Profit Infra Marginal Electricity Producer Curve Integration Of Cost

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Other possible forms of lock-in deserve greater consideration, in particular with respect to energy efficiency improvements. Some energy efficiency measures need to be undertaken at a given time - for example, when new plants or buildings are designed and built - or risk costing much more at a later stage. Accepting too large an investment in renewable technologies while neglecting timely energy-efficiency programmes clearly runs the risk of locking in societies' too-high energy consumption patterns, with detrimental long-term implications for both energy security and climate protection.

40) By the same token, such considerations suggest that climate policies can hardly be technology neutral. Transport infrastructures, city planning and building codes are long-term determinants of future GHG emissions, and require political decisions. As Azar and Sanden (2011) argue, the debate should not be about whether climate policies should be technology specific, but how technology-specific the policies should be. For example, should one support all renewable electricity technologies indiscriminately, or should one distinguish wind and solar as they take advantage of distinct resources and have different maturity levels? If so, with respect to solar should one distinguish between photovoltaic (PV) and concentrating solar power (CSP) or let the market value the thermal storage capabilities of the latter? Should one give different incentives to roof-mounted PV and ground-mounted PV devices, and/or to multi-crystalline PV and thin-film PV technologies? It is important when addressing these questions to strike the right balance between the chances of maximising the effects of learning investments and the risks of picking the losers instead of the winners, or of preventing useful competition.

Other interaction effects

Another possible aspect of the interaction between CO2 and RE policies seems to have received very little attention so far. It relates to how both policies transfer wealth from utilities to (deregulated) customers or vice versa.

Several studies show, from either theoretical models or observations from existing electricity markets, that the introduction of a large share of RE electricity tends to reduce the electricity price for deregulated customers (for a review, see Poyry, 2010).

This can best be observed with wind power, which has recently become a significant player in some European countries. At about the same time, their electricity markets underwent deregulation. In deregulated markets, the price is set where supply and demand curves meet. The demand for electricity is relatively inelastic - it does not change much with the price. Typically, the supply is made up of various power technologies: wind, hydro, nuclear, combined heat and power plants, coal and natural gas plants, and gas turbines. In a power market the supply curve is called the "merit order curve" and goes from the least to the most expensive units, taking account only of the marginal variable costs (mostly fuel costs). Utilities bill all kilowatt hours sold on deregulated spot market at the price set by the last and most costly unit. Therefore, they get the benefit of so-called infra-marginal rents.

Figure 3

How wind power influences the power spot price at different times of the day.

Figure 3

How wind power influences the power spot price at different times of the day.

The variable marginal cost of wind is very low, and wind power thus enters near the bottom of the supply curve. This shifts the supply curve to the right (Figure 3) and leads, in general, to lower power spot prices. This so-called merit order effect is larger in peak demand times, where the merit-order curve is especially steep. With more wind in the mix, the size of the rents is reduced, for the benefit of deregulated customers and to the detriment of utilities. These rents, however, are used, at least in part, to fund future capital investments, and their shrinking may impede the security of electricity systems.

A few empirical analyses have attempted to estimate this merit-order effect. For example, SensfuB, Ragwitz and Genoese (2008) calculate that the volume of the merit-order effect would have been EUR 5 billion in 2006 in Germany if the entire electricity demand of a single hour was purchased at the corresponding spot market price. Meanwhile, the cost of incentives for renewables in that same year totalled EUR 5.6 billion.

The same authors estimate the value of the kilowatt hour produced by renewables (i.e. the costs avoided by substitution of electricity from other sources) at around EUR 2.5 billion, leaving EUR 3.1 billion as the true extra cost of RE support incentives. Of these, 0.6 billion are directly paid by final consumers, while the remainder EUR 2.5 billion are basically paid by utilities through a decrease of their infra-marginal rents due to the merit order effect. In this way, the merit-order effect transfers wealth from utilities to deregulated customers.

In reality, not all electricity is sold on the spot market in Germany, and bilateral contracts mitigate this result.

Furthermore, the lower price paid by deregulated customers does not represent a lower cost for producing electricity. The overall cost of wind remains higher than some of the other generation technologies, even if the gap has considerably narrowed in the last decade. Utilities may ultimately find ways to pass part of these costs to customers.

A more recent study on wind power in Ireland provides even more striking results. Clifford and Clancy (2011), using a detailed model of the all-Island Single Electricity Market, show that the wind generation expected in 2011 will reduce Ireland's wholesale market price of electricity by around EUR 74 million. This is approximately equivalent to the sum of the Public Service Obligation (financing the feed-in tariff for wind) cost, estimated as EUR 50 million, and the increased "constraint" (or balancing) costs incurred due to wind in 2011. The reduction of Ireland's dependence on fossil fuels and the corresponding CO2 reductions cost nothing in this case, despite the persistence of the support scheme which ensures recovery of the long-term costs of electricity generation from the wind even when the market prices are low.

It has also been shown that the electricity producers and utilities have enjoyed windfall profits from the implementation of the ETS, because the resulting increase in the marginal electricity prices have increased their infra-marginal rents to the detriment of their deregulated customers. This is also an effect of the merit order (Figure 4). Keppler and Cruciani (2010) have estimated these windfall profits for the utility sector as a whole at more than EUR 19 billion for the first phase of the EU ETS, and state that this phenomenon will only be partially mitigated by the auctioning of emission allowances from 2013 on.

Figure 4

Merit order and electricity price increase with CO2 price

Figure 4

Merit order and electricity price increase with CO2 price

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