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Renewable power and electricity prices: the impact of forward markets

Journal

Management Science

Subject

Management Science and Operations

Publishing details

Management Science 2021 Vol 67:8 p 4772-4788

Authors / Editors

Peura H;Bunn D W

Biographies

Derek Bunn

Publication Year

2021

Abstract

Increasing variable renewable power generation (e.g., wind) is expected to reduce wholesale electricity prices by virtue of its low marginal production cost. This merit-order effect of renewables displacing incumbent conventional (e.g., gas) generation forms the theoretical underpinning for investment decisions and policy in the power industry. This paper uses a game-theoretic market model to investigate how intermittently available wind generation affects electricity prices in the presence of forward markets, which are widely used by power companies to hedge against revenue variability ahead of near-real-time spot trading. We find that in addition to the established merit-order effect, renewable generation also affects power prices through forward-market hedging. This "forward" effect reinforces the merit-order effect in reducing prices for moderate amounts of wind generation capacity, but mitigates or even reverses it for higher capacities. For moderate wind capacity, uncertainty over its output increases hedging, and these higher forward sales lead to lower prices. For higher capacities, however, wind variability conversely causes power producers to behave less aggressively in forward trading for fear of unfavorable spot-market positions. The lower sales counteract the merit-order effect, and prices may then paradoxically increase with wind capacity despite its lower production cost. We confirm the potential for such reversals in a numerical study, suggesting new empirical questions while providing potential explanations for previously contradictory observed effects of market fundamentals. We conclude that considering the conventional merit-order effect alone is insufficient for evaluating the price impacts of variable renewable generation in the presence of forward markets.

Keywords

Electricity markets; Renewable energy; Forward trading; Cournot competition

Available on ECCH

No


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