This is an assignment I wrote for my Power Systems Engineering 5 course which I believe is particularly relevant and should be open to a wider audience.
Question
The essay should start from describing how development of renewables (wind, marine, solar, biomass, etc) is encouraged in different countries. Based on that analysis, you should try and answer the following question: can renewables at all be made compatible with electricity markets without granting them special support? What would be necessary to achieve that?
Abstract
This essay discusses whether renewables are compatible with the market by first outlining the different economic support systems in effect in the UK, Europe and America. A discussion is given of both Renewables Obligation quotas and Fixed Feed-In Tariff systems. The unique Californian Participating Intermittent Resource program is discussed as it is an important example of near-market compatibility. The generation cost in p/kWh for a selection of technologies is given as a market compatibility metric. Estimates are then given of the remaining fossil fuel resources. This is followed by a discussion of the effects of the finite supply of fossil fuels on the compatibility of renewables. A discussion of the competing effects of technological progress is then given. This is followed by an examination of the effect of a ‘carbon tax’ as an indirect renewables incentive. Finally, it is concluded that the fact that renewables are granted support suggests that they are not compatible with current energy markets. However, due to the finite supply of fossil fuel resources, and exponential technological progress, renewables will not remain uncompetitive for ever.
Introduction
This essay discusses whether renewables are compatible with the market, and concludes that, generally, they are currently incompatible in the absence of special support, but that this condition is likely to change in the future.
In order to examine this conclusion, the market support granted to renewable generation is first outlined for a number of countries and technologies. The question of whether renewables are currently compatible with the market is then discussed, followed by an analysis of whether this situation is likely to change.
Market Support for Renewables
Two main issues regarding market compatibility of renewables are discussed here. The first is that renewables are not currently cost-competitive with conventional generators and this is what the British, European, and American renewable support systems are designed to address. These are discussed first. The second market compatibility issue is that renewables are uncontrollable (except large hydro) and this contributes to their cost-competitiveness as well as inhibits their participation in traditional electricity markets. The Californian Participating Intermittent Resource Program hopes to address both of these market compatibility issues, and is therefore discussed last. The issues of network reliability and the location of generation are not discussed in this essay.
In the United Kingdom, an incentive for renewable generation is created by OFGEM’s Renewable Obligation Certificates (ROCs) [1]. The Renewables Obligation scheme has changed for this fiscal year and electricity suppliers are now mandated to provide a certain number of ROCs, rather than present evidence that a fixed percentage of their supply is met by renewable sources [2]. If electricity suppliers cannot meet their Renewables Obligation for a given fiscal year, they are required to ‘buy-out’ their MWh shortfall. The total money in the ‘buy-out’ fund is then distributed proportionally among ROC holders. For the 2007-2008 fiscal period a ROC was worth £52.95/MWh, an increase of £10.41 over its 2006-2007 value [1]. This value is what is made by a renewable generator over and above income from the electricity market. Therefore, an effectively separate market for renewable energy is created under the ROC scheme and electricity suppliers are motivated to produce renewable electricity, rather than lose income by buying out their shortfall.
There are technology-specific premiums under the Renewables Obligation scheme. For example, the relatively developed hydroelectric and onshore wind technologies obtain one ROC per MWh, while relatively undeveloped technologies such as wave and geothermal, achieve two ROCs per MWh to greater encourage their development [3]. Hydroelectric stations constructed prior to 1990 are excluded from participation in the Renewable Obligation scheme [3].
The majority of other European countries provide economic support for renewable electricity using Fixed Feed-In Tariff (FFIT) systems that are mostly based on the German Renewable Energy Sources Act (EEG) [4-6]. FFITs guarantee the price at which renewable electricity is sold to the grid and mandate that the grid purchase this electricity for 15-30 years, depending on the technology [6]. These two factors significantly reduce the risk of investment in renewable energy. In Germany, the FFIT system also offers different premiums according to the technology, maturity, and size of the renewable generating plant [6]. The tariffs awarded to each technology are reviewed yearly. Recently, the tariffs for photovoltaic, geothermal and biomass have been increased to spur development and investment, and uniquely, the tariff paid to wind power generators has been reduced due to technological advancements and the increasing wind penetration level [6]. In contrast to the UK Renewables Obligation system, a separate renewables electricity market is not created under the FFIT scheme.
