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Published on October 12th, 2012 | by Guest Contributor

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Wind Power Lowers Electricity Prices, And How



 
Editor’s note: We’ve covered the some of the topics below several times (check out our World Wind Power page for a bit more on this), but given how much misinformation there is out there about wind power, we could hammer this home every day and it probably wouldn’t be enough.  For now, check out this wonderful piece, “How Wind Power Helps Lower Electricity Prices,” from Richard Caperton of Think Progress:

by Richard W. Caperton

Here’s something that shouldn’t surprise anyone: A company that benefits from high power prices is lobbying for policies that would raise power prices for consumers. What should surprise everyone, however, is the sheer audacity of their effort: using a deeply flawed study to argue that tax incentives for wind power are “distortionary” while arguing for the exact same incentives for their preferred technologies.

Earlier this summer Exelon Corporation, a large U.S. power generator and utility operator, began quietly lobbying against extending the production tax credit for wind energy. Its effort gradually became more public, and has now erupted into a full-scale war on the wind industry. In fact, the American Wind Energy Association terminated Exelon’s membership in the association. And Exelon is now touting a study by the NorthBridge Group, an economic and strategic consulting firm, that purports to show that the production tax credit is deeply harming consumers by—get this—saving them too much money.

Exelon’s argument is strange but has gained some traction among wind energy opponents on Capitol Hill. Sen. Lamar Alexander (R-TN) and Rep. Mike Pompeo (R-KS), for example, just penned an editorial in The Wall Street Journal parroting NorthBridge’s claims. Fortunately, though, the facts are on the side of wind power.

This issue brief will show how the wind production tax credit benefits our economy, while also shedding light on Exelon’s efforts against the wind industry by:

  • Explaining the anticonsumer motives behind Exelon’s antiwind arguments
  • Showing some of the serious flaws in the study that Exelon claims justifies their arguments
  • Describing how nuclear power—Exelon’s primary power source—could be substituted for wind in Exelon’s arguments, which shows that their concern is really wind power and not market distortions

Let’s begin with the benefits for consumers.
 

 

Consumers benefit from cheap power but Exelon doesn’t

It’s critical that we keep Exelon’s fundamental motivations in mind. Exelon is in the business of selling power, and would prefer that power to be expensive.

Studies show that wind energy lowers power prices in wholesale markets, so it’s perfectly rational for Exelon to oppose wind power. But Exelon’s argument about the production tax credit hurting consumers is deeply misleading. Before digging into their argument, however, we need to review how wind power drives down prices.

Much of Exelon’s power is sold in competitive wholesale power markets, which allow power generators (like Exelon) to sell power to local distribution utilities, which in turn sell that power to businesses and homeowners. Competitive markets all operate on a “single clearing price” basis, which means that all generators get paid the same amount for their power, no matter how much it costs to produce. This auction method ensures that every generator bids in the lowest price they’re willing to accept for their power.

While the details are extremely complicated—the rules for the market that operates in the mid-Atlantic area are more than 2,000 pages long, for example—the basics are fairly straightforward. Every generator in the market tells the market operator how much power they’re willing to provide and at what cost. At the same time, every distribution utility tells the market operator how much power they need to buy. The market operator then stacks up the generators from lowest to highest bid.

Then, starting at the lowest bid, the market operator adds up all of the bids until they have enough power to meet the distribution utilities’ demands. The last bid accepted becomes the “clearing price”—the price the distribution utilities pay for all of their power, and the price that every generator receives.

To see how wind impacts power markets, consider the hypothetical examples displayed in Figure 1. Say a market has five different generators: a wind farm, a nuclear reactor, a coal-fired power plant, an efficient and modern natural gas power plant, and an older and less efficient natural gas plant. Each of these plants will offer to sell power at the price that covers their operating cost. On the other side of the market, distribution utilities need to buy 3,000 megawatts of power. This means the market operator will then stack up the bids from lowest to highest and then add up the bids until enough power can meet the 3,000 megawatts of demand.

