As discussed in yesterday’s post about the merit order effect, renewables compete well on the spot market because they have low marginal cost, and (at least in the case of wind and solar photovoltaic) don’t have storage facility to hold off until the most opportune time to bid in.

The result of this effect is to displace the most expensive bidders on the spot market: generally, the gas peaker plants. Mostly this is being done by wind farms, as in the South Australian example, although the effect of the growing number of rooftop solar panels could be having a similar effect too.

Today’s article will examine some of the implications of these effects for the electricity market and raise some questions that ought to be considered  in advocating the transition to renewable energy.

The cost of wind farms

This is not the same as saying that wind farms are cheap: they still have an upfront cost to build them. So, having generated a certain amount of electricity, and possibly sold it at quite a low spot price, they then sell the Renewable Energy Certificates (RECs) they have earned and in this way recoup costs.

This subsidy, operating under the Renewable Energy Target (RET), is currently coming under criticism, such as in the Energy White Paper just released (which we commented on here). If the RET were removed, it would not mean existing wind farm operators would bid higher in the spot market: they still would bid low in order to ensure they sell electricity when the wind blows.

But it would make their overall operation less profitable, and in a world of private electricity generators, that would make it very hard for wind developers to find finance to build new wind farms.

This has essentially been the problem that has stalled wind farm development for some time: the REC price dropped due to policies of the Rudd government (which we have outlined here).

Wind farms in and of themselves may not be particularly cheap, but in the NEM they can actually lead to big cost savings on wholesale prices. This does not only occur in the abstract charts I produced to explain the system: it has occurred in South Australia, where wind is now 20% of their electricity generation and wholesale prices are at their lowest since the beginning of the electricity market there.

Solar panels and “negative growth” in the market

The growing uptake of solar panels is also impacting on the market. As solar panel installations are decentralised, they are not generally counted in the market as a generator, but as a subtraction from overall electricity demand, along with energy saving measures.

Alan Pears wrote recently at The Conversation that energy demand overall is falling: “The Australian Bureau of Agricultural and Research Economics, in its 2011 Energy Update, shows a decline of 5.4% in 2008-09, followed by a 1.2% decline in 2009-10. Ausgrid has reported ongoing declines in NSW electricity consumption.”

Pears notes a number of factors that may be contributing, such as more efficient building design, or the uptake of solar and gas hot water. He also notes the role of solar panels:

“Over the past 18 months, Australians have installed around 650 megawatts of solar cells on their roofs – a large proportion of recent peak demand growth.

“These effectively reduce the visible electricity consumption by replacing grid electricity on-site and in the local network. They work well to offset the commercial sector peak day demand profile, and undermine demand at the most profitable times for the electricity industry – hot sunny days.”

This could be very problematic for the electricity market and businesses operating in it. Markets are supposed to grow: a shrinking market is not an area an investor wants to be in! Pears notes:

“…the traditional electricity industry will face increasing uncertainty and risk of building assets that may no longer be needed in a few years. Costly decisions could be made, as large power stations and powerlines take years to plan and build, and a long time to recover their costs.

“If they try to pass these costs onto customers, they will simply accelerate investment in energy efficiency, renewable energy and smart energy management. And if they fail to deliver reliable supply, they will face criticism and pressure from government, business and the public. They will lose more demand to alternatives that allow business and households to insulate themselves from lack of reliability.”

In Germany, Climate Spectator has reported that some peaking gas power plants may be retired by their operators due to unprofitability. We could expect to see this sort of thing elsewhere if renewables are taken up.

Are renewables unfair?

Renewables may compete well on the existing spot-market, but as I noted, they need subsidies (such as RECs, or a Feed-in Tariff as in Germany) to be built on commercial principles.

Free-marketeers naturally criticise the subsidy as unfair, but we have also pointed to huge subsidies to fossil fuels built into the economy: as much as $11 billion in one year.

In fact, the dynamic currently at play in the spot market is precisely that of a market: a greater range of options for electricity generation are being made available in a traditionally monopolised sector, and the most expensive bidders in the market (gas peakers) are not coping well. C’est la vie!

It could be argued that we need the gas peakers to manage periods of high demand, so it’s not in our interest to have them shut down. This might be true, but only for the short period it would take to build solar-thermal power stations with heat storage: these can easily replace the despatchable power provision of the gas peakers, as Beyond Zero Emissions have convincingly set out in their Zero Carbon Australia plan.

Unintended outcomes: is the market working?

One reader commented on yesterday’s article, “One of the unintended consequences of injecting wind into the generation mix is that it forces out gas, not coal.”

Is that the effect we really want, when burning coal causes more carbon emissions than burning gas? Carbon pricing, which we are now getting, can help to make gas more competitive as opposed to coal; but then new gas has been fiercely criticised by Beyond Zero Emissions because it threatens to stimulate a whole round of investment in new gas plant and infrastructure – when climate science indicates we need to be going straight to renewables.

Particularly as coal-seam gas now enters the mix, the latest studies are beginning to casting doubt as to whether gas is always much cleaner than coal anyway, when fugitive emissions of methane are factored in.

Rather than blaming the new market entrant, renewables, it might make more sense to question whether this market system is actually working for providing the nation’s electricity.  Strategic decisions about climate impacts, or about providing despatchable power that can complement wind farm and solar panel output, are not necessarily the outcomes that we get from the electricity market.

Unfortunately, the response from the energy sector seems to be to resist any change. Giles Parkinson wrote an article on this very topic at Climate Spectator: “in Australia, the established energy industry considers [the RET] to be evil, because it threatens the very business model of current and future fossil fuel generation investments.”

But the giant, inflexible “baseload” coal power stations we still rely on at this point were not built on free market finance. They were built by state governments with government money. It’s unlikely anything like them would be built on current free market principles, because the time it takes to start getting a return on the huge investment is too long for most private financiers (it takes years just to build such a large plant).

We could take the same general approach to renewables, instead of clinging to a market that is showing signs of failing. We didn’t always have an electricity market; there is no reason to suggest that it has to remain, unchanged, forever.

The entry of zero-fuel-cost renewables into the electricity spot market is threatening to destabilise the existing electricity supply system. An unstable electricity supply is not an outcome anyone is looking for.

We know that maintaining a safe climate requires fossil fuels be kept in the ground: why not ensure the clean alternative is firmly prioritised, and find a socially acceptable way that government and industry can do that?