Giles Parkinson at ReNewEconomy has a call to redesign the way energy markets work to handle the shift to renewable energy - It’s time to redesign the world’s energy markets.

The path from point A to point B in the de-carbonisation of the world’s electricity markets is looking more problematic by the day. Even as more people can see what the destination looks like, few are sure of the best path to get there.

More and more reports are being produced that demonstrate how the world’s biggest economies can be powered by renewable energy sources – essentially the wind and the sun. The EU has done its own scenario planning, as has the International Energy Agency and numerous other institutions and think-tanks, including Australia’s UNSW, the Melbourne Energy Institute, and Beyond Zero Emissions. The US-based National Renewable Energy Laboratory this week released a report showing how the world’s biggest economy could be powered 80 per cent by renewables by 2050. But the problem is how to manage that transition.

Most studies, such as the IEA’s, Desertec’s and NREL’s, talk of a “new paradigm” in energy markets. But it’s not just a new way of thinking. Some utilities who operate in these markets are more prosaic – fearing that these markets are effectively defunct because renewables redefine the rules on which these markets were built. Or, at least, they displace those that were previously favoured.

This is in reference to the merit order effect, which we have documented on numerous occasions, and which is now entering the broad lexicon of policy decision-making.

Australian utilities have a particular interest – although the merit order has impacted revenue and profits to a lesser extent than in Germany, the sort of penetration that is being envisaged by the world’s largest economies – and which will be demanded by consumers who can see that rooftop solar is a cheaper option that grid-connected power – could challenge, or even ruin, the business models of the incumbent fossil fuel generators.

In short, they are about to go through the same sort of revolution that is being experienced by the media industry disrupted by online publications. And no-one is too sure how to react, other than assuming and implementing a massive upheaval.

The German government – which has an ambitious renewables program to fill the gap left by nuclear – has recognized the issue, and called emergency talks to discuss what regulatory initiatives could be adopted to ensure that enough capacity remains in place to manage that transition.

This week Stadtwerke Leipzig, a local utility, noted that renewable energy is lowering power prices, but in doing so has left the country with a market whose design is no longer effective.

“As long as renewables have zero margin costs, the market design we have doesn’t work,” Jens Teresniak, team manager for business development and market analysis at Stadtwerke Leipzig, said in an interview in with Bloomberg. He said capacity markets, that allow utilities to fix prices for guaranteed backup power supply in advance will support margins for gas and coal electricity plants as renewables output rises, and could be the solution.

This is now being openly discussed among German policy makers – because major power producers are refusing to build new gas plant without it. It is even being discussed in Australia, although some wonder if a system that guarantees payment to generators whether they are producing or not, can be the most effective mechanism.

Germany electricity prices have fallen substantially and fell 18 per cent to 43.49 euros ($54.36) a megawatt-hour in the first five months of this year compared to last year, according to data from European Energy Exchange. Australian wholesale prices are also at record lows, hit by the impact of renewables, and lower demand.

“Renewables have shifted the merit order and now it’s like we have two different markets, one for renewables with 20 years’ guaranteed FIT, and one competitive for conventional power plants,” Thorsten Korner, the head of energy trading at Stadtwerke, told Bloomberg. “We have to think about integrating renewables and how we will organize 80 percent renewables on the grid by 2050.”

Meanwhile, the NREL study, a collaboration of 100 contributors from 35 organisations, laboratories, NGOs, corporates and universities, is being billed as the most comprehensive analysis yet undertaken of high-penetration renewable electricity in the US.

The bottom line conclusion was that it was possible, though challenging.

“Renewable electricity generation from technologies that are commercially available today, in combination with a portfolio of flexible electric system supply- and demand-side options, is more than adequate to supply 80 percent of total US electricity generation in 2050, while meeting electricity demand on an hourly basis in every region of the United States,” it said.

However, new sources from grid flexibility would be needed to manage the daily fluctuations from solar and wind generation, and this needed to come from a suite of supply- and demand-side options, including flexible conventional generation, grid storage, new transmission, more responsive loads, and changes in power system operations.

NREL estimates such a scenario would result in average annual retail electricity price increases of 0.8 per cen to 1.2 per cent – compared to around 0.3 per cent on the baseline scenario. But tis was based on technology costs estimated in 2010. Solar PV is already half its price then, and the costs are likely to be significantly lower than forecast.

The bottom line, however, is the need for a complete transformation of the current electricity system – including generation, transmission, and markets.

“This transformation, involving every element of the grid, from system planning through operation, would need to ensure adequate planning and operating reserves, increased flexibility of the electric system, and expanded multi-state transmission infrastructure,” it said. “And it would likely rely on the development and adoption of technology advances, new operating procedures, and evolved business models, market rules, and regulatory regimes.”

It is these institutional challenges that are among the biggest barriers to a decarbonised electricity supply. A lot more so than technology and cost.

