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What happens when the energy price falls to zero?

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Numerous studies tell us that 100% renewables is possible, and cost effective. But how to structure an energy market where there is no fuel cost? Germany is already grappling with this dilemma, and the world is watching with interest. This is part of a series of articles on Germany Energiewende. More can be found in our Insight section.

 

One of the big questions about scenarios for 100 per cent renewable energy production is how to structure the energy market. We now know that having electricity supplied to a major economy entirely by renewable energy sources is possible, and most likely no more expensive than building new fossil fuel generation.

What we don’t know is how to structure the energy market so it provides the right incentives: If the marginal cost of solar and wind energy is close enough to zero (because there is no fuel cost), then the energy price in a 100 per cent wind and solar market is going to be zero – at least in the current market structure. But who would invest?

This is one of the major questions being put to regulators and policy makers around the world, but the country most in the firing line is Germany, one of the world’s most successful industrial nations.

It’s not that Germany is about to arrive at 100 per cent renewables any time soon. But the penetration of renewables (now above 25 per cent) is getting to the point where the current energy market, based around the cost of fuels, is no longer functioning as it used to. And by the time the country gets to 40 per cent by 2020, and close to 60 per cent soon after 2030, this will be a critical issue.

Some analysts, such as Macquarie Bank, have described the energy market as already broken, and there is no doubt that fossil fuel generators are screaming in pain because their coal and gas fired plants no longer make the profits they once did. German regulators and policy makers concede that their energy markets need to be redesigned.

How they do that is going to be one of the big tests for Germany’s Energiewende, the transition from a largely centralized base-load generation system, with lots of nuclear, to one based around renewables. And it is going to be one of the big challenges of the new “grand coalition” between Angela Merkel’s centre right CDU, and the left of centre SPD, which has its base the coal-rich regions of northern Germany.

And what is decided, and is achieved in Germany, will likely have a significant impact on the pace, and ambition, of renewable energy schemes in other major economies.

Still, despite the clamouring of the incumbent industries to have capacity mechanisms introduced into the market, the German policy makers appear to be in no hurry to indulge them. The recent treaty between the two main parties provides for no capacity mechanism before 2018, by which time the share of German renewables may well be close to one third of total demand.

It could be that Germany is looking for the survival of the fittest. “I would be very, very careful not to jump into capacity markets too early,” says Andreas Loeschel, who heads a government appointed expert committee looking into the energy transition process. Loeschel is also based at the Centre for European Economic Research (ZEW), and is also professor of economics at the University of Heidelberg.

“We don’t need them (capacity markets) at the moment,” he says. “We have excess capacity, but maybe it is something for the future.”

Rainer Baake, a former permanent secretary to Germany’s Minister of the Environment and now head of an energy industry think tank called Agora Energiewende, says some form of capacity market in the future is inevitable, but it is likely to be a mechanism that allows maximum flexibility, and so encourages not just “baseload” generators but other enabling technologies such as energy storage, demand management, smart grids, or whatever else is needed to deliver flexibility in a market with high renewables penetration, and the potential for large amounts of “pro-sumers”, households and businesses that can generate their own electricity.

“We need market where different answers to the problem are able to compete with each other, and we need more flexibility in the system,” Baake told RenewEconomy in a recent interview in Berlin.

“A few years ago, we thought we would have an energy only market and everything would be fine. Now we are looking at what sort of market we should introduce and when the right time to introduce it will be.”

(And it won’t be a simple capacity market, where generators receive payments simply for the ability to provide output on demand, even if it is rarely used, as is the case in Western Australia. It is more likely to be a sort of “capabilities” market, a more refined version that reflects environmental and other qualities. It’s just the name “capabilities” market hasn’t caught on yet).

This transition seems to be accepted by the two biggest generation groups in germany, RWE and E.ON, who are both now talking of a move away from centralized generation and towards distributed systems, where consumers do produce a lot of their own energy, and the role of utilities is to provide security of supply, added value and services to those “pro-sumers”. (Please read today’s interview with E.ON’s chief executive, and the recent insight into RWE’s new strategy).