An interesting aspect of the EEG FFIT is that the tariffs granted for some renewable technologies reduce by a percentage every year [6]. The theory behind this tariff ‘degression’ is that it is hoped that reduced tariffs will spur the technological development of renewables by providing an incentive for cost-reduction. Again, the degression rates are technology-specific and adjusted to reflect the maturity of the technology and the movement along the learning-curve [6].
Large hydroelectric plants (>500kW) were not supported by Germany’s EEG scheme prior to 2004 whereas there is currently a small premium to create an incentive to upgrade existing large hydro plants. The support for micro-hydro generation (<500kW) has increased since the EEG was enacted [6].
In America, renewables are given incentives on a state-by-state basis, with some federal influence [7], due to the nature of the US political system. The American system involves an amalgamation of FFIT, renewable credit quota systems, and assorted tax and loan incentives [8-10]. What is intriguing about the American approach is that some incentives are given on a regional and electric company basis, even within states [10]. The American schemes are also technology specific. Special provision is made for Solar power systems in California which are paid a premium [10] due to their ability to follow maximum air conditioning load [11, 12].
Of the American methods for promoting the development of renewables, the unique Participating Intermittent Resource Program (PIRP), developed by California in 2004, is of particular interest [13-16]. The PIRP is a method of attempting to integrate intermittent energy sources, such as wind, into the existing hour- and day-ahead electricity markets, without excessive economic support. The main problem of integrating intermittent energy sources into electricity markets is that any deviations (over- or under-generation) relative to the scheduled production results in harsh financial penalties [13, 14]. This market system is essential to guarantee security of supply and reduce the cost of electricity, but was designed for classical thermal plants, where unexpected deviations from schedule are rare. The inherent intermittency of the wind prevents wind generators from participating in this market without being penalised with hefty fines. The PIRP circumvents this problem using two devices. Firstly, improved and mandated weather forecasting technology is used to more accurately predict the wind speed, and hence the power produced by each wind farm, reducing the absolute deviations from schedule. Secondly, fines are not levied on a daily basis; instead, the deviations from schedule are averaged over a month, reducing the total fines, and hence reducing the associated wind investment risk by providing improved predictability of pay-back periods [13-17]. Wind farms participating in the Program receive the Locational Marginal Price [14, 17].
The PIRP is interesting because it improves the market-compatibility of renewables, without making as large a electricity market-distortion as either FFIT or Renewables Obligation systems. This is because, due to the nature of the operation of thermal plants, deviations from schedule are either predictable, due to scheduled maintenance, or rare, due to mechanical failure, and their market operation will be unaffected by the changed rules for wind power. With the current level of wind penetration in California, no significant change to the operation of thermal generators has been required thus far, and so no large market distortion has occurred [13, 18]. However, as increasing levels of wind power come online, thermal plants will be pushed into the ancillary service market in order to maintain security of supply [19]. The PIRP could therefore be viewed as causing electricity market-distortion in the future. In one regard, the PIRP actually reduces market-distortion because it prevents wind generators from gaming the electricity market as the Independent System Operator (CAISO) specifies their bid [19].
Market Compatibility
To discuss whether renewables can be made compatible with the market, the assumed definition of market compatibility is first given, followed by a discussion of the compatibility measurement metric used in this essay. Data on several renewable energy sources is then presented for comparison with conventional technologies. This is followed by a discussion whether the finite supply of fossil fuels and technical change will enable renewables to become compatible with the market without being granted special support. Finally, the impact of a potential carbon tax is discussed.
A good or service is said to be market compatible if the cost of production is lower than the market clearing price, for competing goods or services of a similar type, such that a profit can be made by selling said good or service [20]. The previous section illustrated that economic support is given to renewables in a number of locations around the world. This fact strongly suggests that renewables are not currently compatible with the market without being granted special support. Therefore, a reasonable measure of market compatibility would be to analyse the cost of production of each generation technology [20]. Cost of generation is only a basic measure and does not take everything into account [21], such as grid stability and location of generation, which are different discussions entirely. However, cost is seen as providing an appropriate basis of comparison suitable for the scope of this essay.
