Futures contracts could fix energy's future.

Photographer: Christopher Furlong/Getty Images

Trade Futures, Save the Planet

Mark Gilbert is a Bloomberg View columnist and writes editorials on economics, finance and politics. He was London bureau chief for Bloomberg News and is the author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable.”
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With the world finally recognizing the need to do more to ameliorate the effects of energy production on climate change, financial markets can make a valuable contribution to the shift toward renewable sources. In the same way that the derivatives markets help farmers manage crop prices, futures contracts can help power producers offset the vagaries of the weather.

Climate Change

One of the obvious problems with harnessing the sun and the wind to generate power is their unreliability. Turbines don't turn on calm days; cloudy days don't turn on photovoltaic cells. Here's a chart that illustrates how much more volatile the output from U.K. wind farms has been in the past six months compared with the megawatts from its nuclear power stations:

If you own a field full of turbines and the wind doesn't blow, you may have to buy power on the open market to meet the needs of your customers. As the chart shows, it's hard to guarantee consistent output when the weather doesn't cooperate.

Here's where financial engineering can play a role. Suppose a utility could sell a futures contract whose value rises and falls in tandem with an index measuring how hard the wind blows. The contract would hedge the risk of too little wind to generate power. Any profit from trading in the futures market would offset the cost of buying electricity to deliver to customers.  Conversely, losses from futures would be offset by profits in the physical market.

Both the Nasdaq OMX Group and the European Energy Exchange are considering introducing futures contracts based on indexes of wind strength. Konstantin Lenz, Nasdaq's country manager for Germany, said last week that a product to "help hedge the risks of renewable power" could be introduced in Germany by the end of the year. EEX Chief Executive Officer Peter Reitz said wind-power contracts could be available as soon as this summer.

Europe leads the world in replacing fossil-fuel with renewables. According to BP Plc's annual Energy Outlook, published Tuesday, renewable energy already contributes twice as much to the European Union's energy needs as it does in the U.S. or China, a gap that's set to widen in the coming decades:

Source: BP

The global picture for renewable energy is encouraging, according to the BP study. Renewables will grow by more than 6 percent by 2035, while annual coal demand will increase by just 0.8 percent. "Onshore wind power in the best locations is increasingly able to compete with new conventional fossil power plants," BP said. "Among non-fossil fuels, renewables (including biofuels) gain share rapidly, from around 3 percent today to 8 percent by 2035, overtaking nuclear in the early 2020s and hydro-electric in the early 2030s." The total contribution of non-fossil fuels will climb to 38 percent in the next two decades, up from 32 percent in 2013, BP said:

Source: BP

In Europe, a fragmented patchwork of subsidies is distorting the market. Germany, for example, guarantees above-market prices for electricity from wind and solar; in the U.K., companies rushing to add capacity before a planned cut in government subsidies almost doubled the nation's solar capacity last year. 

The more that countries rely on renewable energy for their needs, the more worried they get about avoiding gaps in supply. Fostering the development of futures contracts that help European utilities manage their wind and solar risks would be a useful step toward weaning the industry off subsidies and integrating renewables more seamlessly into the region's energy market.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Mark Gilbert at magilbert@bloomberg.net

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net