The megawatts invested in capacity to produce electricity from renewable energy and the megawatts/hours produced from this capacity are growing faster than expected within the European Union. That is definitely good news for climate change mitigation. However, what about the cost of such policy? Evaluating the cost of renewable sources within the energy mix is not an easy task. A key ingredient that needs to be considered is the intermittency of renewable energy sources. It affects the financial balancing of the electricity industry where fossil fuel plants are to be built and operated to replace intermittent sources at dates they are not producing.
The point is that among the highly heterogeneous renewable energy sources (hereafter, RES) the two most subsidized sources are wind and solar energy. They produce intermittently, partly in a cyclical way, partly in a random way. In practical terms, it means that whatever large the installed capacity and total production of RES, there is no guarantee that power will be available at the time we need it. At some dates, production will be larger than demand, at other dates it will be smaller. One could ask market authorities to solve the adjustment problem by allowing energy prices to move up and down at high speed. This actually cannot work as long as consumers do not receive the price signal. And even if they could know the spot price thanks to some electronic beeper, they still would have to adapt their energy withdrawal in real time, which requires specific electronic pieces of equipment. Absent all these smart helpers, the solutions that could be envisaged are technical. They combine i) energy transfers, either from one location to another (transmission) or from one date to another (storage), ii) demand adaptation (black-outs, brown-outs, load-shedding), and iii) additional production from non-intermittent sources. Let us now focus on the investment in fossil fuel plants as a back-up for the intermittency of solar and wind energy.
Consider the near future where one can expect that the RES investment costs will be low enough to compete against the thermal technologies. In this framework, both types are then installed, the former because of their close-to-zero operating cost, the latter because RES are intermittent. In a world of perfect information of consumers on the state of nature at production nodes, electricity should then have a low price when RES are available and a high price when they must be replaced by plants burning a costly fuel (including CO2 certificates). The optimal mix of technologies would combine RES and fossil-fuel plants on the basis of these state-contingent prices and both types of producers would balance their accounts. Actually, as long as the cost of installing smart appliances at consumption nodes coupled with devices from the Information and Communication Technologies all along the grid is too high compared to the welfare increase from introducing state-contingent prices, consumers continue to be offered only one price whether the intermittent sources are producing or not. They consequently consume too little energy when the intermittent sources are available and too much when they are not. Suppose that the equilibrium (or the regulated) non-contingent retail price is an average value of the marginal costs of production in the different types of generation plants. Then the retail price is above the RES cost and below the thermal plant cost. It results that the generators using fossil sources of energy will lose money so that they prefer to leave the industry.
Anticipating the future where RES will be able to compete against fossil fuel plants without subsidies, we therefore have to consider structural and legal solutions to implement the optimal energy mix constrained by non-contingent prices. Under free entry and exit, in order to keep generators using fossil fuel in the market, the price should not be lower than the long run marginal cost of their MWh. It is as if consumers will have to pay for a warranty of electricity supply. The drawback of this solution is that the owners of plants using intermittent energy pocket a profit equal to the difference between the long run marginal cost of electricity from fossil fuel and the long run marginal cost of electricity from intermittent energy. Consumers pay for being insured against random supply and the money they pay accrues to those who create randomness. With this profit in view, RES producers invest even more, which increases the intermittency of the installed mix.
Two basic public policies can reduce the rent assigned to intermittent energy producers and restore the second best energy mix. The first one consists of taxing RES and subsidizing thermal plants in order to balance the budget of each type of technology, the reverse of today policy. The second one consists of a mandatory technological mix in order to produce a non-random energy outflow. Each producer should either control the two technologies or buy an insurance contract that secures energy supply any time. These legal arrangements would force both the incumbents and new entrants to guarantee energy provision whatever the state of nature at the production plant locations. Both policies have their drawbacks. The first one, more market based oriented, comes at the cost of levying and redistributing public funds. The second one, more in line with command-and-control regulation, restricts the firms’ flexibility in their technology choice.
An intermediary solution is to reinforce the role of suppliers in providing final consumers with both energy and insurance through a menu of contracts. Yet this is for a more distant future because the provision of some consumers with cheap intermittent electricity and others with expensive reliable electricity within the same distribution network will necessitate more than smart meters. Consumption appliances will have to be equipped with microprocessors and connected through the “internet of things” to the suppliers. At periods of scarce energy, the suppliers will then be able to (partly) disconnect Mr. A who did not sign a “non-random contract” while still fully supplying Ms. B, his nearest neighbor, who did it.
Stefan Ambec, Toulouse School of Economics (INRA-LERNA-IDEI), and University of Gothenburg, and Claude Crampes, Toulouse School of Economics (GREMAQ-IDEI)
P.S. The authors have built an analytical economic modeling of the first-best and second-best production mix when intermittent sources can be combined with reliable sources. See “Electricity provision with intermittent sources of energy” published in Resource and Energy Economics 34 (2012) 319– 336 at http://www.sciencedirect.com/science/article/pii/S0928765512000024