In the first example the market will clear at $50 per megawatt-hour of electricity. Now, consider what happens to this market if someone builds a new 500-megawatt wind farm, as shown in the second example. The need for power hasn’t changed at all, so the cheapest 3,000 megawatts will still determine the clearing price. In this case, the market now clears at $30 per megawatt-hour of electricity.

This effect of wind power driving down wholesale prices is known as “price suppression” or the “merit order effect,” and its benefits are well known.  A recent study of the Midwest Independent System Operator, for example, found that large amounts of wind could save consumers $200 per year.

While the benefits for consumers are clear, existing generators lose some profits. In the original scenario, the nuclear reactor—let’s say it’s owned by Exelon—was making $40 per megawatt-hour more than their operating cost. (This isn’t technically “profit,” since some of this $40 goes toward covering fixed costs.) In the latter scenario, the reactor is only making $20 more than their operating costs.

Of course, while Exelon makes $20 less, consumers save $20 on their power bill.

The production tax credit is not “distortionary”

Exelon knows that saying wind power is bad because it saves money for consumers is hardly a winning argument, so they’ve made a slightly different argument to avoid the real issue. They are now touting a September report by the NorthBridge Group, which concludes that “[production tax credit]-driven negative prices directly conflict with the performance and operational needs of the electric system and with federal energy policies supporting well-functioning competitive wholesale markets.” What they mean by this: Wind farms are paying grid operators to take their power, which is reportedly distorting electricity prices in wholesale markets.

NorthBridge has identified the rare occurrence of negative power prices—when power generators pay someone to take their power—and have used that as the basis for a full-scale attack on tax incentives for wind energy.

There are two questions here. First, is the production tax credit the main cause of negative power prices? And second, are negative power prices a bad thing?

Negative prices are a reasonable response to these market conditions. Market operators could avoid negative prices by implementing an arbitrary price floor of $0, but this would be economically inefficient and could lead to challenges with figuring out which power sources to use. If there are more generators willing to give away power than there is demand for power (at a time of low usage during off-peak hours), a market without negative prices would have no way to determine which power source to use, and would probably select generators at random. Negative pricing fixes this problem.

To answer the second question, negative power prices are not necessarily bad. There are a few reasons why a generator would pay a customer to take their power. If a nuclear power plant shuts down, for example, it can take days to restart, so the operator would rather pay someone to take the plant’s power for a short period of time rather than turn off. A hydroelectric facility may face penalties if they don’t allow water to go through the dam for fish, and will avoid those penalties by paying people to take the facility’s power.

Wind power is different. Not only does wind power have zero operating costs, but wind turbines earn a $22 tax credit for each megawatt-hour of electricity they produce. Thus, the rational response for a wind turbine owner would be to pay someone just under $22 per megawatt-hour to take the turbine’s power.

Exelon still faces challenges

Exelon’s attacks on the production tax credit are misguided, but the company still faces challenges. Consider the 99.9 percent of prices that aren’t negative. Those prices are largely set by energy sources other than wind power, and in much of the country, the majority of prices are determined by natural gas (as in the rough example in Figure 1).

Let’s be clear: negative power prices are a very rare occurrence. NorthBridge would have you believe that wholesale power prices are negative as much as 10 percent of the time in some parts of the country. Indeed, the implications of this would be large, although still not necessarily bad for consumers.

But other data sources differ with NorthBridge’s conclusions. According to the Energy Information Administration, no competitive market sees negative prices as much as 0.1 percent of the time, which means Northbridge overstates the problem by about a hundredfold.

The difference is probably methodological, and it appears that the Energy Information Administration’s methodology is much more comprehensive. Their data are based on looking at the price over every single location on every single market operator’s system. (For reference, the California Independent System Operator has about 3,000 locations with unique prices.) Because of transmission constraints and other physical realities of the grid, prices can be different at each node, and there is no single, systemwide price for power.

