3 Key Ways that Renewables Disrupt Power Markets

Renewable power will form an increasing proportion of future power systems across the world. Wind and solar have seen spectacular and permanent falls in installed costs, making them cheaper than fossil-fuelled alternatives in a growing number of markets.

For policymakers and incumbent power firms in particular, it is crucial to understand why this transition towards renewables is so disruptive, with long-term structural changes that go way beyond simply swapping old sources of electricity supply for newer ones.

Below I summarise three of the key issues that lie ahead.


1.  Increasing separation of wholesale and end-use electricity prices.

Power systems have traditionally operated a system based on power plants that can be turned on and off to match demand, and dispatched in what is termed the “merit order”.

Simply put, that has meant that where the sources of supply burn fuel (coal, oil, gas, nuclear), these sources have been used in order of the cost of fuel, per incremental unit of electricity produced (their marginal cost). When demand is low it makes sense to use those plants that create the least extra fuel bill, adding more expensively-fuelled plants to the mix as demand rises. At a wholesale (ex-power plant) level, electricity at peak demand has been more expensive to produce than electricity in the middle of the night when demand is low.

Adding sources like wind and solar into this mix completely disrupts that economic model.

They involve no fuel cost – their marginal cost is zero – so they dispatch first in a merit order system. The more “free” sun or wind is available, the less fuel is required and wholesale prices can be driven downwards.

However these sources cannot be guaranteed to match demand: output can be high even when demand is low (high wind speeds overnight, for example). To enable investment in such projects, policymakers usually guarantee dispatch for renewable power plants, regardless of demand levels. They use systems such as feed-in-tariffs or other power-purchase agreements to fix how much these power plants are paid, to reduce their revenue risks.

The result is that these renewable sources can drive down wholesale electricity prices while being themselves immune from the economics by which these are set. Instead, payments to these renewable suppliers are funded via levies, top-up payments or taxes additional to or beyond the impact of their marginal, wholesale costs.

In addition, policymakers are increasingly deploying mechanisms such as capacity markets, paying electricity suppliers not for energy generated, but on the basis of capacity availability (i.e. ability to guarantee generation at peak times).

Unless absorbed by government subsidy, all these extra costs all appear within the final (retail) price of electricity for end-users!

Here’s example data from Germany, showing how wholesale costs (blue) have been falling, becoming an increasingly smaller proportion of retail end-user prices (which have stayed high: the red line):


2.  Energy users become energy prosumers

The business of electricity has been dominated in the past by one or a handful of large organisations in each market. They have built and operated a small number of large power plants, relying on a mixture of long-distance, high-capacity and local, ubiquitous grid infrastructure to move the electricity to where it is used.

The arrival of renewable power in many countries has been accompanied by policies to encourage competition to incumbents through independent power producers (IPPs). Often these IPPs are still building relatively large (so-called “utility scale”) projects that tap into the centre of the power system – much as would any other, conventional plant.

However solar photovoltaic (PV) in particular lends itself to deployment at much smaller scales; so-called distributed generation. This means that generation can be added at the edge of the system – at the same locations where electricity is used. These locations can be domestic rooftops or can be rooftops or land associated with commercial/industrial premises.

In short: energy users become “prosumers” (producer/consumers)

The energy produced can be used onsite, to replace electricity purchased through a grid connection, or it can be fed into the grid to add to the general “pool” of system supply. When connected to an onsite battery or other system, whose costs are also falling, it can be stored for use later (when prices to buy grid-supply might be higher). Depending on capacity, or combined with other sources of supply onsite, it can form part of a strategy to go “off-grid”.

Which of the various options make sense will depend on the economics of a prosumer’s unique circumstances: their electricity usage, retail prices, grid connection costs, natural resource, installed capacity, grid reliability and more. At an individual prosumer level, there is no single answer to the question “what impact will distributed generation have?”. Decisions will be automated and complexity hidden by clever smart software; creating a gateway between prosumers and a “smart grid”, the latter providing signals of system loading, power quality and price.

Nevertheless, viewed from a system and policy level, some aggregated challenges do arise:

  • As more end-users generate and consumer their own power, the market for centralised supply shrinks.
  • For distributed prosumers, as for centralised power generators, the economics of consuming or selling power are better when demand is high (i.e. times of higher generation value). The shrinking of the supply market will therefore be skewed towards peak times, where conventional generators can be most profitable (and hence on which their business often depends).
  • Many prosumers want to keep the insurance of a grid connection and access to centralised supply. When the business of the latter is shrinking, how should this insurance – the cost of grid maintenance and keeping less frequently used centralised generators viable – be paid for?
  • If prosumers want to sell their power, how should electricity markets be structured to efficiently match these many small sellers to electricity buyers? Should the prices paid to distributed generators be the same wholesale ones as those paid to centralised power plants? Should they face the same forecasting risks (e.g. penalties if they fail to deliver as scheduled)?