The Climate Spectator has another article on how renewable energy can bring power prices down - Why solar parity scares big utilities.

Thursday January 29, 2009, was a big money day for Victoria’s brown coal generators.

After a night of uncomfortably warm temperatures, and a dawn reading of 32°C, Victoria’s residents turned to their air-con and pedestal fans in near record numbers. By 9am, demand had spiked so high that electricity prices had soared to $10,000 a megawatt hour as utilities switched on every last generator they could find to meet demand. These wholesale prices are normally between $35-$50/MWh.

During that day, which reached a peak of 44.3°C in Melbourne in mid afternoon, the wholesale electricity price never fell below $1,000/MWh. For nearly four hours, it hovered around the $10,000/MWh price. The way the National Electricity Market works means that every generator switched on at that time receives that price, even though it still only cost the brown coal generators around $4/MWh to shovel the coal into their power plants. Over an eight-hour period, the state’s generators would have pocketed an estimated $550 million in revenue, near one fifth of their total revenue for the year.

It was, needless to say, an absolute jackpot for the generators. But while this was an extreme case, it was not an atypical event in the NEM. It is estimated that, on average, around one quarter of the revenue from electricity sales each year is generated from the prices gleaned from around 24-36 hours of peak production. The business models of the energy utilities depend on it. But now those models are under threat.

What, for instance, would have happened that day to electricity prices had there been large amounts of solar deployed along the eastern seaboard available to meet demand? According to modeling conducted by the Melbourne Energy Institute at the University of Melbourne, 5 gigawatts of solar PV would have been very effective in curbing peak demand. Prices would still have spiked, but not over $300/MWh, and for shorter periods. The total revenue for the day would have been just over $340 million – half of what it would otherwise have been.

This is what is known as the merit order effect: the effect technologies with a short-run marginal cost – i.e. with fuel that costs next to nothing, such as solar, wind – have on the market when they deliver electrons en masse to the grid. The overwhelming evidence from Australia and overseas is that they bring the wholesale cost of energy down, sometimes so much that the reduction in prices is greater than the cost of the subsidies that got them built in the first place. And established utilities with higher-cost fuel, such as coal and gas, don’t like it one bit, and are suddenly realising the extent of the threat to their business.

Normally, the overnight load in Victoria stands at around 5.5GW, not enough to even meet the output of all of the state’s coal-fired generators. Wholesale prices barely meet the cost of production. At 8.5GW of demand, an average high-load weekday, peaking gas generators are required and the wholesale price jumps to around $70/MWh. The coal-fired generators make money. But would this still be the case if 1.5GW of solar was available? The Melbourne Energy Institute says not; it would mean that gas-fired utilities normally brought into the grid would not be required and the wholesale price would remain at modest levels.

This might explain why state governments, in Victoria and NSW in particular, are happy to delay the rollout of renewable energy at a large scale. As noted here before, Victoria’s decision to defer an increase in its state-based renewable energy target was motivated by the potential impact of the merit order effect on the state’s coal-fired generators. Right now, the deployment in both wind and rooftop solar is at a virtual standstill because of policy uncertainty. That suits the established generators just fine.

Mike Sandiford, the director of the Energy Research Institute at the University of Melbourne, says that in the case of solar, this is simply delaying the inevitable. Grid parity – and the deployment of solar at a scale that the modeling contemplates – is coming whether the governments and the utilities like it or not, and it’s time policy makers faced up to the issues that it presents.

“We can either hide from grid parity or we can embrace the challenges,” Professor Sandiford said. “All we ever hear is that it is expensive, can’t deliver, or is not worth investing. We rarely hear of the opportunities.” The modeling of the 5GW solar scenario was extended to cover the entire 2009 and 2010 years. It found merit order savings of $1 billion in the first year and $600 million in the second, and avoided transmission and distributed investment.

As those figures show, it’s not just the generators that are impacted by this, it is the network operators as well. NEM data shows that while peak demand is growing, mean demand has plateaued and is now falling, possibly as a result of rising electricity prices, more solar PV, the merit order effect, or even the benefit of the pink batt program.

This divergence has meant that more infrastructure is being built to meet peak demand and is being used less during the day. And despite spending billions on network upgrades, and contributing well over half of the increased retail prices, the industry is losing productivity at a rate of 1 per cent a year. In most industries, this would be untenable. A dramatic increase in distributed energy such as solar would force the network operators to revisit the means to make money.

Professor Sandiford says most of the pubic discussion around feed-in tariffs and other green incentives is to pitch them as a form of regressive tax. That, he says, is way too simplistic. “There are other values here. It can shave peak demand, and it mitigates against extreme prices,” he says. “We are using less electricity at medium prices and more at the peak. It is important to know the answers to these problems before we go off spending. Whether we like it or not, it is going to hit us. We should try and understand what these issues are.”