The merit order effects in the power sector 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. Considering this theoretical approach we stumble however over the dispatchability and reliability issues.
PRICING OUT THE EXPENSIVE ENERGY
Now let us take a look at the market prices quoted in the energy market.
With higher and higher market shares of renewable energy power plants and the smart grids’ functionalities, the market price of energy should ultimately be falling (even if we look at spot prices averaging in forward contracts). The more expensive power plants would not be able to compete anymore in the market and to be more precise, they would not be able to afford to deliver energy at lower prices than their total costs. Today it is still not the case, as power demand increases, and the renewable power plants seem to fill in the emerging supply and demand gap.
We could say all right, let us take them gradually out of the market.
But, till another solution is not found, we need those power plants because, unlike solar or wind energy that depends on the time of the day and weather, so is not entirely reliable, the conventional power plants deliver as much energy as it is planned. The supply of the latter is reliable. Technical problems arise about the cooling process and not reliable transmission grids.
They must be maintained operational, at least during some transition period, to avoid blackouts when renewable energy power plants cannot deliver as much energy as needed. Even with the smart grids’ functionalities, producing all power, we would need during on and off-peak hours only with renewable energy is yet technically not feasible. The blackout risk is too high.
The distant future solution is international, even intercontinental cooperation of energy markets and energy storage. Till this becomes a reality, technically, we cannot afford to get rid of conventional and nuclear power plants.
Today the pricing systems might be, for example, based on the marginal power plant. The power plant with the most expensive marginal costs determines the price for all power plants involved in power generation at the given moment. The market price is at the level of the marginal plant, and the cheapest power plants get out with a surplus that allows them to faster cover the investment costs. The more expensive power plants are on a stand-by not paid for the services. Still, they bear maintenance and replacement costs. Or, they generate power that has no buyer, losing on fuel costs.
If conventional power plants are state-owned and treated as a kind of public infrastructure, as far the investment is concerned, must not achieve the break-even, it is not a problem. The same rule is nevertheless applied in other infrastructure sectors. The full financial viability of investment projects is not aimed at. It is considered sufficient when users cover the operational costs or at least the short-run marginal costs. The investment costs might be covered by the taxpayer’s money, as all taxpayers are its potential users.
But what if a power plant is a private company built on private capital that invested years ago but still did not reach the break-even? The private investors have to be somehow compensated if such a power plant is dismantled or let us say, for the greater good was forced to operate below the costs. Please remember that private investment into the public utility infrastructure usually goes with governmental guarantees. The ‘invisible market hand’ rule does not apply here due to high entry and sunk costs; the energy market is susceptible to market failures. (The non-economists, please excuse me for the last ‘academic’ sentence, but I could not resist writing that.)
THE CHALLENGES AHEAD
Hence, real-time climate change is only one side of the coin among the structural changes in the energy sector. Due to near zero marginal costs of operations and economies of scale as far as the investment costs are concerned, the renewable energy power plants are much more price-competitive than the conventional and nuclear power plants.
With the development of smart grids and wide spreading of smaller and bigger renewable energy power plants or the so-called power farms, the conventional and nuclear power plants will be continuously pushed out of the market by the price mechanism. Of course, first to go are the coal power plants – not only because of the marginal costs of operations but also because of the ecological footprint marginal costs. In turn, these would mean dismantling costs, sunk costs, and job losses both in the power sector and in the coal mining industry. Gradually coal mines will disappear. The spillovers will widespread in other sectors as well. Miners will have to look for new jobs, not necessarily there where they used to live. They will move out of towns and villages that traditionally used to live out of coal. Shopkeepers will lose clients and so on, and so on.
Before the world supports its power consumption solely on renewable energy power plants or some other technology with no ecological footprint, the power industry will go through a transition period. Step by step, the conventional and maybe also nuclear power plants will be switched off.
If there was already a kind of a social agreement in a country that the big power plants have been the prerogative of the governments, the investment was funded out of the taxpayer’s money, users were supposed to cover only short-run marginal costs renewable energy sources will provide for new demand for power and gradually force out the conventional and nuclear energy entirely without distorting the power market status quo. Nobody will notice. However, the situation gets complicated in countries where those big conventional or nuclear power plants had been based solely on the private capital that still did not reach break-even and would not reach it in the foreseeable future.
In both cases, pricing and quoting systems in the power market will have to be adjusted to serve the transition phase. The world will require investment funds to cover the fixed costs of the investment into renewable power plants and simultaneously funds to dismantle the conventional and nuclear power plants so that nobody loses capital invested in the past without at least the coverage of those costs plus a reasonable margin. The world will need some cross-subsidizing schemes, that on one side, allow for the development of smaller and bigger renewable energy farms and, on the other side, keep nuclear power plants to level off the risk of blackouts till the new power market status quo is reached. One of those cross-subsidizing schemes is when a power supplier generates both conventional or nuclear energy and simultaneously builds and operates wind farms. Surpluses gained when delivering cheaper renewable energy at a demand peak when the spot price is higher cover losses at off-peaks.
The hybrid transition phase in the power market will, for sure, last for one or two decades or even longer. There are currently only a few countries in the world with a mixture of renewable power plants or farms and nuclear power plants providing a stable and reliable energy supply.
The power market in Europe or the European Union is today international. Energy generated in one country is used in other countries. Still, there are countries where the clouds prohibiting sunshine from reaching the surface are much more frequent than in other countries. A country with access to the sea will naturally have more wind power then a country locked or even double-locked somewhere in the middle of the continent. The international cooperation will be hence not only about trading with the excess energy but, above all, about stable energy provision.
Photo by Flickr and Gustavo Fring on Pexels