Supply and Demand: Are Renewables Affecting Wholesale Energy Prices?

by | Nov 30, 2021 | Blog

Rows of solar panels on a green field.

Summary

  • It’s well-known that broad implementation of renewables is required to reduce greenhouse gases in the atmosphere. Governments set up financial incentives to help individuals and businesses invest in renewable energy to push this initiative further. Now that these programs are coming to an end, they may hinder the sector’s growth.
  • Most people agree that the cost of generating renewable electricity is reducing dramatically due to government payouts, increased demand and changing attitudes towards the environment.
  • Despite the declining cost of generating renewable electricity, wholesale energy prices have remained unaffected. The steady rates may cause a problem with generating cash flow and revenue for clean energy projects, which may knock on future investors.
  • Due to the various payment schemes, wholesale energy prices aren’t competitive enough. Even with new lower generation costs, it will struggle to outweigh the cost of older subsidized plants. Moreso, as wind and solar depend on weather patterns, periods of high generation may not correlate with increased demand—meaning the wholesale price is affected, and operators generate less cash flow.
  • Reports show prices are on the mend in 2021, and new technology, such as solar batteries, may help capture prices while generation is at its peak. This could balance the issues associated with wholesale prices.

Introduction

…with increasing demand for renewables and lowered pricing, wholesale energy prices may be affected.

Renewable energy is vital for reducing greenhouse gas emissions and living in a cleaner environment. By displacing fossil fuels and making cleaner options more accessible, it could significantly impact global warming. What’s more, as the transport sector moves towards electric vehicles (EV), there is an even bigger push for clean electricity. The energy that powers EV must be clean; otherwise, we are simply increasing the demand for oil, coal, and gas.

To help push the green initiative, governments have created payment incentives to reduce the cost of renewables and make them more accessible to the broader population. Schemes like these have done a lot to help individuals and businesses switch to clean power. However, with increasing demand for renewables and lowered pricing, wholesale energy prices may be affected. If wholesale electricity rates match the retail prices, it can dramatically affect revenue predictions and slow the growth of the renewable energy sector.

Why is Renewable Electricity Generation Cost Declining?

…the International Renewable Energy Agency (IRENA) discovered 62% of new renewable generation cost less than the cheapest new fossil fuel option.

The cost of generating renewable electricity has been declining for decades. Between 2010 and 2020, electricity costs fell by 85% for utility-scale solar photovoltaic (PV) power. Interestingly, this downward trend continues as the International Renewable Energy Agency (IRENA) discovered 62% of new renewable generation cost less than the cheapest new fossil fuel option. With concentrated solar power (CSP) showing the most significant decline of 16% cost reduction. The data clearly shows that the cost of generating renewable electricity is becoming more affordable year on year, but why are these costs falling?

Firstly, the industry finds new ways to manufacture renewables with less expense and more efficient models as technology and design advances. For instance, wind turbines are larger and have a greater capacity compared to over a decade ago. Solar panels are also becoming more efficient as experts figure out ways to slim them to cut material costs without compromising capacity. Furthermore, the sector operates on a utility scale, alongside more expensive smaller projects like rooftop PV panels.

Lastly, tax credits, feed-in-tariff, and payment incentives contribute to the cost decline of renewables like wind and solar. Government schemes like these target the renewable energy sector specifically, increasing demand and making energy more affordable. With the cost of renewables dramatically declining, it’s natural to assume wholesale electricity prices would also drop.

Why Aren’t Wholesale Energy Prices Changing?

The reason wholesale prices rarely change is that generators pay them; whereas, the final customers pay retail prices to reflect the entire lifecycle of delivering electricity.

Despite the considerable fall in renewables cost, wholesale energy prices remain unchanged or increased. This confusing relationship between rates is seen in the European Union, where between 2015 and 2018, the average quarterly wholesale price rose by approximately 20 euros per megawatt-hour.

Moreover, economists at the Energy Policy Institute at the University of Chicago (EPIC) released a paper on the cost-effectiveness of renewables. After reviewing the renewable portfolio standard (RPS) programs across 29 states in America, the authors discovered that although retail prices had risen significantly, CO2 emissions only reduced moderately. These figures may spark queries about why energy price increases are necessary.

So, how are renewables affecting wholesale prices? Although renewables’ levelized cost of energy (LCOE) is falling and the grid share of renewables is increasing, wholesale electricity costs don’t seem to be getting any cheaper. The reason wholesale prices rarely change is that generators pay them; whereas, the final customers pay retail prices to reflect the entire lifecycle of delivering electricity. Generation accounts for approximately 44% of the final cost, with other expenses including maintenance, taxes, and depreciation, to name a few.

An infographic of someone analyzing the data of solar panels and wind turbines.

Why Is There a Disconnect Between Wholesale Prices and the Cost of Renewable Electricity?

Price cannibalization is another reason investors may avoid financing subsidy-free renewables because the high output of weather-dependent energy overwhelms the system and causes the price to drop—resulting in lowered revenue.

There are several reasons why renewable generation prices and wholesale rates may not align, but they may be rooted in the increased availability of affordable clean electricity. Recent price reductions may not outweigh the cost of older renewable plants subsidized through government support schemes. What’s more, renewables only account for a small percentage of electricity production, and the price will depend on which electricity it’s displacing, the location and the time of distribution.