Each node has a price for every hour of the year, or 8,760 unique prices. This means that the Energy Information Administration looked at roughly 25 million data points for the California system alone. Of all of those data points, fewer than 0.07 percent had a negative price—and this is by far the highest rate of negative prices of any system in the country.

NorthBridge’s methodology isn’t clear, but it appears to be talking about any hour in which at least one node has a negative price. NorthBridge also tries to directly link negative prices to wind power, but that’s not necessarily the case, either. As the Energy Information Administration states:

The [system] with the highest number of instances of negative prices in 2011 was the California ISO (CAISO). The resource mix in CAISO is highly dependent on nuclear, hydro, and wind generation. Also, typically in the late spring, California imports significant quantities of excess hydroelectric generation from the Pacific Northwest.

To summarize, Exelon, with the help of the NorthBridge Group, is arguing that negative prices are a serious problem, and that they’re caused by wind power. But that fact is that more than 99.9 percent of power prices are positive, and that even the less than 0.1 percent that are negative are caused by a multitude of factors, not solely wind power.

Nuclear power also has a production tax credit

It’s worth noting the irony of Exelon, a large nuclear plant operator, complaining about a production tax credit. Since 2005 new nuclear plants have been eligible for a production tax credit of $18 per megawatt-hour. This, of course, is on top of at least $185 billion in federal subsidies the nuclear industry has received since 1947.

And it’s also worth noting that nuclear power, especially when combined with a production tax credit, could also lead to negative power prices. Given the significant costs incurred by shutting down and restarting a nuclear reactor, these plants may already offer to sell their power at negative prices. Adding the production tax credit—which is only available to new plants and not those that are currently in operation—would simply reduce the price they’re willing to accept by another $18 per megawatt-hour.

Conclusion

The production tax credit is a government investment success story. Since the creation of the credit, wind energy deployment has boomed while costs have come down an astonishing 90 percent. With a stable investment environment enabled by a long-term extension in 2009, the amount of wind energy used in this country has doubled in the last four years. This has helped the wind manufacturing sector take off, with more than 60 percent of the value of a turbine now added domestically.

But the production tax credit is under attack by companies that are harmed by wind power, which has serious implications for our economy. Wind is helping to drive down power prices, which benefits consumers. Wind is also helping put people back to work, and these jobs are at risk if the credit is allowed to expire. According to Navigant Consulting, expiration would put 37,000 people out of work, and we’re already seeing the beginnings of these layoffs.

Unfortunately, some companies—like Exelon—that benefit from higher power prices have decided to argue against the production tax credit. Their arguments are flawed, however, and should not convince policymakers to do the wrong thing and let the credit expire.

Richard W. Caperton is the Director of Clean Energy Investment at the Center for American Progress.

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  • LangReynolds

    The utility market is obviously not structured correctly for high renewable penetration – what can be done to change them?

    • Bob_Wallace

      The market will change them. There a great article on the NY Times about how cheap wind and gas are causing nuclear and coal plants to fail. Solar is eating into their profitability as well.

      “According to an internal industry document from the Electric Utility Cost Group, for the period 2008 to 2010, maintenance and fuel costs for the one-fourth of the reactor fleet with the highest costs averaged $51.42 per megawatt hour.

      That is perilously close to wholesale electricity costs these days.

      Bruce E. Biewald, the chief executive of Synapse Energy Economics, a consulting firm in Cambridge, Mass., compared the nuclear plants to old coal plants now facing big capital expenses. The cost of new pollution control equipment has coal companies “writing off hundreds of millions of dollars right and left,” he said. Much the same is now true for nuclear plants. “An asset that might have been worth a couple of billion dollars is now basically worthless,” he said. And with average costs approximating average revenue, some reactors face higher-than-average costs.

      http://www.nytimes.com/2012/10/24/business/energy-environment/economics-forcing-some-nuclear-plants-into-retirement.html?_r=1

