Wind and solar currently dominate the global growth of renewable electricity production. In 2015, the combined share of investments between these two technologies comprised 90% of global renewable energy (excluding large hydro resources) investment of nearly US $286 billion. At the same time, various jurisdictions around the world have pledged to significantly reduce greenhouse gas (GHG), indicating the future generation portfolio globally may be largely comprised of non-GHG emitting renewable resources. Absent breakthroughs of other technologies, wind and solar with near zero marginal costs are assumed to be the leading technologies.
Today’s deregulated wholesale markets have been designed to lead to better short-term operational decisions (lower cost dispatch based on merit order) as well as long term investment decisions, such as through capacity markets or scarcity mechanisms. A system with higher penetration levels of renewable resources with negligible variable costs and variable outputs may look substantially different. The increase in these resources will drive the short-term production costs of energy – the main product – towards zero, as nowadays observed in California, and leave assets to rely more heavily on other revenue means. There will be a need for the market systems and price signals that currently focus on short-term production costs to shift to one that minimizes production cost (including costs that were traditionally treated as fixed or sunk) over a longer period and perhaps includes scarcity rents that may occur when electric supply from the indigenous resources fall below the load.
Such a future market may find synergies in markets outside the electricity industry. Every market system, regardless of the industry or service type, has capacities that limit the supply of goods. Once the demand exceeds the supply capacity, the price of goods will increase based on the elasticity of demand; the consumers’ ability to obtain the certain goods will depend on their reservation prices. This is not an acceptable solution for the electricity industry because of the physical network affects; severe mismatches in supply and demand can lead to cascading failure of the entire system, including blackouts. There are reasons beyond engineering, such as the general political view of electricity being an essential right, similar to having access to air and water, for example. Therefore the future market of electricity will need to address the cost of maintaining adequate supply capacity, or in other words, investment decisions to minimize the risk of such cascading failure, but after incorporating the anticipated resource mix. This includes not only the renewable resources, but also newer unconventional technologies such as storage and demand side management. The question of how these unconventional resources respond to a market with reduced short-term variable price signals is a separate discussion that also needs to be addressed.
Markets with higher capital cost for capacity and lower variable cost for operations may include the telecommunication industry (free long distance call vs. high investment cost in wires and fiber cables) or transportation industry (cost of fuel used in individual cars is much smaller than developing ports, highways, railroads, subways, or other public transportation infrastructure). In these industries, the capital cost of developing the infrastructure is typically minimized through competition (through public RFPs) and the subsequent usage level (equivalent to the electricity load in this analogy) is oftentimes controlled through pricing. The electricity industry is likely moving towards this direction because the higher renewable future will certainly require a tighter link between maintaining the adequate capacity (longer term investment decision) and the scarcity (short term operations). This is especially true when the price of energy – the main product traded today – could become increasingly closer to zero.
Another important note is the rapid spread of distributed generation, which the system planners of today do not necessarily see, compared to centralized generation resources that are part of the wholesale market. This will have a larger impact on the transmission and distribution systems where the current planning is still largely centralized, but in a world with significant decentralized generation options may be much harder to plan. The resulting challenge of the electricity industry is two-fold; first, a vision of a market structure that accommodates these changes; and second, a transition that needs to be done without disruption, both physically and financially. How to advance renewable technology to enable this transformation is left to us.
The Brattle Group