Whatever wind, solar, geothermal or other project was built then was due to one thing: government mandates. Under the Public Utility Regulatory Power Act of 1978 (PURPA), for example, electric utilities were forced to pay premium prices for any renewable energy produced. And what followed was predictable: a building wave of highly inefficient plants that pushed up utility rates and ultimately did little for either the environment or US energy independence.

It’s still government mandates that drive renewable energy’s growth here in 2009.

In recent years, however, we’ve seen some fairly impressive technological advances that have brought costs down sharply. In fact, it’s fair to say that renewable energy in some regions of the country is actually a cheaper option than available conventional energy.

One place where government and industry are putting that to the test is Hawaii. The island has long been known for its abundant wind and sun. For decades, however, that potential field has laid fallow, as incumbent utilityHawaiian Electric (NYSE: HE) has relied wholly on imported oil to generate electricity.

Using oil has had its advantages. Mainly, the company has had plants in place to use it, and it can be easily obtained from the transoceanic tankers that frequent the archipelago. Management has also had little incentive to change its ways, as increases in fuel costs are automatically passed through into customer rates under state regulation.

That’s given the utility, which serves virtually the entire state of Hawaii, far and away the highest power rates in the country, year after year. In fact, they’re currently five times the average rate paid in the lower 48 states. Put another way, the state spends 10 percent of its gross domestic product on power, which generates a third of its overall carbon dioxide (CO₂) output and leaves it chronically dependent on the global oil market, one of the most volatile in the world.

But change is on the way. Hawaii is launching what it calls an “energy sovereignty plan,” under which it hopes to wean itself off at least most of its foreign oil needs. In a partnership with the US Dept of Energy, the goal is to obtain 70 percent of the state’s electricity from “clean energy” by 2030. That’s 40 percent renewable energy and 30 percent from energy efficiency measures that reduce demand.

That’s by far the most ambitious renewable energy plan in the country, more than twice California’s goal of 33 percent by 2020. The Dept of Energy will provide a large chunk of the funding as well as technological research. That will take the financial burden off the state and the utility, opening the door to more rapid development.

Two massive wind farms are planned, which together could account for up to 25 percent of power demand on the island of Oahu. Some industry observers believe these facilities could feature availability rates as high as 50 percent, compared to less than 20 percent for the typical wind plant in the continental US. Greater use would, of course, mean more wear and tear on the equipment and greater possibility of accidents. But it would also dramatically raise the economics of the plants.

The islands also have impressive potential for exploiting solar and geothermal energy as well as ocean thermal energy, a relatively untested idea that would take advantage of different water temperatures at varying ocean depths. And the state plans to develop an electric vehicle (EV) fueling network, which would allow EVs to draw electricity at off peak times and generate it for the state grid at the time of day when demand is high.

As for energy efficiency, the plan proposes to decouple utility rates from power usage, as has been done in California. As a result, Hawaiian Electric would no longer be incentivized to sell more power, but would be able to increase earnings instead by spending on measures that reduce use of electricity.

Step one would be the installation of a new generation of “smart meters,” which would allow Hawaiian Electric and its customers to better control power flows. The cost would be immediately recouped in utility rates as incurred, adding to rate base and earnings. There are also other incentives for adopting energy saving technology, such as encouraging mass use of solar water heaters that Hawaiian Electric would install and maintain.

Is the Hawaii plan a fair test of the economics of renewable energy? In a classic sense, it decidedly doesn’t rely on market signals to change behavior, in this case what source of energy is used to meet the island’s electricity needs. Rather, it has basically accepted the premise that replacing oil fired power with renewable power and conservation will provide favorable economics. And it’s also tacitly accepted the idea that such a switch can’t happen without direct government intervention to create the needed incentives.

Market history, of course, is full of examples of governments trying to create incentives to promote objectives and then failing miserably as consumers and businesses do something completely different. It’s hard to argue, for example, that the energy bull market of the ’70s was pulled down by PURPA and other government action rather than the giant price signal of sky-high gasoline prices that triggered permanent demand destruction through conservation and a switch to alternatives.