    • http://www.smartpowergeneration.com/ SmartPowerGeneration

      The profitability problem, quite simply, is a reason of net load variability (see:
      http://j.mp/RZU0Vc): “When 10%, 20% or more of the energy provided to meet load comes from renewable energy, the pattern changes, and dispatchable resources (such as thermal power plants) no longer serve the load, they serve the net load. Net load is the system load minus the energy supplied by renewables, sometimes referred to as the residual load. Wind and solar
      provide energy according to wind and solar incidence patterns — the pattern in net load is more erratic and cyclic in nature and less predictable. In other words, the variability in net load is much greater than that of the system load. Consequently, dispatchable resources must undergo a greater amount of cycling, starts and stops, and reduced capacity factors.”

      Coal and nuclear, i.e., the traditional forms of base load power generation, have relatively high capital expenditure, but low operating expenditure. Thus, they need to sell a lot of electricity (at a profit) to recoup the original investment. With the increasing share of renewables, wholesale prices are, on the average, lower and more volatile. Thus, nuclear and coal are in trouble, as they’re not flexible enough to accommodate their output in response to price fluctuations (shutting down and starting up a nuclear plant takes a week).

      On what’s being done about this: the UK government is, according to reports, negotiating a “contract for difference” with EDF, effectively guaranteeing a given price for electricity if they build new nuclear in the UK (see:
      http://bit.ly/RZH12t). Similarly, in Germany, the government has drafted a law that would give additional money to utilities while preventing them from closing down certain gas-fired power plants deemed critical for system stability (see:
      http://bit.ly/P7sZyC). If this seems odd, it’s because in Germany the price situation between coal and gas is the exact opposite of the US: gas is expensive, and coal power is very cheap now that the price of emission permits is in the tank.

      Best regards,

      Kimi Arima
      Wärtsilä Power Plants
      http://www.smartpowergeneration.com

  • Jim Nelson

    The editing of this article is wretched. Two consecutive sections (

    “Negative prices aren’t a very big issue”, and “Exelon still faces challenges” are nearly identical. Being green doesn’t make up for sloppiness.

  • Ronald Brak

    We have a lot of wind capacity here in South Australia and so I am getting an 8.1% reduction in what I pay per kilowatt-hour for grid electricity next year.

  • http://www.facebook.com/edward.kerr.33 Edward Kerr

    Since some of these imbalances appear to be somewhat localized it occurs to me that for society as a whole we should also be looking at the distribution system (grid). Since it’s in need of repair anyway now would be a good time to upgrade to have our grid match our (at least my) new “smart meters”. These are mostly technical problems until someones money toes get stepped on. Corporate problem quickly turns into a political problem.

  • http://www.facebook.com/russell.j.lowes Russell J. Lowes

    We already have more natural gas capacity than we have of coal capacity in the U.S. No additional plant capacity is needed.
    The real solution here is to ramp up energy efficiency (EE) investment and blend that with wind and solar increases. With EE being 3 cents per kilowatt-hour saved (negating the need for generation), and new solar now at 18 cents or so, with new wind at 13, delivered price, if these are blended in a ratio of 60% EE to 40% renewable solar and wind, then the average price can be below 10 cents. This would be below the national average for electricity prices.
    All the while, we can ramp down our fossil fuel and nuclear capacity, as we bring in energy storage technologies.
    By the way, we have been making major gains in energy storage. University of Arizona has an ice production energy storage technology, where they build up ice reserves when electricity use is lower and then release the coolness to the majority of the campus through tunnels connecting their buildings.
    Let’s not get into the natural gas trap. Over 52% of our natgas is now fracked (hydraulic fracturing to extract gas from rock/earth). Natgas is more and more unsustainable and destructive to our environment as fracking goes up.
    We are well on our way toward more sustainable electricity production with EE, solar, wind and energy storage.

    • Bob_Wallace

      Natural gas generation – I suspect there is a distribution problem. Could we get enough gas-electricity to a coal intensive state such as Kentucky?

      I question your wind and solar prices. The LCOE of wind is now about $0.05/kWh. PG&E just signed at purchase contract for solar at $0.104/kWh.

