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Negative electricity prices [ClearOnMoney]
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Commentary

Negative electricity prices

27 Mar 2013 by Jim Fickett.

There are regions of the US where the wholesale price of electricity is negative a significant fraction of the time, that is, utilities must pay to put electricity on the grid, rather than be paid for their trouble. This is old news, but it is an important and continuing distortion in the energy markets, and worth understanding in some detail.

The short story is that the structure of tax incentives pays wind farms to produce even when there is no demand, and these incentives will continue for at least 10-13 more years. It is good that this encourages the production of more electricity from a renewable source. However wind is intermittent, and the grid also needs baseload power plants that are not intermittent. The fact that baseload generators are forced to subsidize wind, via the negative pricing that results from the incentives, is an unfortunate side effect of the law.

The main incentive at issue is the Production Tax Credit (PTC; Wikipedia has a useful historical overview). The main idea is that the PTC provides a certain number of cents per kilowatt-hour (kwh), via a tax credit, to producers of electricity from certain sources (including wind), for the first ten years of a facility's operation. The first version of the law, in 1992, specified a credit of 1.5 cents/kwh; the most recent version specified a credit of 2.2 cents/kwh. The law has lapsed and then been extended a number of times. Previous versions of the law required that construction of a power production facility be completed while that version of the law was in effect, creating a real roller coaster for companies trying to guess what law would be in effect when multi-year projects were finished. The latest version of the law, passed as part of the fiscal cliff extravaganza in January, only requires that construction be started while the current law is in effect (which is through 2013). So for all wind farms started in 2013, the PTC will be available starting from the time they are completed (sometime in the next 2-3 years) and ending ten years later. This distortion will be around for a long time.

Certainly government incentives have made a difference. Wind has constituted a remarkably high percentage of all new capacity added to the national electric grid overall in the last few years – over 40% in each of 2008 and 2009:

(The numbers behind the above graph are maximum capacity. Since wind farms produce, on average, at 25-30% of capacity, while coal and nuclear plants operate at something much closer to full capacity, this is a little misleading. Nevertheless, wind is steadily gaining in market share.)

The total installed wind capacity was up to 45 gigawatts (GW) at the end of 2011 (to give some sense of scale, a typical power plant generates something in the neighborhood of 1 GW):

(The two graphs above are from a Department of Energy report entitled, 2011 wind technologies market report.)

The AWEA recently updated these data through last year. 2012 was a banner year, with 13 GW of new capacity added, bringing total installed capacity to 60 GW. Wind now provides about 3% of all US electricity.

It is difficult to find reliable figures on the cost to operate a turbine, apparently because most operators consider this confidential information. But there is some data – according to a guidebook from the American Wind Energy Association entitled Establishing an in-house wind maintenance program,

When utilities share O&M [Operation and Maintenance cost] information, their networking can be valuable. For example, PSE … estimates the O&M range for a five-year-old 1-MW turbine to be between $40,000 and $70,000 per year, or around 1 to 1.5 cents per kWh generated.

Presumably O&M is cheaper than this for a turbine newer than 5 years old, and more for one older than 5 years old, and giving this midpoint is intended to provide an overall ballpark figure. Assuming this figure is typical, it costs a wind farm 1 to 1.5 cents per kWh to operate, and the tax credit pays them 2.2 cents per kWh to operate. So even if there is no demand, they make a profit operating.

You might think that with only 3% of the nation's electricity coming from wind, some excess production from wind farms would have little effect. This turns out to be false for three reasons:

  1. The fraction of power that comes from wind varies greatly by region. For example, the DOE report mentioned above estimates that, as of end 2011, six states obtained more than 10% of their power from wind (South Dakota, Iowa, Minnesota, North Dakota, Colorado, and Oregon)
  2. In many states, state law requires grid operators and utilities to accept electricity from wind farms even if there is no demand; there is no requirement, on the other hand, to accept power from baseload power plants
  3. The market share of wind continues to grow rapidly; some think the goal of 20% by 2030 is realistic; and recall that the PTC will continue to pay for at least 10-13 more years, more if renewed

Presently, the distortion is substantial for at least some power plants. The Chicago Tribune reports:

[Exelon]'s Byron nuclear plant in Illinois, [Exelon Corp. Chief Executive Christopher Crane] said, is in a negative pricing scenario 16 percent of the time.

And Bloomberg reports:

On gusty days in the five states with the most wind power - - Texas, California, Iowa, Illinois and Oregon – this can flood power grids, causing prices to drop below zero during times when demand is light. Wholesale electricity during off-peak hours in Illinois has sold for an average price of $23.39 per megawatt hour since Jan. 1, after hitting a record low of -$41.08 on Oct. 11, the least since the Midwest Independent Transmission System Operator Inc. began sharing real-time pricing in 2005.

Meanwhile, nuclear and coal plants must continue running even as this “negative pricing” dynamic forces them to pay grid operators to take the power they produce. …

Before 2006, when wind power began its latest growth spurt, negative prices were extremely rare. The phenomenon is now prevalent in parts of the Midwest, Texas and the West Coast where turbine installations are growing fastest, data compiled by Bloomberg show.

“We can’t find enough demand for the amount of energy created by Mother Nature,” said Doug Johnson, spokesman for the Bonneville Power Administration, which manages the grid in the Pacific Northwest. The transmission operator, based in Portland, Oregon, paid wind operators $2.7 million last year to stay off line so it could make room for the power from hydroelectric generators handling the runoff from melting mountain snows. …

Negative prices are starting to seep into a Southern California power hub and may become more frequent as state regulations mandate that 33 percent of its power come from renewable sources by 2020, Blaha said. “That extra amount is going to knock out about 15 percent” of energy filled by fossil fuels.

Exelon, the largest U.S. nuclear operator, says a surplus of wind power is making negative pricing a problem in Illinois, where it owns six nuclear plants and a wind project. Prices for markets served by Exelon’s Clinton and Quad Cities reactors trade below zero between 8 percent and 14 percent of off-peak hours, said Joseph Dominguez, Exelon’s senior vice-president for governmental and regulatory affairs and public policy.

“must continue running” here is meant in an economic sense. It is complicated and expensive to shut down and start up nuclear and coal plants. So the choice is between operating with lower or no profit, on the one hand, or shutting down semi-permanently.

For the nation, the most interesting point is whether the incentivized ramp-up of wind can be done in a way that does not force too many baseload plants out of business. It will be interesting to see if it comes to the point of truly inadequate baseload power.

For my portfolio the proximal question is Exelon which, for now, I continue to hold. The question for the short term is whether the rise in natural gas prices will compensate for the overly cheap wind power. For the long term, the question is how the balance will work out, over the next 12 or more years that some form of the PTC will remain in effect, between the rise in the market share of wind, and the end of the PTC for older wind farms.