How the current electricity market design may keep fossil fuel alive Friday, 7 July 2017
Increasing the use of solar power and wind power may make continuing to burn fossil fuels for electricity production more attractive if the electricity market stays organised the way it is now. That’s the surprise outcome of a study by energy researchers Professor Wolf Ketter and Derck Koolen of Rotterdam School of Management, Erasmus University (RSM).
In the study, the researchers modelled how markets would be likely to react to more sustainable electricity production in the future. To understand why producers of power from fossil fuels still stand a chance in such a scenario, we need to understand how energy markets function, and how power producers make strategic decisions, Koolen says.
Currently, electricity producers sell most of their production to retailers in advance on forward markets, committing to deliver a certain amount at a certain time for a certain price. But in reality, demand and production both vary; they don’t perfectly match earlier predictions. Such imbalances are then smoothed out by selling and buying electricity on the short-term, or spot market. This happens on the day itself, or even in real time to ensure the electricity grid remains stable.
Weather conditions affect solar and wind power production. When the power supply from renewable sources falls short of demand, fossil fuel power plants fire up extra capacity to produce additional electricity. Or at other times, renewable energy producers may exceed their predicted production; on these occasions and fossil fuel power plants need to scale down to ensure grid stability.
In both cases, renewable energy producers fail to meet the commitments they made earlier on the forward market.
The researchers wanted to find out how a growing share of renewable sources will change the way electricity producers make decisions on the forward and spot markets, and how that affects electricity prices.
The outcomes of their simulations were two-fold, says researcher Koolen. The good news is that adding electricity from renewable energy sources to the market initially brings down the market price because of the low marginal cost of running solar and wind plants: once installed, there are few extra operational costs required.
But after a certain ‘tipping point’ ‒ once electricity from renewable sources supplies a greater proportion of the market ‒ the researchers’ models predict fossil fuel power producers could be pushed onto the spot market. Here, they can expect higher profits, either by selling extra electricity at a higher price when renewable sources can’t deliver supplies, or by being compensated for scaling down their generating capacity when there is a surplus of energy from renewable sources.
So increasing the percentage of renewable energy creates additional stimulus for conventional fossil-fuel burning power plants to remain in service in the long run, the researchers found.
Koolen indicates that to determine how far renewable energy must penetrate the market before seeing this effect, depends on market conditions and how the grid is set up. Further research is needed to assess how this plays out in particular countries or regions.
Professor Ketter says the study demonstrates that the current design of the electricity market needs to become more flexible to accommodate the rising share of renewable energy, and to reduce the use of fossil fuels to generate electricity.
More flexibility can be achieved by better energy storage, by improving market design, and better business models for renewable energy. For example, it should be easier and more profitable for consumers to trade the energy they produce on a decentralised grid. This way, the flexibility required to deal with uncertainties can be delivered in real time.
Rotterdam School of Management, Erasmus University (RSM) is one of Europe’s top 10 business schools. RSM provides ground-breaking research and education furthering excellence in all aspects of management and is based in the international port city of Rotterdam – a vital nexus of business, logistics and trade. RSM’s primary focus is on developing business leaders with international careers who can become a force for positive change by carrying their innovative mindset into a sustainable future. Our first-class range of bachelor, master, MBA, PhD and executive programmes encourage them to become critical, creative, caring and collaborative thinkers and doers. Study information and activities for future students, executives and alumni are also organised from the RSM office in Chengdu, China. www.rsm.nl
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