      End user solar has reached retail parity for large parts of the US. If we get only a modest amount of rooftop solar we’ll see the general price of grid electricity drop. Rooftop will replace a lot of very expensive peak generation.

      We’re in the natural gas trap. For the most part the decision of how we generate electricity is made by people who don’t put a value on CO2 emission or on pollution past the point of what they might be required to mitigate. Natural gas is cheap and “bottom line is all that counts” utility decision makers are going for gas.

      We’ve got two promising utility scale battery technologies going into production in the next few months and Ambri’s liquid metal battery could provide very cheap storage. I think we’re stuck with natural gas until we get cheap storage. (Or the general public gets concerned about climate change enough to require a price on carbon.)

    • http://www.smartpowergeneration.com/ SmartPowerGeneration

      Hi Russell,

      I agree, energy efficiency is also a big part of the solution, especially in the US where energy consumption is twice that of Western Europe.

      On the gas capacity: there’s a lot of it as is, yes, but it’s the wrong kind of capacity. The capacity we have was designed for base load operation, i.e., running on full for 8,000+ hours per year – not ramping up and down continuously in order to compensate for wind and solar output. That’s a whole another ball game, and one of the main implications of this kind of operation is that the 60+% efficiencies touted for combined cycle plants turn into 40% or less. And that’s not good in terms of total system efficiency.

      Best regards,
      Kimi Arima
      Wärtsilä Power Plants
      http://www.smartpowergeneration.com

  • http://www.smartpowergeneration.com/ SmartPowerGeneration

    Nice post, a thorough explanation on the effects of the merit order effect, especially the negative pricing and why that happens. Good stuff.

    Of course, I want my electricity to be as cheap as possible. But I also don’t want the situation to end up like in Germany, where the government is implementing a (tax-funded) payment to utilities so that they won’t shut down some of their older plants. Because of wind, these plants get very few running hours, so are bleeding money, but the system still needs them from a security of supply point of view.

    The main character in this story is not Exelon or the wind companies, it’s the power system as a whole. Renewables are the answer in the long run, but for some time still, fast flexible gas fired capacity will be needed to balance the fluctuations in wind and solar output. Yes, in 10 years we might have a breakthrough in energy storage technologies, but we’re not there yet, and if we want to do something about CO2 today, then it’s wind and gas, and these two sides should recognize the fact and work together.

    Once again, good post, keep it coming.

    Best regards,
    Kimi Arima
    Wärtsilä Power Plants
    http://www.smartpowergeneration.com

    • Bob_Wallace

      I’d be quite happy to see us pay coal plants go into “mothball” state for the vast majority of the year. Bring them back on line for the roughly two weeks a year that the grid is really stressed for supply.

      That would take those coal plants off line fifty weeks, 96%, of the time. Think how much CO2 we would avoid. How much less mercury. How fewer health problems.

      Yes, we do need some gas as fill-in for wind and solar until we start bringing more storage on line. But your ten year time line is very likely much too long. We’ve got multiple promising battery storage technologies and two going into manufacturing at the moment.

      • http://www.smartpowergeneration.com/ SmartPowerGeneration

        Bob,

        thank you for the comments. I agree with your view that it’s possible to dramatically reduce the use of coal plants. Just bear in mind that the 96% reduction in use might only see, say, an 85% reduction in emissions, as coal plants and their pollution prevention systems are designed to operate optimally on stable full load operation. But that’s still a good amount.

        I am also with you on the energy storage issue, in the long run that is the only way to go (at least in view of currently available technologies). However, the power generation industry is notorious for its inertia, described accurately by the saying “in the power business, a quarter is 25 years”. The first commercial wind plants were installed in the early 1980s. Solar cells were invented in the 1950s. I suspect my ten year timeline is, if anything, optimistic.

        Best regards,
        Kimi Arima
        Wärtsilä Power Plants
        http://www.smartpowergeneration.com

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