Green, RJ

English

Spiral - Imperial College Digital Repository

International Association for Energy Economics | 27Welfare Analysis of Offshore Wind by Julian Silk:               A CommentBy Richard Green*In the IAEE Energy Forum for the 2nd Quarter of 2012, Julian Silk offered an analysis of the welfare economics of offshore wind power, motivated by Maryland’s proposed scheme and inspired by the tools used to analyse the impact of an import quota on a domestic market.  Unfortunately, those tools do not easily transfer from the trade-relevant case of a maximum supply from a cheap source to the energy case of a minimum supply from an expensive one.  In the case of trade, once the quota of cheap imports is used up, all other demand must be met from domestic sources, and the price must rise to their marginal cost (if that market is otherwise competitive).  This price is also received by importers, despite their lower costs.  The governor of Maryland is currently proposing to source 20% of its electricity from renewable sources, and Dr. Silk argues that the marginal cost of these sources will set the price for all the power sold in the state. “The price going to the wind suppliers will be [the cost of offshore wind]. If the price is higher, more wind supply will come into the market to drive it down. If it is lower, wind suppliers will exit the market … the last, marginal, fossil supplier has a supply price equal to [the cost of offshore wind]. If this fossil supply price is higher, more wind will be purchased, and the price will be driven back down. If it is lower, the electricity market will attempt to purchase more fossil energy, and come upon the binding quota restriction, which will drive the price back up.”  This is represented by a leftwards shift of their supply curve, and Dr. Silk comments that “[the area between the old and new supply curves] can be considered to be costs for fossil fuel producers.”  Is the effect on prices the equivalent to the standard analysis of an import quota, in which the ability to sell at a price raised by the quota leads to higher profits for the importing firms?  I will argue that neither wholesale nor retail prices will be affected in the way that Dr. Silk suggests.  Furthermore, I cannot conceive of a way in which, as in Dr Silk’s world, the pres-ence of a quota of high-cost generators somehow raises the costs of every other generator on the system.To analyse the price impacts, we need to know how the renewable generators will be supported – in Maryland, this is to be through Offshore Renewable Energy Certificates (ORECs).  The owner of an offshore wind farm is entitled to sell one OREC (at an administered price) for each MWh it generates, giving up all the energy market (and other) revenues it receives in return.  The ORECs are then bought by electricity retailers, in proportion to their sales, and the cost is offset by redistributing the wind farm’s energy revenues to the OREC holders.  The net cost is thus the difference between the OREC price and the market price for the station’s output.  A retailer that does not hold enough ORECs pays an (adminis-tratively set) penalty.Dr. Silk discusses these certificates and suggests that “it would be reasonable for generators to purchase the [O]REC, and immediately sell 1 MWH of their own genera-tion.”  This somehow leads him to conclude that the fossil generators would now have a higher marginal cost than the wind farms and would, therefore, require a subsidy if they were to continue to operate.I am not quite sure how fossil-fuel generators could purchase an OREC and immediately sell their own power, since the OREC is only given for output actually deliv-ered.  But rather than struggle further with Dr. Silk’s ar-ticle, I thought it might be helpful to present some analysis that reflects the way in which electricity markets actually operate.  In the short run, the output from wind farms can be taken as completely inelastic – absent transmission or other constraints, the entire available output will be sold, given its zero marginal cost.  Once wind farms have been added to an electricity system, we, therefore, need to shift the supply curve of the fossil-fuelled stations to the right, by the amount of wind production.  This can reduce wholesale market prices in the short run, as observed in Germany (Sensfuß et al, 2008) and in Spain (Sáenz de Miera et al, 2008).  Figure 1 shows a short-run market equilibrium with the supply curve shifted in this way.  The fossil stations produce the difference be-* Richard Green is the Alan and Sabine Howard Professor of Sustainable Energy Business at Imperial College Business School (r.green@imperial.ac.uk).  