Of more immediate concern, however, to the German regulators is how to manage the cost of this energy transition, and the cost of what has already occurred in the form of feed-in tariffs. Although it is important to note that a lot of nonsense gets written about this issue.

Loeschel says Germany – as a whole – is paying the same percentage of GDP (2.5 per cent) on electricity costs as it did 20 years ago. The problem is how these costs are distributed. The retail consumer has borne the brunt of the EEG, the tariff assigned to support green energy support schemes, because many industries are exempt.

The irony is that as the amount of wind and soalr has increased, the price of wholesale electricity, on which many energy intensive industries costs are based, has fallen by nearly half. And because the way the EEG has been structured, a fall in the wholesale price results in an increase in the EEG tariff paid by consumers. This, says Loeschel, has allowed complaints about rising electricity bills to be exploited by those who want to slow the Energiewende down.

But as Baake points out, no party that had an Energiewende slowdown as its official policy got any seats in parliament in the recent elections. And the grand Coalition has rejected any talks of retrospective changes in tariffs. Indeed, it has actually increased and expanded the renewable energy targets out to 60 per cent by 2035 – although some people say the country could achieve more, and this in fact represents a slowdown!

Still, these costs need to be capped. One of the causes of the scare campaign against the Energiewende is that industry fears it will lose its recent favourable treatment and energy discounts. “The people who are complaining the most are actually better off than they were a few years ago,” Loeschel says.

Baake’ Agore Energiewende has come up with its own solution, as illustrated by this graph below, although it probably requires a bit of explanation, particularly as it is in German.

agora market

 

The diagram is designed to illustrate how to get to 40 per cent renewables with minimum cost. This requires a total of 240Twh of renewable production – out of total grid demand of 600TWh. The vertical box on the left, EEG 1.0, represents the costs of tariffs already committed. Baake says this is around 17 euro cents/kWh. That, he says, was the cost of Germany’s learning curve, and it is locked in until 2020, when it will start to decline as the first tariffs expire. There is no talk of retrospective cuts, so the big question is what to do in the future.

Baake proposes something called EEG 2.0. Having installed 160TWh of renewables at an average of 17c/kWh, he suggests a cap of 8.9c/kWh for new renewable installations.  This is nearly half the cost of EEG 1.0 and is highly significant, because from now on it means that whatever Germany invests in, be it fossil fuels or renewables, the energy costs will be the same. “We are at a turning point in the cost debate,” he says.

However, to encourage enough fossil fuel or balancing capacity to remain in the market, Baake proposes the capacity measures mentioned above. Right now, wholesale power prices are at 3c-5c/kwh, many plants need higher returns to ensure positive cash flows. This could come from some form of capacity premiums.

Of course, he incumbent fossil fuel industry would like that light blue rectangle to be bigger and broader, but Baake says it is important for this part to be controlled. Many see this as the biggest threat to the development of the Energiewende.

Loeschel is happy to see a shakeout in the market. “The wholesale price has probably dropped a little too far. But this will change if we allow capacity to go out of the market. The larger companies try to bribe policy makers by telling them going to shut down power plants. We should now allow that.”

But, he conceded, changes are needed. His proposal is to create “mini markets” that would result in capacity being installed where it is most needed, and maybe overcome germany’s principal problem of having a lot of generation away from the main areas of demand.

“I’m very confident about the future of the Energiewende,” he says. “This is a long term project and an important one for Germany. We should not throw this whole thing out just because we have some problems in the first few years.”

 

 

 

 

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  • sean

    What rubbish!

    no wind farm would consistently bid at $0/mwh if the rest of the market also bid at $0/mwh they would bump it up to $20/mwh quick smart. They only bid that low because they know they will be getting something for it as the rest of the market will bid higher. If there was a much larger proportion of wind you would see bids of $10,$15 or even $20/mwh, because even if you have no fuel – you still have capital cost. But this would not inflict as much pain on their competitors (because they find it harder to curtail their production), Nor keep the price so low for consumers.

