be controlled; however, managers can improve their ability to predict the magnitude of resource uncertainty with additional knowledge and experience. This can be achieved by evaluating large meteorological datasets to better understand temporal and spatial variability of renewable resources. Unfortunately data are not always shared, can be expensive, or are unreliable, increasing the challenge of historic data evaluation (Atkinson et al, 2006). Actions can also be taken to reduce the magnitude of consequences from resource uncertainty, such as: smart management of grids to better distribute energy, and utilizing buffers (e.g. hydrogen storage) to help level out the fluctuations (IEA, 2011; Tylock et al., 2012). In these ways, resource uncertainty can be reduced through knowledge and evaluation of historic data, and the possible consequences can be reduced by systematic control measures. Technological Uncertainty Technologies are constantly evolving to improve efficiency, be more cost competitive, or meet changing societal needs. Every industry experiences the uncertainty of whether their product may become obsolete or uncompetitive. As such, technology is one of the greatest forms of uncertainty for a business (Hans et al., 2007; IEA, 2011; Tylock et al., 2012). You dont know what the next company may come up with, especially in immature markets where the wheel is still being invented, so to speak (Atkinson et al., 2006). Technological uncertainty is especially relevant in the renewable energy industry. While the concept of renewable energy may date back to BC times, it has only recently become a major player in the global market and therefore intensive international research and development (R&D) 2

into renewable energy technologies is in the early stages. Someone could invent a little black (e.g. cold fusion) box tomorrow that could power cars, houses and cities, in which case all investment into other forms of RE technologies could become obsolete. Although this risk may be unlikely, minor risks of this nature are continuously occurring in business. As mentioned previously, one of the best ways to manage for technological uncertainty is knowledge. In this case, knowledge in the form of hiring the best people possible who are not only up to date with current knowledge, but also innovative thinkers. Ones who can think outside the box and see new approaches and opportunities (Atkinson et al., 2006). Paying attention to other technological innovations can also help. China is not known for coming up with new technological innovations, but they are very adept at adopting others ideas and reducing the costs of production. One can follow the road most travelled, improve existing but less developed roads, or create entirely new roads. With a good birds-eye view of the landscape, a clear sight of the destination, and knowledge of all neighboring roads that can be used or avoided, one could reduce the chance of building a road leading to a cliff or into a lake, and increase the probability of building the most direct route to their destination (or objective). Infrastructure Uncertainty Infrastructure is what allows for communication and utilization of a product or service; it is the required framework to enable development and incorporation of a business or project into a wider network. Examples of infrastructure include the internet for a web-based company, the stock market for a trading or banking company, or roads for the transportation industry. Without infrastructure, the capillary system of an industry, businesses would cease to exist. Uncertainty of infrastructure can be considered in terms of external threats and opportunities, and just as opportunities to access or improve infrastructure may arise, so too may threats to existing infrastructure (Ward and Chapman, 2003; Atkinson et al., 2006; Holburn, 2012). The global financial crisis of 2007-2012 was a threat unforeseen by the majority of the world, and thus a good example of an uncertainty in the financial infrastructure. While those with knowledge and historical perspective might have predicted its occurrence, no one entity could have prevented it, but all entities that depend on the infrastructure were impacted. In the context of renewable energy, the uncertainty of infrastructure plays a crucial role in how projects and businesses are managed. While conventional energy distribution has been traditionally concentrated in centralized areas, the nature of renewable energy demands a more dispersed distribution network, and one which is currently undergoing development and 3