In this case, however, proponents of clean energy really have only one customer to win over: Hawaiian Electric. Because it basically holds a monopoly over generation, transmission and distribution in the state, the utility is ultimately responsible for what energy will be used to generate power. Consumers may or may not conserve energy as regulators want. But creating an incentive system that makes sense for the company is pretty much all that it will take to switch output to renewable energy from oil in Hawaii over the next 20 years.

That’s essentially what other states around the country have realized as well. Even as the collapse in homebuilding has slowed sales of solar panels in the US, generation of renewable energy is accelerating, as utilities are incentivized by government mandates and goodies to build and buy power from wind, solar and generation plants.

Conservation may or may not be coming on strong. But spending on new technology to encourage efficiency is ramping up because utilities’ rates are decoupling from energy demand, and because the cost of applying new technology to conserve energy can be instantly added to rate base. No longer are utilities penalized with lower earnings for helping customers use less energy. Rather, they’re increasing earnings while dramatically reducing the risks inherent in building new power plants.

The Easier Road

For most if not all utility executives these days, trying to build a new coal-fired power plant, no matter how clean its emissions, is increasingly like trying to ram your head through a brick wall.

Duke Energy’s (NYSE: DUK) Cliffside plant, for example, will replace five older units on that site. That would substantially eliminate the entire site’s emissions of acid rain causing gases, mercury and particulate matter. It will also immediately cut the site’s CO₂ emissions by more than half per unit of power produced. And it can ultimately be retrofitted with technology that will capture and store CO₂ for other uses.

None of that, however, has prevented CEO Jim Rogers from being pilloried by the “death to coal” crowd. Neither has the fact that Mr. Rogers has been a leading proponent of carbon regulation on Capitol Hill, or that Duke has a thriving wind power arm, or that it’s a leader in developing new technology to clean up coal.

The bottom line is the debate on coal in the US has broken down for many into a fight between good and evil. That means any new project, even if it involves cutting CO₂ emissions, will be heavily litigated, driving up costs and running the risk of making it uneconomic. And Duke has it a lot better than most, with favorable regulation in the Carolinas, Indiana and Ohio.

As I pointed out here a couple weeks ago, Energy Secretary Stephen Chu has apparently emerged as a champion of the nuclear power industry. But building a new nuclear power plant faces even more hurdles than constructing a coal plant these days. For many Americans, there will never be a safe nuclear plant. Nor for them can there be a reasonable solution to the problem of what to do with nuclear waste, or of the supposed risk of terrorism.

As a result, the only sites even being considered for new nuclear power plants are existing ones. And only companies that are able to secure substantial financial and rate commitments are even contemplating them, such as SCANA (NYSE: SCG) in South Carolina and Southern Company(NYSE: SO) in Georgia. To be sure, the existing fleet of nuclear plants provides the most competitive source of electricity in the country and is holding steady at 20 percent of overall output. Some plants will indeed be built. But for most companies, nuclear is just too expensive an option and too fraught with potential regulatory and legal headaches.

In stark contrast, constructing renewable energy facilities and spending on efficiency measures are easy decisions to make. Regulators and the public are broadly supportive, meaning investment gets put into rate base with dispatch. In fact, regulated rates of returns are frequently higher. And shareholders too are happy as their companies go green.

Of course, it’s one thing to pass broad mandates to use renewable energy and to make systems more efficient. It’s another thing entirely to reach those goals, given current technology. And it’s another thing again to reach those goals in a way that creates value.

Hawaii’s potential renewable energy assets aren’t matched anywhere else in the US. And they’re ideally suited to the state’s geography as well, which requires relatively small-scale generation to serve a large number of individual islands. For example, what’s now the state’s largest solar farm provides just 1.2 megawatts (MW) of capacity, versus 1,200 for the typical baseload power plant. The “micro grid” built by SunPower (NSDQ: SPWRA) it’s connected to, however, is expected to provide up to 30 percent of peak power needs on the island of Lana’i.

In short, assets like these are pretty much the right scale for this sized market. Neither is the fact that solar plants require a great deal of land a problem on Lana’i, where there’s ample space. That wouldn’t necessarily be the case in many areas of the US, and 1.2 MW of capacity, no matter how efficiently used, wouldn’t go very far in a large market with a centralized grid.

Such is the essential problem for renewable energy’s expansion in the lower 48 states. Costs vary not only by source technology, for example wind is cheaper than solar. But the cost of each source varies widely depending on the geography. Wind power potential may be in abundance in the Midwest, but it’s relatively scarce in the Southeast.

