Renewable energy that might be delivered by prosumers and smart grids that emerged as the world has been recently going digital pushes the conventional power plants out of the energy mix and the power market. A chance to get cheap energy at near-zero marginal costs (>>>) is becoming appealing for the society. The zero net emission challenge taken by the major economies to cope with real-time global warming (>>>) strengthens the process making changes irreversible.
If you think that conventional or nuclear power companies invest in giant wind farms or solar farms just only to extend their business in a new power market segment or to prevail in their activities in the future, you are not wrong. Still, there are yet more complex financial and technical considerations behind those investments.
THE SMART GRIDS
The conventional energy grids were created in times as energy needs were very simple. We did not have as many household appliances we have today. We did not have to charge our computers or tablets or smartphones or Wi-Fi transmitters. The energy demands of private households were limited.
A local power company delivered power to a household, the energy was used, and the usage was manually monitored and billed by the energy supplier. Let us say once a month.
The fundamental change that happened with the development of digital technologies is the emergence of smart grids with multiple functionalities, far beyond delivering power and metering use to bill us.
Today the communications between the households and the energy supplier are based on smart devices, are two-way and automated. That what is exchanged is not only power but also information. Smart meters measure our energy consumption more frequently than analog grids did in the past, delivering to the grid managers exact data on the changing daily demand and the demand trends. That, in turn, allows for better planning and optimization of power production levels in real-time. Please remember that the supply of power must exactly match with the demand at a given moment. (Some electricity is lost however during transmission or it is used for pumping of water used to cool the furnaces.)
If our home is smart, the optimization could also work the other way around. Our smart household appliances could be programmed so that they switch off during peak demand for power and switch on when the grid is less burdened. This kind of optimizations gets more critical if we want to charge plug-in vehicles at homes at a larger scale, which seems to be another trend for the nearest future.
If the peak and off-peak pricing systems are adopted, this would mean optimizing our energy bills. The energy costs more during peak-hours as supply must match higher demand, and less during off-peak hours. Peak power might be more expensive also because if the demand increases, the less cost-efficient power plants have to deliver energy.
The smart grid allows for private solar and wind energy production integration, as well. The energy consumers who invested in their own photovoltaic installations are becoming prosumers, producing energy and delivering what they cannot use in the given time, and taking power from the grid when they cannot generate energy like during night when the solar panels do not work.
The variability of supply levels from renewable resources is another challenge for smart grids. The wind is not always blowing. The sun is not shining at night. The real-time analysis of current and changing renewable power supply is automatically passed by the smart grid to the grid manager allowing for supply adjustments (if possible) in conventional and nuclear power plants.
Another functionality of smart grids is (if, of course, technically possible) rerouting automatically transmission of power through other lines in cases when some part of the network was damaged by strong wind or some other event.
Smart grids enable a gradual shift from scaled centralized energy production to decentralized production laterally scaled.
THE MERIT ORDER EFFECT
The energy market suppliers might be vertically integrated, which means they are both power generators and suppliers to the end consumers. Energy might also be traded in the wholesale market, where power generators trade with power that is quoted according to market fluctuations. The wholesale power market allows the supply of electricity to be balanced with demand.
Some of the customers use energy under regulated tariffs and some at market prices. Short-term prices (spot prices) of energy are highly volatile as the power demand and power supply might change rapidly with, for example, changing weather conditions. The prices quoted in that market are usually less volatile. They are based on forward contracts averaging the spot prices over a more extended period.
Theoretically, the energy cost should be levelized (the so-called levelized cost of energy, LCOE). It should be the ratio between all the discounted costs of the installations over the lifetime, including investment costs of an electricity generator divided by a discounted sum of the actual energy amounts delivered. In practice, due to the fluctuations in demand and supply and different cost levels of different kinds of power generators (price competitiveness) and the dispatchability in power generation, the prices in the energy market cannot be set at the levelized level.
Dispatchability in energy generation is about delivering energy on demand, which means flexible rising or lowering supply. The fastest plants to dispatch are hydroelectric power plants and natural gas power plants. On the opposite side is the renewable wind and solar energy that is non-dispatchable and non-reliable. Nuclear and coal power plants are highly reliable but work in cycles that take hours or even days to increase or lower the output energy.
The appearance of renewable energy power plants changes the status quo in the energy market. It is by far not only about the net-zero emissions challenge and stopping climate change. Renewable energy is cheaper than conventional or nuclear energy. Mother Earth is not billing us for the sun shining and the wind blowing. We only need to learn how to tap their energy to power our lives and cope with non-dispatchability and non-reliability.
As demand and supply volatility and price competitiveness of power generators exclude the usage of levelized pricing, we instead look at short term-marginal costs of delivering power. Ordering power plants from those with the lowest short-term marginal costs to those with the highest short-term marginal costs is considered a merit order. Short-term marginal costs of energy production are about a kind of variable cost of production that comprises fuel costs, operations, and maintenance, including dispatchability issues. Due to economies of scale and long power plants’ life cycles, we omit here, in fact, fixed costs, including investment or replacement, or dismantling costs. We also overlook the external costs of the ecological footprint.
In the merit order theory, to meet the power demand, we should first use the cheapest power plants, and only with increasing peak demand, we should add on the more expensive power plants in terms of marginal costs to the system. So, if wind farms generate vast energy quantities at a very windy night, and simultaneously, the power demand is low, we should take out most of all other power plants from the system. The market price for energy should be at the near-zero level, as wind is for free, operational costs of windmills are low, and as for the investment costs, the economies of scale apply.
Here, we stumble, however, over the problem of dispatchability. The full flexibility of energy production is not possible for conventional and nuclear power plants. Power plant furnaces cannot be quenched or launched just on demand. We will need them the next day, as the wind does not blow that high, and the clouds in the sky make solar panels work at lower efficiency. So, if the cheaper wind energy is sold at night, and the market does not buy the more expensive nuclear power, although it is generated, nuclear energy was produced in vain.
In the context of the net-zero emissions challenge, we stumble here, however, over yet another problem. The merit order of marginal production costs is not the same as the social marginal cost’s merit order. Power based on gas is more expensive than that based on coal, but its environmental footprint is lower. It is also highly dispatchable, and that based on coal is not. With the zero net emissions challenge, coal power plants should be driven out of the market first, and gas power plants should follow.
To sum up, the merit order effects are about pushing more expensive power plants out of the market. The more expensive power plants should deliver only at peak demand and be taken out of the system off-peak in a short time. In a longer perspective, the near-zero marginal costs of renewable energy power plants should theoretically replace conventional power plants, which means that the latter would be closed. But as said before, we stumble here over the dispatchability and reliability issues.