    The idea of a capacity market is utterly ridiculous. We already have a mechanism for rewarding a player that can provide power when it is needed – a market price! When there is an under-supply the price continues to increase until demand reduces or new supply is found!

    what needs to happen is for the market price to be more transparent to the end consumer. when the price reaches 60c/kwh(or whenever it is profitiable to do so) i want to see every hospital, TV station radio station, police station, emergency management centre, data centre, shopping centre, telephone exchange, football stadium, theatre, military base, University, financial centre flick to their standby generators.

    but it will never get that bad, because while homeowners are paying through the nose for power, Westfield is paying only a fraction of that, and they are insulated from the spot price.

    I do however fully support the idea of breaking up the wholesale market into smaller geographic regions, reflecting the fact that it costs money to transport energy around the country.

  • Askgerbil Now

    The premise on which this article is based:

    “If the marginal cost of solar and wind energy is close enough to zero
    (because there is no fuel cost), then the energy price in a 100 per cent
    wind and solar market is going to be zero”

    is not correct.

    If an investment of $1 million in government bonds yields a 10 percent return and an investment of $1 million in an energy generation plant that has a fuel cost of zero and a market price for its only product of zero, then the investment in this energy generation plant will be…. ZERO.

    The cost of capital is not zero. The costs of depreciation and maintenance are not zero and the opportunity cost of any investment decision is not zero, etc, etc….

    The price of just one of the inputs (for instance, fuel) does not determine the cost of production or the market price of any product.

    • Giles

      Er, that’s the point of the article. Most wholesale market are energy-only markets based on the marginal cost of generation. That is why they need to be restructured to take into account capital costs and LCOE.

      • sean

        they don’t need to restructure squat. if the wind company wanted to they could bid at $1500/mwh they CHOOSE not to bid above $0, if they want more money – bid higher, until you are undercut by your competitors.

  • Intrepid

    “What we don’t know is how to structure the energy market so it provides the right incentives: If the marginal cost of solar and wind energy is close enough to zero (because there is no fuel cost), then the energy price in a 100 per cent wind and solar market is going to be zero – at least in the current market structure. But who would invest?”

    Well, I think that, when the energy price falls to zero, energy supply will be provided by 100% volunteer works incentivized by passion to make the world better and keep our air and water clean and climate stable.

    Thank you.

  • Intrepid

    In the world where the energy price falls to zero, you can’t apply existing economics or business models. You need to apply totally different perspective.

    Economics so far have been based upon scarcity. Scarcity creates values. And, values set the price that suppliers can receive.

    However, in the the world where the energy price falls to zero, energy supply is abundant. You can’t put a price to them. Therefore, energy supply will be provided by 100% volunteer works incentivized by passion to make the world better and keep our air and water clean and climate stable.

    If you are working as a volunteer, you can understand it. If you are working for money, you will never be able to understand it.

    Thank you.

  • Dimitar Mirchev

    The solution is, of course: STORAGE

    Add enough storage and the price of electricity will depend only on how much energy is stored in the storage. Pretty much how the oil is priced in USA depending on the oil reserves.

  • InsightWind

    Early belief in renewable energy as an affordable solution for future energy supply
    has shown itself to be well founded. The current subsidy structures introduced
    to kick-start renewables have largely done their job. So have the old power
    market structures of the past, which evolved to provide centralised electricity
    generation mainly through exploitation of fossil fuels and latterly the use of nuclear
    technology.

    What is needed now, as Giles Parkinson so rightly states, is a whole new way of
    structuring the business of generating and selling electricity.

    Policy discussions often confuse very different elements of power system operation, which makes finding a workable long-term solution nigh on impossible. When discussing whether capacity markets are essential for security of supply, or not, it is vital to recognise that system RELIABILITY and operational STABILITY are
    two very different requirements.

    RELIABILITY is about having a margin of capacity over and above peak demand to cover for power plant outages, whatever the cause. The size of that margin is decided by probability statistics and remains constant on any power system, whether or not a high proportion of electricity is generated from renewable sources of energy.