Figure 1: A market with a wind quota: short-run equilibriumDemandSfossilSwindSfossil + orecPretailPwholesaleSfossil + penalty$/MWhGWQwind QtotalInternational Association for Energy Economics | 29Committee on Climate ChangeSáenz de Miera G., P. del Río González, I. Vizcaíno (2008) “Analysing the impact of renewable electricity support schemes on power prices: the case of wind electricity in Spain” Energy Policy, vol. 36, no. 9, pp. 3345-3359Sensfuß, F.; M. Ragwitz and M. Genoese (2008) “The Merit-order effect: A detailed analysis of the price effect of renewable electricity generation on spot market prices in Germany” Energy Policy, vol. 36, no. 8, pp. 3076-3084Response to Professor Green’s CommentI thank Professor Green for his comment on my analysis.  My impression, in working through the comment, is that we are making different assumptions.  That the short-run supply of wind is absolutely inelastic with respect to price is certainly a different assumption than I was making.  That the wind sup-pliers will enter the market regardless of their receipts is different as well.  If the wind suppliers lower the wholesale prices over what they would otherwise be, as in the examples of Spain and Germany that are cited, well and good, but I wonder if there are not some other costs that are being disguised or not counted.My understanding, which I will be delighted to correct if it is mistaken, is that the wind producers must receive payment to cover their all fixed costs and marginal costs each year, or they will not enter the system at all.  Yes, the marginal costs are zero for wind.  But the fixed costs in annualized terms are not. In looking at Figure 1, the wind producers just get what they get.  But implicitly, it would seem that the marginal cost for the wind producers is as in Figure 2, much higher than the market equilibrium price.  If this is the case, and the price is only pfossil, how do we know that pfossil + orec covers the payment for the fixed costs of the wind suppliers?  Either the wind suppliers are given a long-term guarantee that their costs will be covered later, which has market value now, or the fossil fuel generators pay for it, or the consumers pay for it.  If the wind suppliers were willing to accept less, why would Delaware’s offshore wind farm, so similar (almost in swimming distance) to the one proposed for Maryland, be facing the financing difficulties detailed in “Offshore wind ‘backbone’ still a plus for Delaware”, online at http://www.delawareonline.com/article/20120517/BUSINESS09/305170027/Offshore-wind-backbone-still-plus-Delaware? Professor Green accepts a discontinuity at the intersection between supply and demand in Figure 1; I am much more skeptical.  My renewable energy certificates are much more expensive than Professor Green’s, it seems.Something similar seems to apply for Figure 2.  The wind producers are receiving a much higher payment for the power they produce than are the fossil fuel producers.  The wind producers are mak-ing an economic profit of zero, yes.  But the fossil fuel producers are paying Area C plus the lower two rectangles, as Professor Green rightly notes.  Why should they do this in the long run?  It was always an implicit assumption in my argument that there was an electricity market as an alternative to PJM to which electricity generators could turn if PJM did not provide at least as much profits as the alternate market.  As the fossil fuel producers close up shop, retire plants, or more likely, never build them at all, LRMCfossil moves up.  If it moves up until it meets LRMCwind, then these payments stop, and that’s what I think will be the equilibrium result.Actual wind production is plagued by the need for spinning reserve, periods of negative pricing and loop flow, in addition to the constant high annualized cost.  I have tried to go into this in my “Wind Problems” submission for the IAEE Blog.  To cite from there, “There have been various attempts to use batteries as spinning reserve. The latest and most efficient of these is being conducted in Chile (see http://generationhub.com/2012/05/03/aes-combines-advanced-battery-based-energy-storage).”  If batteries (as in Chile), can be used as backup for wind, then perhaps we can have an empirical test to see who is right.Trying to seriously discuss wind on a large scale for the U.S. has an air of unreality now, in the wake of the success of Governor Scott Walker (R-Wisconsin) in the recall election called to replace him.  This bodes very well for the success of Governor Mitt Romney, who has made renewable energy a favorite target, in the November U.S. Presidential election.  My object is not to generically oppose wind or any renewable energy, far from it.  It is to make absolutely sure it delivers on its promises, especially for cost, without special pleading, so as to escape the backlash that is threatening it, and become a significant part of the world’s energy supply.Julian Silk

Welfare Analysis of Offshore Wind by Julian Silk: A Comment

Abstract

Similar works

Full text

Available Versions

Spiral - Imperial College Digital Repository