The cost of generation of electricity assumed in this essay is the unit cost (pence per kWh) including the capital cost of the generating plant, the fuel cost (if applicable), and operation and maintenance costs. Figure 1 illustrates this cost for a selection of generation technologies according to a study performed in 2004 by the Royal Academy of Engineering (RAE) [21]. The cost of ‘large hydro’ electricity was derived from a separate source published in 2000 [22] and converted to GBP in 2004 to achieve parity between references, assuming an exchange rate of 0.7 EUR to GBP [23], and approximating inflation at 3% to align the Hydro cost estimates to the year 2004. The data for other generation technologies given by H. Weis et al [22] is also comparable to the RAE data when given the same inflation treatment, and this tends to support the RAE estimates.
Figure 1: The relative costs of a selection of generation technologies in 2004 according to [21], and according to [22] for large hydroelectric plants. Nuclear cost includes decommissioning. All costs include capital, maintenance, and appropriate fuel costs. All cost estimates assume 7.5% discount rate, except where stated.
The data illustrated in Figure 1, while not comprehensive, serves to indicate the relative cost of each generation technology and, with the exception of large hydro, it can be concluded that renewable technology is consistently more expensive than fossil fuel-based technologies. The relative cost of each technology is also reflected in the levels of support given in the German EEG system, with more expensive renewable technologies being granted greater support [6]. It should be noted that the estimates illustrated for the cost of wind power in Figure 1 may be optimistic [24].
It is not all doom-and-gloom, however, as there are existing special cases of compatibility, and cases of almost-compatible renewable energy technologies. As can be observed from Figure 1, for example, certain large hydro schemes are cost-compatible with other generation technologies [22]. This is reflected in the fact that support for large hydro plants in Germany is zero for new plants and at a low level for upgrade investment [6].
The main problems with investing in large hydro power plants in the developed countries are the large initial capital cost, and the fact that the most profitable sites have already been exploited [25, 26]. By contrast, in developing regions such as South America and Africa there is estimated be a large untapped profitable hydro resource [25] and the limitations are the infrastructure available to sell the produced electricity, and political instability. Another issue is that financing is less favourable in these regions due to weak or inflation-prone currencies which increase the investment risk. These factors make large hydro less appealing, but are not technically related to the electricity market.
There are also cases of near-market compatibility for renewables. For example, the California PIRP is an optional scheme, and has been adopted by one-fifth of the installed wind capacity over a FFIT [14, 19]. As discussed, this Program could be thought of as not distorting the electricity market as it does not offer additional money up-front to wind generators. Furthermore, there is also talk of integrating Solar Thermal power plants into the Californian PIRP [19], due to the recent developments in solar irradiance forecasting technology [11]. This could potentially be the first case of naturally compatible renewable energy, because peak output from Solar Thermal power stations mirrors peak demand, which occurs when temperatures and hence air conditioning load are at their highest [11, 12, 19]. Therefore, electricity from Solar Thermal plants could be sold at maximum price in the hour- and day-ahead electricity markets, while minimising the penalty for forecasting errors. The youngest existing Solar Thermal plant in California sells electricity under 30-year FFIT contract, due to the high cost of generation, at 6.7 p/kWh [12] (USD to GBP 2004 [23]). However, it is predicted that the exponential learning-curve associated with Solar Thermal technology may bring the cost of generation down to 3.4 p/kWh [12] (USD to GBP 2004 [23]) by 2020, which would result in market compatibility, even assuming unchanging fossil fuel generation costs.
Fossil fuels are, by their nature, a finite resource. However, there is an important difference between resources and reserves: resources are the total remaining amount of a substance that is known to exist, but not necessarily recoverable with current economics and technology; reserves are the amount that is currently economically and technologically recoverable. To some extent, therefore, reserves are replenishable. In 2007, the World Energy Council (WEC) estimated that there is greater than 56 years of remaining gas reserves, at the current rate of consumption [25]. For nuclear power, the WEC estimated that there are at worst 85 remaining years of uranium resources at the current rate of consumption, with no recycling, and thousands of years of resources with recycling, although the New Scientist estimates that there are only 19 years of remaining uranium reserves [27]. However, thorium is an alternative nuclear fuel and is estimated to be more abundant than uranium [25]. The case for coal is more complicated. The traditional view is that there is plenty of remaining coal and that it will last over a century, positioning coal as a fall-back fuel [25, 28]. This view is held by the WEC, who estimate that the remaining reserves of coal will last for more than 100 years at the current rate of consumption [25]. However, using Hubbert Linearisation, validated by predictions made for the UK and USA, the New Scientist estimates a global coal ‘peak’ as soon as 2025 [28].