    STABILITY is all about day-to-day smooth operation of the entire power system without unintended loss of supply for any customer. The more complex the mix of
    generation and the more renewables on a power system, the more FLEXIBILITY a
    power system operator requires to achieve operational stability.

    Adequate reward for providing FLEXIBILITY on any power system, but particularly those with high penetrations of renewables, could, theoretically, obviate the need for capacity payments. The tricky part is to reward flexibility adequately but not to pay too much for it, which would add unnecessary costs for customers. An energy
    market that through payment for ancillary services recognises the true value of
    flexibility may be the best option.

    Affordability and flexibility will be the watchwords of future energy market structures. But neither of these aims are likely to be easier to achieve if capacity
    remuneration mechanisms are introduced as a permanent fixture — and they will
    certainly not be achieved by the creation of full-scale capacity markets and
    all their expensive complications.

    My fear is that talk of a new “capabilities market” carries the risk of adding more
    turmoil by further confusing the separate requirements for RELIABILITY on the
    one hand and FLEXIBILITY (to achieve operational stability) on the other. Ask
    any system operator if the two requirements are one and the same and the answer
    well be a resounding “no”. Provision of each is necessarily dealt
    with entirely separately within power system management, which is perhaps not
    always full understood in the political arena.

    I delved into these issues recently in a straight-talking series of articles over six pages published in Windpower Monthly. It includes a number of bullet-point
    conclusions. The question tackled by the article series is whether capacity
    payments are essential for guaranteeing security of supply in a high renewables
    power system, or whether promotion of them is all about keeping legacy thermal
    assets solvent well past their sell-by date.

    Read the article series here (scroll down to Seeds of Confusion for more on the
    discussion above):

    http://www.windpowermonthly.com/article/1218191/trouble-capacity-markets

  • Chris Marshalk

    I just got a letter in the mail from Energy Australia saying Electricity Prices & Gas Prices are going up in 2014. Again ?????? What a Fkn Joke !!!!

  • SFGale

    The notion of ‘zero energy cost’ is incredibly naive. There are three problems in pricing:

    1. Renewable energy resource substitutes capital cost of renewables for capital and feedstock cost of inventional generation and distribution. Failure to understand this by some prominent opinion leaders has caused some of the erroneous ‘apples to oranges’ comparisons of economics. Further, the fact that renewables require a more substantial up-front cost, particularly at the retail consumer level, has created a speed bump that impedes adoption for their longer term economy in a presumed increasing fossil fuel price trend over time (the shale revolution notwithstanding).

    2. Fossil fuels are under-priced on two grounds.

    2.1 They don’t bear their rightful cost as a ‘pollutant’ contributing to impacts of climate change, as would other polluting industrial processes.

    2.2

    • Bob_Wallace

      “the fact that renewables require a more substantial up-front cost”

      Median overnight cost for wind is $1.57/MW.

      Median overnight cost for coal is $1.92/MW.

      Median overnight cost for nuclear is $3.10/MW.

      http://en.openei.org/apps/TCDB/

      Then add in the much higher financing costs of coal and nuclear based on the number of years it takes to build a plant (cumulative interest).

      Only combined cycle natural gas has a lower up-front cost with a median overnight

      cost of $0.92/MW.

      And in the windy parts of the US we’re starting to see wind beat out NG.

      “In the Midwest, we’re now seeing power agreements being signed with wind farms at as low as $25 per megawatt-hour,” said Stephen Byrd, Morgan Stanley’s Head of North American Equity Research for Power & Utilities and Clean Energy, at the Columbia Energy Symposium in late November. “Compare that to the variable cost of a gas plant at $30 per megawatt-hour. The all-in cost to justify the construction of a new gas plant would be above $60 per megawatt-hour.”