improvement. Many managers are beginning to develop renewable energy projects without any guarantee that they will have a grid connection when the project is complete. Furthermore, there is uncertainty as to whether the grid will be capable of handling the power being produced as more and more renewable energy projects are being developed while existing grid networks remain unimproved. This is especially relevant in the current financial crisis as governments are determining that less and less funds are available for new infrastructure (Holburn, 2012). In many cases, renewable energy managers find that they have jumped through all required hoops (EIA, planning permission, development constraints, etc.), but have no means to transmit their product upon completion. Ways in which infrastructure uncertainty can be managed include planning in more secure areas where transmission infrastructure already exists (low hanging fruit), building away from other projects where there is less competition for the grid capacity, and researching areas that have a history of successful renewable energy project approval and integration. Market Uncertainty No business can exist without a market, but markets can be unpredictable and affected by uncontrollable external factors such as economy, competition, and resource availability. International markets can be even more complicated as you have differences in cultures, currency, trade barriers, geography, etc. (Kaufmann and Carter, 2006). Market uncertainty comes from not knowing what future markets will want and how much they will be willing to pay. Further complications are added when international interests and conflicts are involved. In the case of the solar industry, China has been accused of dumping solar panels on the international market by providing them at a price which is lower than the cost of production. This may have been unforeseen by other players in the market as it is unsustainable behavior, and not short-term profit driven as would be expected under the Homo Economicus model. It is difficult to manage for this type of uncertainty, especially when market actors behave in ways that are not predictable or expected. However, while pro-active, or preventative measures cannot be taken to avoid this type of uncertainty, reactive measures can be taken (Hans et al., 2007). This is demonstrated by the US who has responded with a 31% anti-dumping trade tariff on Chinese PV panels to help level out the market (Leone, 2012). One risk of this type of management strategy, however, is the development of trade wars where international trade becomes restricted (embargos or sanctions), moving away from the goals and objectives of a free market economy. 4

Other ways to reduce uncertainty in the market are to adopt different market strategies such as becoming a technology leader for a new type of product to reduce competition from others (e.g. Apple iPhones), or following businesses with a known track record in existing markets (e.g. China producing known products for lower prices). Renewable energy managers face all types of market challenges due to the lack of history and thus high level of uncertainty in the market. The US and Germany may be technology leaders, coming out with new innovative technologies, but are not necessarily market leaders as China and other countries have greater capacity for lower cost mass production. The uncertainty in the renewable energy market has led to the demise of many companies, as evidenced by the increasing number of bankruptcies filed by PV panel production companies in the US and Europe. While failures are inevitable in new markets, managers can reduce the risk of the uncertainty and consequences by increasing their knowledge of competitors, increasing and maintaining R&D in the market, and playing fair with other actors (game theory) for a greater benefit to the overall market (Kaufmann and Carter, 2006). Economic Uncertainty We operate under a capitalist system where goods and services are produced for profit, so no matter how philanthropic or green a business or company may aim to be, it cannot survive without profit. The magnitude of profit, however, depends on all of the previously mentioned uncertainties, in addition to how well the overall financial plan or strategy has been implemented. Economic uncertainties can arise from the inability to predict market demands, changes in production costs, changes to financial subsidies, divergence from assumptions of competitor costs (e.g. fuel escalation rates), and fluctuations in different currencies. In the renewable energy sector projects are generally dependent on tax credits or feed-in tariffs (FiT) in order to be profitable and competitive with conventional energy. This is a major financial uncertainty for renewable energy managers, although more prevalent in the initial stages of project development. Often, planning and permission processes can take years, after which point, degression of FiT can result in a lower long-term profit than may have been originally assumed. An additional consequence to project timescale delays is increased debit term, or paying credit fees during unprofitable start-up periods (Barradale, 2010; Tylock et al., 2012). Once projects are approved, this uncertainty becomes negligible as there is usually a longterm FiT and power purchase agreement commitment of up to 20 years. In January 2012, the highly successful FiT program in Spain was cut immediately and without warning by the new government in an effort to aid the failing economy (Couture, 2012). As such, projects that were not yet approved are no longer eligible to receive a FiT. This sort of uncertainty, while always a 5