The basic economics of supply and demand suggest that as supply reduces, with unchanged demand, the price increases [29]. Therefore, as the supply of fossil fuels reduces, the fuel price of coal, gas and nuclear power stations would be expected to increase. Thus, the cost per kWh indicated in Figure 1 for coal, gas and nuclear power stations, would also increase. Additionally, increasing population and economic growth can be expected to enhance the rate of depletion of the world’s natural resources [30]. Therefore, the previously given WEC estimates [25] for the years of remaining fossil fuel reserves at the ‘current rate of consumption’ appear optimistic. Consequently, as fossil fuel reserves diminish, renewables will naturally become compatible with the electricity market in the future, regardless of their level of development.
Another important issue regarding the future market compatibility of renewables is technological development; however, it is a double-edged sword. When making predictions about future technological progress, it is generally assumed that advancement will continue at the current rate and that the rate of the last x years will apply to the next x years [31]. By contrast, in many fields, the rate of development either follows exponential or power laws, of which the classic example is Moore’s Law [32]. Exponential technological development would affect the market compatibility of renewables directly, and there have been a number of recent technological developments in renewables which illustrate this [33]. The exponential technological development of renewables can therefore be expected to continue and accelerate, leading to cost reductions and efficiency improvements [34, 12]. Additionally, a new market-compatible renewable technology breakthrough may occur relatively soon and transform the energy market, as CCGT technology did in the past [35].
Conversely, technological developments in other fields can be expected to slow the rate of growth of energy consumption [36] and improve the efficiency of fossil fuels. For example, the energy efficiency of the US has improved seven-fold since 1900 [37]. However, fossil fuels are further along their learning curves than renewables, and so their relative rate of improvement would be expected to be less [38]. Moreover, technological development will also have the effect of transforming some fossil fuel resources into reserves [25]. On the other hand, while technological development may slow the rate of growth of world energy consumption, it does still grow with time [30] and this will have the effect of progressively making it harder for renewables to achieve market compatibility through technical innovation.
There are also two alternative ways in which renewables could become market-compatible without special support. Firstly, natural compatibility would occur if consumers were willing to pay higher prices for renewably-sourced electricity. This could perhaps be achieved through increased awareness of climate change and finite fossil resources. Secondly, an indirect incentive could be given by penalising fossil fuels in order to raise their costs above those for renewables. This could be achieved through a carbon tax. The effect of charging carbon emissions at £30/ton on the price per kWh on the generation technologies illustrated in Figure 1 is given in Figure 2 [21, 22]:
Figure 2: Cost per kWh including a charge of £30/ton of carbon for a selection of energy sources [21, 22]. Only includes fuel emissions, no assessment of construction emissions. Otherwise, the same considerations as Figure 1 apply.
It can be seen from Figure 2 that more renewable technologies become competitive as the price of carbon emissions increases. However, this would have the knock-on effect of increasing energy prices so there would be an associated welfare loss. On the other hand, in the longer term, the welfare gain due to reduced climate change may outweigh the higher energy costs [39]. Such a carbon tax may only be effective if implemented on a global scale, however, to prevent unfavourable competition from businesses in regions where no carbon tax is applied, and to ensure the most efficient allocation of carbon-saving resources [39].
Conclusion
Renewables are not currently compatible with the electricity market without special support, as can be observed from the fact that renewables are given economic incentives in a large number of countries. However, large hydro is already market-compatible and there are cases of where near-market compatibility has been achieved without significant economic support, such as the Californian PIRP system which is designed to address both intermittency and cost considerations. Solar Thermal technology may also soon reach market compatibility in the American Midwest due to the PIRP system, technological development, and its natural load-following ability.
Economic incentives are given to renewable technologies in order to encourage investment in the hope that market compatibility will eventually be achieved due to the development pressure which is created. These economic incentives are essential to ensure that technological development of renewables occurs and that the world will be left with energy technologies that are sufficiently advanced when fossil fuels are depleted. The exhaustion of natural resources will produce a point at which renewables become competitive due to the market forces of supply and demand, regardless of their level of development. However, market compatibility would be ideally achieved before this happens and the fact that the technological progress of renewables is exponential rather than linear gives hope that this can be achieved.
References
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