      Byrd acknowledged that wind does receive a subsidy in the form of a production tax credit for ten years at $22 per megawatt-hour after tax. “But even without that subsidy, some of these wind projects have a lower all-in cost than gas,” Byrd said.

      http://www.greentechmedia.com/articles/read/midwest-wind-cost-competitive-with-gas-and-coal

      • SFGale

        In reply to Bob Wallace:

        I sense that we’re not in disagreement, but that we’re not necessarily aligned in response to the premise of the article. At the risk of redundancy, I will try to clarify my comment.

        The article offers two thoughts which cloud the fundamental issue:

        “What happens when energy price falls to zero?”

        and

        “But how to structure an energy market where there
        is no fuel cost?”

        Energy and fuel, as implied in the article’s context are not the same.

        Source ‘fuel’, as in renewables, may be free, but its enabling capital infrastructure is not. In moving to renewables, and application of them to uses, we are substituting capital cost in some increment for consumable energy cost of some kind. In the case of renewables, particularly wind, wave and solar, we do not now know the total amount of that capital cost because supporting technologies, specifically storage, have not yet been perfected
        to scale and proven to total cost of ownership to inform a valid cost
        comparison. Some day, but not today, and probably not tomorrow.

        In the case of application technologies, like electric cars, again, we’re substituting a significant capital cost (the battery) up front for energy consumables over time. What is the break-even in total cost of operation over useful asset life? It will probably favor renewables over time, but not today, and probably not tomorrow.

        Application energy, from whatever source fuels, will not likely ever be ‘free’ because it will ultimately be tethered to supporting generation, transmission and application capital costs that must be amortized over useful life. To suggest otherwise, as the article’s title does, is naïve at best and misleading in any case.

        Subsidized energy, as is currently widely the case with renewables, is not cheap energy or a free lunch. Somebody else is paying for lunch, in whole or in part.

        The problem that the article is really addressing is how we manage a transition in technology and economics from the top down over an extended period that is being driven from the bottom up in the short term with unintended consequences and inconvenient truths. Some partisans will say ‘we don’t need a top-down approach! Let the revolution begin!’ That is as naïve as the notion of ‘zero energy price’.

        There is no ideal solution to this challenge, but the absence of a holistic understanding and a consensus on some orderly long-term plan of migration to renewables, in whole or in substantial part, is creating unnecessary disruption that society can ill-afford, and is ultimately hampering attainment of the long term goal.

        Any informed policy, plan or regulation must begin with a clear understanding of the facts and the possibilities that emanate from them. The notion of ’zero price energy’ is not a valid element of that understanding. Unfortunately, too many of the gullible and the guileful are willing to embrace this notion.

        • Bob_Wallace

          We need to remember that many US coal plants are quite old and near the end of their expected lifespan. And some are so dirty that it doesn’t make financial sense to clean them up.

          We’re going to have to replace those coal plants and some of our nuclear plants with some sort of generation. Wind, solar and CCNG plants are cheaper than new coal (>15c/kWh) and new nuclear (>15c/kWh). Additionally wind and solar have no fuel costs.

          “Subsidized energy, as is currently widely the case with renewables, is not cheap energy or a free lunch.”

          “The cost of large-scale solar projects has fallen by one third in the last five years and big solar now competes with wind energy in the solar-rich south-west of the United States, according to new research.

          The study by the Lawrence Berkeley National Laboratory entitled “Utility-Scale Solar 2012: An Empirical Analysis of Project Cost, Performance, and Pricing Trends in the United States” – says the cost of solar is still falling and contracts for some solar projects are being struck as low as $50/MWh (including a 30 percent federal tax credit).”

          “Another interesting observation from LBNL is that most of the contracts written in recent years do not escalate in nominal dollars over the life of the contract. This means that in real dollar terms, the pricing of the contract actually declines.