Meanwhile, using wind requires having a backup power source in case the breeze isn’t blowing, particularly with windmills in most regions running only 20 percent of the time at best. That means the cost of using wind is also determined by the cost of the needed natural gas to pick up the slack in those off hours.

Next to Hawaii, California and Nevada are the two states with arguably the greatest renewable energy potential. State monopoly power company NV Energy (NYSE: NVE) has for the first time met Nevada’s current renewable energy target of 9 percent. But it’s going to require a tremendous investment over the next five years to hit the state’s 2015 target of 20 percent, as well as the higher 12 percent target that kicks in this year.

NV Energy does have a plan in the works to link its northern and southern state service territories together. That has tremendous implications for increasing energy efficiency. And it also could help the company make a major further push into renewable energy, from solar in the south to wind and geothermal in the north.

The Dept of Energy is supportive, providing preliminary approval for the project, and there’s the possibility of garnering some federal money for green initiatives, such as a planned solar thermal facility. This level of capital spending, however, will require the continued support of regulators. And the state remains mired in a recession that’s hit the casino industry much harder than in past recessions.

As for California, the bulk of the state’s power generation isn’t run by regulated power utilities, which has incentivized utes to invest heavily in renewable energy and efficiency as it adds directly to rate base. Here too, however, building the mandated capacity will be difficult to impossible in the required time frame.

The Coming Shortage

As of June 2009, 33 US jurisdictions, including California, Hawaii and Nevada, require utilities by law to derive a percentage of other output by renewable sources. Some mandate by megawatts, others as a percentage of output. I’ve listed them below. Note that these standards would be superseded by pending federal legislation to regulate carbon dioxide:

• Arizona--15% by 2025
• California--20% by 2010, 33% by 2020
• Colorado--20% by 2020
• Connecticut--23% by 2020
• Delaware--20% by 2019
• District of Columbia--20% by 2020
• Hawaii--20% by 2020, 70% by 2030
• Illinois--25% by 2025
• Iowa--105 MW
• Maine--10% by 2017 (was 30% by 2000)
• Maryland--20% by 2022
• Massachusetts--15% by 2020 plus 1% annual escalator
• Michigan--10% plus 1,100 MW by 2015
• Minnesota--25% by 2025 (30% Xcel by 2020)
• Missouri--15% by 2021
• Montana--15% by 2015
• Nevada--9% currently, 12% by 2010, 20% by 2015, 25% by 2025
• New Hampshire--23.8% by 2025
• New Jersey--22.5% by 2021
• New Mexico--20% by 2020
• New York--24% by 2013
• North Carolina--12.5% by 2021 (for utilities)
• North Dakota--10% by 2015
• Oregon--25% by 2025
• Pennsylvania--18% by 2020
• Rhode Island--16% by 2020
• South Dakota--10% by 2015
• Texas--5,885 MW by 2015
• Utah--20% by 2025 (a goal, not mandated)
• Vermont--20% by 2017
• Virginia--15% by 2025 (a goal, not mandated)
• Washington--15% by 2020
• Wisconsin--10% by 2015

Source: Database of State Incentives for Renewables & Efficiency

About half of these have included some sort of minimum solar or site-focused aspect in their mandates. Ohio has included a separate tier of non-renewable alternative energy sources in its mandate. Meanwhile, Virginia and Utah have characterized their requirements as “goals,” meaning there will be no penalty for not meeting them.

To be sure, these are highly ambitious targets. According to the Energy Information Administration, renewable energy including hydroelectric power generated 371,688 thousand megawatt hours of electricity in the US for 2008. Renewable energy not including hydro produced 123,603 thousand megawatt hours, up an impressive 17.5 percent from 2007 tallies.

Of total electricity produced and consumed in the US, however, renewable energy, including hydro, was only 9 percent in 2008. And renewable energy not including hydro but including all solar, wind, geothermal, etc., was just 3 percent.

It doesn’t take a degree in mathematics to see that it takes an awful lot of work to boost a 3 percent share to even 10 percent, let alone the much higher figures now on the books of some states. And if you throw in the fact that overall power demand is expected to grow by roughly 20 percent over the next 20 years, that gap becomes wider still.