Distributed generation promises to give energy consumers much greater control, at the expense of the traditional, large centralised power companies – the “democratisation” of energy. But it does need to be managed.

How do policymakers ensure that democratisation doesn’t become “energy anarchy” but is enabled in a way that also incorporates appropriate roles and responsibilities within a wider connected system?


3.  Flexibility for oversupply becomes as important as that for undersupply

Conventional power systems have been built with installed capacity scaled relative to peak demand, designed so a “safety” margin (capacity margin) above this is always assured.

In markets with high installed bases of renewable power generation, particularly variable ones, it is increasingly recognised that future benchmarks of system security and reliability will be based less around past concepts such as capacity margin and more around measures of “system flexibility”.

Variable renewable power sources (solar and wind) are inflexible – they generate when the natural resource is there, which may not be when the system wants them to (when demand is high).

Much focus has been applied to having enough other, flexible resource within a power system to be able to meet demand when the sun isn’t shining or the wind isn’t blowing. When faced with a situation of diminished supply, potentially below the required demand, there are several technological and market-based solutions:

  1. Flexible supply; sources of power generation that can be turned on (or up) when the sun or wind resource dips. Hydro or gas plants, or even small diesel generator-sets are ideal if there is a need to respond quickly to undersupply. Filling gaps over longer time periods, we can consider any other “spare” capacity that can be turned on/up (e.g. coal, nuclear).
  2. Storage represents a fast-reacting source of flexible supply. The key difference from the previous paragraph is that storage is not a source of additional energy. It can provide additional power on demand, but requires that the energy required (power applied over time) has been stored earlier: in a battery or pumped hydro scheme, for example.
  3. Interconnection represents another source of additional supply; but one that lies outside the power system: i.e. imported electricity.
  4. Demand-side Response (DSR) tackles the problem of undersupply not by providing more supply, but by encouraging or requiring end-users to reduce their demand, until there is sufficient supply to meet it (at an acceptable price).

All these mechanisms are being used, and their growth encouraged by policymakers, in systems where variable renewable power capacity is growing.

Because their outputs vary by large amounts, renewable power plants like solar and wind have relatively low capacity factors. This means very high installed capacities will be required to provide the same total amounts of energy over time as conventional alternatives. Even in a sunny market, it is likely to require three to four times the capacity of PV compared to nuclear, to generate the same amount of annual energy.

I have already outlined the flexibility solutions needed to ensure that capacity margins are maintained when demand is high and renewable capacity availability low. But high installed capacities, required to create large annual shares of renewable electricity, means there will be times when this large capacity is providing a lot of supply. There will be times when this is more than required to meet demand (the wind blowing hard overnight, for example): a situation of oversupply.

A situation like this can arise throughout a system, or within a specific part of it (typically where access to distant demand is limited by grid capacity).

In a reverse of undersupply, solutions to oversupply must decrease supply or increase demand:

  1. Curtailment. If there is insufficient demand for a source of supply, one option is to curtail it (turn it off).
  2. Storage: increase demand by charging a battery or pumping water up a hill.
  3. Interconnection: tap into extra demand outside the system (i.e. export excess power)
  4. Demandside Response (DSR): increase demand by encouraging some loads to turn on (or up). As an example, we can divert excess electricity into heating domestic water tanks.

Clearly curtailment is undesirable – if the sun is shining or the wind blowing, it is a shame not to use it (and potentially a disaster for investors in the power plants affected). China is an example of a market where curtailment (due to lack of grid capacity) has been a big problem:


The last three options are the same as those highlighted as solutions to undersupply; but operating in reverse – charging rather than discharging, exporting rather than importing, turning demand up rather than down.

There is a clear lesson here when planning future system flexibility!

Building (or maintaining) flexible supply such as gas or other conventional power plants solves only one problem – undersupply. However future power systems with high penetrations of low capacity factor renewables will encounter problems of oversupply too.

Smart policymakers will create mechanisms which drive investments into flexibility solutions that work in two directions: as sources of extra supply and as sources of extra demand.

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