          This means that towards the end of their contracts, the solar plants (including PV, CSP and CPV) contracted in 2013 will on average will be delivering electricity at less than $40/MWh. This is likely to be considerably less than fossil fuel plants at the same time, given the expected cost of fuels and any environmental regulations.”

          http://reneweconomy.com.au/2013/big-solar-now-competing-with-wind-energy-on-costs-75962

          “The prices offered by wind projects to utility purchasers averaged $40/MWh for projects negotiating contracts 2011 and 2012, spurring demand for wind energy.”

          http://newscenter.lbl.gov/news-releases/2013/08/06/new-study-finds-that-the-price-of-wind-energy-in-the-united-states-is-near-an-all-time-low/

          http://www1.eere.energy.gov/wind/pdfs/2012_wind_technologies_market_report.pdf

          Federal subsidies for solar and wind reduce the cost by just over 1 cent per kWh. They receive a PTC of 2.3 cents for their first 10 years of production and PPAs are generally 20 years long. New nuclear receives larger subsidies than do either wind or solar.

          ““In the Midwest, we’re now seeing power agreements being signed with wind farms at as low as $25 per megawatt-hour,” said Stephen Byrd, Morgan Stanley’s Head of North American Equity Research for Power & Utilities and Clean Energy, at the Columbia Energy Symposium in late November. “Compare that to the variable cost of a gas plant at $30 per megawatt-hour. The all-in cost to justify the construction of a new gas plant would be above $60 per megawatt-hour.”

          Byrd acknowledged that wind does receive a subsidy in the form of a production tax credit for ten years at $22 per megawatt-hour after tax. “But even without that subsidy, some of these wind projects have a lower all-in cost than gas,” Byrd said.”

          http://www.greentechmedia.com/articles/read/midwest-wind-cost-competitive-with-gas-and-coal

          Wind is the cheapest new generation in the Midwest. Solar is the cheapest new generation in the Southwest.

          • SFGale

            I do not disagree with or dispute the information you provide, but it is irrelevant to the fundamental issues in the article.

            Yes, renewables will become cheaper in absolute terms as we improve production economics. Yes, they will be cheaper in relative terms to non-renewables over
            time as non-renewables become more scarce or more costly through appropriate application of a carbon tax for their environmental and economic consequences.

            But today, the economies of Midwest Wind and Southwest solar don’t mean squat to me in New England where my ISO doesn’t derive benefit from either.

            And Southwest solar threatens the stability of the California energy market which has apparently not prepared for its infusion in a rational manner, any more than it has mediated the conflicts between the producers of that marvelous energy resource and its environmental opponents who apparently suffer multiple personality disorder in getting the voices in their head to resolve the
            conflict between the creation and transmission of clean energy and the visual pollution and disruption of an otherwise pristine landscape in that cause.

            Germany and Spain have similar issues on a larger scale to California in the economics of energy transition, as the article notes, and that remains my fundamental point. We must bring the silos together to see the transition process as a whole, and manage it as a whole.

            We are not well-served by partisans who suggest as the
            author has that renewables are without cost, or partisans for frack-gas who suggest that it is our salvation without recognizing its collateral costs. We are not well served by advocates of distributed renewables who chant ‘Screw the
            utilities; full speed ahead’; or by utilities which refuse to recognize the inevitability of renewables and seek to impede it by all means rather than facilitate it intelligently. The partisans on all sides of the energy issue are pursuing their own narrow goals of self interest or self-enlightenment to the exclusion of collateral compelling considerations. It is not working well, as the article notes.

            Doing more of the same will not improve the situation, as Einstein noted in his laconic definition of insanity.

          • Bob_Wallace

            4 cents per kWh is a nationwide average for 2011 and 2012. Wind might be a bit more expensive in New England but it will come down, as will solar.
            The energy world is changing and utilities will have to adopt.

            Some livery stables became car garages and some wagon makers started to make cars. Some didn’t adapt and failed.

  • http://www.trongdong.weebly.com/ Nhan

    What come will … come , energy sector waylaid everyone for a long time ,

  • cleanthinking

    The German Energiewende is a very important project for the world facing climate change and fossil fuels. Germany is on its way to very cheap energy prizes, but companies like RWE and EON are still in trouble inspite of this decentralized Energiewende. Maybe this article is interesting for your discussion: http://www.cleanthinking.de/eeg-reform/energie-soli-auf-eigenverbrauch-ist-unsolidarisch-36580/