LCOE may play a role in how wholesale prices are affected. As we’ve discovered, the cost of generating wind and solar energy has declined in the past couple of decades. It is now equivalent to or lower than conventional power like fossil fuels. In short, renewables can generate more power for less capital.

To get it to this point, payments from governments have helped develop more sustainable energy solutions. Criticism is starting to die down as the cost of these schemes may fall on the taxpayer. However, while it may seem positive for consumers, the government schemes make energy prices almost equal to wholesale prices in some areas.

Moreover, renewable capacity has been growing steadily for years, but relying on natural resources can pose an issue for generating revenue. The intermittency of power may put pressure on a project’s revenue prospects. For instance, the combination of solar and wind may create a solid year-round supply of electricity, as solar generation peaks in summer and fades over winter. In contrast, the wind picks up during the colder months and subsides during warmer months.

However, these elements alone could be temperamental because the highest output may not coincide with the highest demand. With that in mind, there seems to be a correlation between the amount of renewable energy output and the wholesale price of electricity. To make matters worse, if wind and solar costs are depressed during a favourable period, it creates less cash flow than the operator may have projected.

In other words, this is known as “price cannibalization”. This term refers to the depressive influence of high-output renewables like solar and wind on wholesale electricity prices. A low capture price (i.e. the actual price of electricity in the market) for solar and wind may lead to costs depressing over time.

Price cannibalization is another reason investors may avoid financing subsidy-free renewables. The high output of weather-dependent energy overwhelms the system and causes the price to drop—resulting in lowered revenue. There would be no guaranteed revenue if wholesale rates ever fell below the generating costs of new subsidy-free wind and solar projects. Thus, the prospect of renewables cannibalizes its own revenue.

Closing Thoughts

While making renewables affordable through government incentives has paved a strong future for clean energy like wind and solar power, there is an unexpected hurdle to address. The relationship between renewables and wholesale energy prices is complex. The intermittency of weather-dependent power could cause what is known as price cannibalization. If wholesale prices aren’t profitable enough and power is only generated when prices are depressed, it could deter potential investors. If the renewable sector struggles to receive private-sector investment, it may present an issue for decarbonization.

That said, renewable output intermittency could be addressed by developing new solar batteries and combining solar and wind energy.

Frequently Asked Questions (FAQs)

Why is the cost of renewables declining so fast?

There are several reasons why renewable energy has become so affordable. As attitudes towards climate change have developed over the last decade, individuals, companies and governments have taken greater responsibility for their emissions. Consequently, we’ve seen a massive rollout of financial incentives to encourage people to invest in renewables.

These schemes help make renewables more accessible, which has a domino effect because as the demand increases, the price of renewables continues to fall. Therefore, with payment incentives, higher demand, and changing attitudes, renewables, like solar, have become more affordable. In fact, solar power is now one of the cheapest electricity sources to generate.

 

How do wholesale energy prices affect renewable investments?

Government incentives have been a leading cause in making renewables accessible and affordable. Unfortunately, as wind and solar are weather-dependent, they may only generate power when prices are lower—this increased demand when prices are low will further push prices lower.

This decline may alter the predicted cash flow of the clean energy project. Furthermore, government schemes have previously caused prices to fall to wholesale rates. If wholesale prices fall below new solar and wind power, there is no guaranteed revenue and little reason to invest. If the sector struggles to receive private investments, it could lead to issues with decarbonization.

 

What is price cannibalization?

Price cannibalization in the context of renewables refers to the effect high-output renewables have on wholesale electricity prices. In the past, the intermittency of solar and wind meant it had a low capture price making prices decrease over time. Unfortunately, periods of high output can overwhelm the system and make the price drop.

When this happens, it drives down cash flow and potentially affects the operators’ predictions for the project’s revenue. Moreover, as some government schemes have made retail prices almost equal to wholesale rates, price cannibalization may result in no guaranteed revenue. This prospect is a huge deterrence for potential investors, which could harm the aim of decarbonizing.

 

Will COP26 affect energy prices?

During the COP26 summit, world leaders came together to assess and implement plans to reduce global warming. There is a consensus that investments in the fossil fuel sector must stop immediately if any progress commences. If fossil fuel production begins to decline even further, we may see changes to energy bills. Fossil fuel-based electricity will likely increase in price, and the demand for renewables will rise too.

However, at the COP26 summit, many leaders commented that the fossil fuel industry is so large that it isn’t financially viable to switch to a renewable economy. Some people argue fossil fuel prices should decline, but this would be met with criticism as the world desperately needs to move away from these sources. Lowering the cost will, unfortunately, increase demand and greenhouse gas emissions.

 

Are wholesale prices still being affected?

According to the International Energy Agency’s (IEA) review, wholesale electricity prices have recovered. It seems although solar, wind and hydropower depend on the weather, the effect of intermittency isn’t as impactful as previously thought. Shifts in the oil and gas market may have a more significant impact than those in renewables. Moreover, experts could rectify the intermittency effect by implementing and developing batteries to store energy all year round.