Do utilities and power generators have a chance to reach those targets, or the broader one envisioned by federal regulators? And what happens if they don’t meet them? Given the Marshall Plan-sized investment needed to build so much renewable energy capacity and the balance sheet strength needed to raise the money, could state and federal regulators risk really punishing utilities for noncompliance? And if they didn’t punish companies, wouldn’t that risk taking the needed teeth out of the law?

These are all questions to be answered in coming years. Thus far, regulators have been generally loath to punish companies that have been making an effort to meet the mandates. Nevada regulators, for example, didn’t penalize NVE Energy for taking until now to meet their 9 percent renewable mandate, and they don’t appear anxious to if the company fails to meet this year’s 12 percent target.

Maine completely blew its 2000 deadline for a 30 percent renewable mandate. It now has a far more reasonable requirement in place for 10 percent by 2017. Incumbent regulated utilities, however, are no longer significant operators of generating plants. So the state’s only option for punishing generators for noncompliance is to go after independent power producers, which could create some serious problems for supply. And reliance on biomass is likely to be a major liability until the US housing industry revives, as that’s the only thing that will get the timber industry up and running and generating wood waste.

No doubt, in many of these states, the governor and legislature knew they’d be long gone when the state mandates they pushed started to have teeth. As a result, they could look good being tough on the environment, and leave the practical matter of cleaning up the mess to their successors.

What’s probably surprised everyone most is the progress that the industry has actually made toward rolling out renewable energy technology that even a decade ago was hopelessly impractical. The cost of providing wind and solar energy still isn’t nearly as low as baseload nuclear or coal. In fact it would take an extremely high tax on the latter to bring them into the same ballpark.

Meanwhile, we’ve already seen shortages of turbines and other equipment needed to build wind power facilities, as well as skilled labor, driving up the cost of construction three-fold since early in the decade. And with credit tight, government support is the only thing propping up many of the players.

Utilities and other power producers nationwide, however, are building and buying renewable energy facilities at an unprecedented rate. And they’re being spurred as much by the carrot of boosting rate base as the stick of what happens if mandates aren’t met.

The upshot is demand for renewable energy is only going to accelerate in coming years, particularly as the deadlines for meeting these mandates approach. No matter how much money government and industry invest, supply will be tight. In fact, given the numbers, I can’t see how it will come close to meeting demand, and that’s a very good thing for investors.

My favorite play for conservative investors on renewables’ growth remainsFPL Group (NYSE: FPL), the nation’s largest producer of both wind and solar energy. The company’s unmatched scale and first-mover position in both sectors consistently put it first in line when it comes to new projects, as well as financing them. And the desire of Berkshire Hathaway (NYSE: BRK/A-B) unit MidAmerican Energy to buy FPL’s properties--rather than build its own--is a pretty clear illustration of the dominance it now enjoys.

For more aggressive investors, it’s time to take another look at SunPower, the top-tier manufacturer of solar panels that’s increasingly finding its growth as a builder of utility-scale facilities. The company is a leading player in the massive Hawaii renewable energy project noted above. And it sells for less than 30 percent of its 52-week high.

As for regulated utilities operating under state renewable energy mandates, the key as always is relations with regulators. If these remain positive, the numbers won’t be so important. Either the companies will be given flexibility to meet them, or they’ll be bent into something more reasonable. If they’re negative, we’re liable to see a lot of stupidity. That means higher rates for consumers and weaker performance for utilities, both in business and the stock market. Either way, it’s bad news we don’t want to be a part of.

Speaking Engagements

Eight score and one year ago, with the onset of the California Gold Rush, San Francisco earned a reputation as a prospector’s town. It’s time again to seek paths to prosperity--and to enjoy one of the most beautiful natural settings in the US, if not the world.

Venture west for the San Francisco Money Show Aug. 21-23, 2009, at the The San Francisco Marriott and discover how Roger Conrad, Elliott Gue and GS Early can help you profit in these adventurous times.

Roger will discuss utilities, Canadian income and royalty trusts as well as his new service focused on exploiting the greatest spending boom in history,New World 3.0. Elliott will detail the new direction for Personal Finance and provide his forecast on energy markets for 2009. GS, a constant at PF for two decades, will be there to speak on emerging tech, nanotech and defense tech.