possibility, was not expected and no doubt resulted in the cease of the majority of new renewable energy projects on line in Spain. Sudden changes like this cause a ripple of uncertainty to spread throughout the industry due to reductions in investor and consumer confidence. Further unexpected costs (e.g. additional maintenance due to a turbine blade breaking off), can quickly make a RE project unprofitable. Ways that renewable energy managers can reduce economic uncertainty include operating in low risk areas for planning permission, selecting project areas with low social, regulatory and environmental constraints to enable quick EIA approval, working with governments that have strong commitments to FiT schemes, securing power purchase agreements to avoid losses on internal rate of return during times of grid overload, reducing or spreading out the financial risk via hedge funds, building long-term relationships with supply chains to reduce fluctuations in cost of production, and continuing to build on market awareness through R&D and marketing efforts (Barradale, 2010; Holburn, 2012; Tylock et al., 2012). Regulatory Uncertainty Regulatory uncertainty can arise from unexpected policy changes, removal of government subsidies (e.g. the Spanish FiT example above), changes in government leaders/parties and their associated priorities or agendas, national commitments, international trade agreements, etc. (Barradale, 2010; Holburn, 2012; Tylock et al., 2012). Even with a strong business strategy, a project or business cant survive without regulatory support. This holds especially true for renewable energy managers as national regulations are constantly changing to meet new international commitments to mitigate climate change (Barradale, 2010; Holburn, 2012). Furthermore, the regulatory framework surrounding renewable energy is very new and there are few examples of countries (e.g. Germany, China, United Kingdom) that have a successful track record and regulatory approach for promoting renewable energy development projects. For renewable energy managers, regulatory uncertainty poses the largest risk in the sense of products or projects not receiving subsidies, not receiving planning permissions due to stringent policies or changing national commitments, protests from stakeholders, government quotas being reached, changes to environmental and social constraint thresholds, and lack of government support for grid expansion (IEA, 2011; Holburn, 2012; Tylock et al., 2012). These uncertainties can be minimized by having a good understanding of the existing regulatory framework, following national and international developments in climate change agreements, using a transparent approach to involve stakeholders and government agencies in all stages of project 6

management, and picking the low-lying fruits (e.g. working in areas with a good regulatory support framework in place). Discussion and Conclusions Uncertainties in all categories: resource, technological, infrastructure, market, economical and regulatory, are an unavoidable component of any business or project. For renewable energy managers, uncertainties are further exacerbated due to the newness of the market and lack of historical experience to help guide market and regulatory decisions. These uncertainties must be strategically addressed and managed in order to minimize the risk and magnitude of unforeseen consequences (Ward and Chapman, 2003; Holburn, 2012). Decision makers should be mindful of cognitive simplification and ensure that all relevant uncertainties and alternatives are considered (Schwenk, 1984). While management programs (e.g. TopSim and RETScreen) can be useful tools to conduct sensitivity analyses and help determine relative impacts of possible uncertainty alternatives, these can also be problematic in that they offer black box approaches to management decisions. Expert systems are like people who have learned a solution by heart without comprehending it (Seiler, 1990). As most modeling programs dont incorporate real experience, common sense, or normative uncertainty, and can be manipulated to yield desired outcomes, they should be used with prudence and discretion (Seiler, 1990; Atkinson et al., 2006). The most effective ways to manage uncertainty (including the renewable energy market) are to: learn from the limited history and make educated decisions; incorporate up-to-date knowledge through continued R&D; hire employees with a strong knowledge base, experience in similar or relevant industries and an ability to think innovatively; work together and share knowledge with other actors (behavioral transparency) to help build the industry collectively and efficiently (post-heroic approach) creating a strong foundation for long-term market stability; and choose low hanging fruits in terms of areas with a higher probability of gaining immediate regulatory approval and long-term financial support (Atkinson et al., 2006; Kaufmann and Carter, 2006; IEA, 2011; Lenfle, 2011; Holburn, 2012; Tylock et al., 2012). While uncertainties cannot be controlled, they can be better prepared for and managed through experience, knowledge and preventative pro-active measures, thus minimizing the risk of unintended consequences. Just as you wouldnt ride a bike down a bumpy and busy road with your eyes closed, management of uncertainties in business should follow the same guiding principle.

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