Feed-in Tariffs, integration costs and increasing shares of variable renewable
energy
Oda Kristine Østbye Bratlie
Thesis submitted for the degree of Master of Philosophy in Economics
DEPARTMENT OF ECONOMICS UNIVERSITY OF OSLO
12th of November 2018
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Feed-in Tariffs, integration costs and increasing shares of variable renewable energy
Master thesis written by Oda Kristine Østbye Bratlie to obtain the degree of Master of Philosophy in Economics
Supervised by Professor Christian Traeger
at the Department of Economics at the University of Oslo
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© Oda Kristine Østbye Bratlie 2018
Feed-in Tariffs, integration costs and increasing shares of variable renewable energy Oda Kristine Østbye Bratlie
http://www.duo.uio.no/
Trykk: Reprosentralen, Universitetet i Oslo
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Abstract
For the last 20 years deployment of variable renewable energy (VRE) sources such as wind and solar have increased rapidly. The high growth rates of investment have been largely credited to the Feed-in Tariff (FiT) policy which acts as a subsidy to VRE producers.
Increasing the share of green energy in the generation mix is crucial in the fight against climate change, but also induce problems in the energy market because of the variable and uncertain supply, known as integration costs. The FiT subsidy is raised by taxing the consumption of energy which can create welfare losses. In this thesis, I will review the literature and economic theories behind how high levels of VRE will change the energy market over time. Furthermore, I will discuss how the FiT scheme design can be changed to mitigate integration costs. I find that different FiT schemes will have advantages and
disadvantages when it comes to investment incentives, mitigation of integration costs and social welfare. The policy makers choice of which FiT scheme to implement should depend on long-term technological developments in the energy market such as storage capacity and generation flexibility.
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Preface
This master thesis represents the end of many years of studies at the University of Oslo. It has been a time filled with challenges, developments and most of all joy.
I would like to thank my supervisor Christian Traeger for all your help and constructive feedback. I have appreciated our interesting discussions. I would also like to thank my family.
Especially to my mum who has spent time proofreading this thesis despite not understand economic theory and my sister who is always just a phone call away.
My time as a student would not have been the same without my co-students, thanks for countless hours of laughter, eating lunch and endless study-group sessions. In particular, thank you to Frida, Liselotte, Linnea, Karina and Ida for years of wonderful friendship and for never letting me doubt myself.
All errors are my own.
Oda Kristine Østbye Bratlie November 2018
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Content
1 Introduction ... 1
2 What is a Feed-in Tariff? ... 3
3 Why subsidise? ... 8
4 Penetration of variable renewable energy sources and integration costs ... 11
4.1 What are integration costs? ... 11
4.2 Integration costs and the value of VRE through the transitional process ... 14
4.2.1 Short- and mid-term with exogenous installed capacity ... 15
4.2.2 Long-term transition with endogenous installed capacity ... 16
5 Feed-in Tariffs in relation to the energy market and integration costs. ... 21
5.1 Learning rates and degression ... 22
5.2 Exposure to market signals ... 24
5.3 Consumers and social welfare ... 29
6 Conclusion ... 33
References ... 37
List of figures: Figure 1.1: The fixed FiT price model. Retrieved from T. Couture and Gagnon (2010), Fig. 4 Spot market price gap model. Page 959 ... 4
Figure 1. 2: The constant premium FiT price model. Retrieved from T. Couture and Gagnon (2010) Fig. 5 Premium price model. Page 960 ... 5
Figure 1.3: The sliding premium FiT design. Retrieved from T. Couture and Gagnon (2010) Fig. 6 Variable premium FIT policy design. Page 960 ... 6
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1 Introduction
Investment in renewable energy sources (RES) have for the last 20 years increased rapidly.
Increasing the share of renewable energy in the energy production sector and decarbonising the energy mix is crucial to reduce emission of CO2 and to combat climate change.
Governments around the world have announced ambitious targets for an energy transformation to a generation mix with more RES. In 2007 the European commission announced the 2020 climate and energy package, which aims to have 20 % of EU electricity produced by RES by 2020. China has announced a target to have a 20 % share of non-fossil energy by 2030 (International Energy Agency, 2016). Policy makers have used several different support schemes to accelerate investment of RES such as Feed-in Tariffs (FiTs), tax incentives and renewable portfolio standard. FiTs are the most widely used policy and have been credited for the successful implementation of large shares of RES all over the world (T.
D. Couture, Cory, Kreycik, & Williams, 2010). The FiT acts like a subsidy by guaranteeing the producers of RES technology a payment per KWh produced which is higher than the market price. This insures that investors cover their investment costs and capital costs in the long-term and it insures banks giving investment-loans.
The FiT schemes’ success of incentivising investments in RES can be seen in the rapid growth of deployment. There was a 66.6 % increase in the electricity produced by RES in the EU between 2006 and 2016 (Eurostat, 2018). The largest increase in the EU has been in wind power technology, increasing its share of total installed capacity in the EU from 6 % in 2005 to 18 % in 2017. The second largest increase is solar photovoltaic (PV) which grew from being 0,3 % in 2005 to 11.5 % in 2017 of installed capacity (Wind Europe, 2018). Installed capacity is not the same as energy produced. The energy produced is adjusted after demand in the market and when the technologies can produce. Installed capacity is the theoretical full generation capacity. Countries in Asia have also introduced successful FiT schemes, with the Philippines, Thailand and China being some of the countries with the highest growth in shares of variable renewables (Tongsopit et al., 2017). China introduced a FiT scheme in 2009 and is becoming the largest investor in solar PV energy in the world. Wind power has been installed
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in China at a rapid pace, with an annual growth rate of almost 112 % in 2009, when the FiT was introduced, compared to the year before (He, Pang, Zhang, Xia, & Zhang, 2015).
The largest increases in RES deployment are in wind and solar power instalments which are variable renewable energy (VRE) sources. Since these are the technologies with the highest growth rates, they will be renewable energy sources addressed in this thesis. They are variable because they depend on processes in nature to produce, these processes make the generation profiles change throughout the day and can have stochastic changes in production which results in uncertain and variable supply. VRE sources are also called intermittent, non-
dispatchable or fluctuating energy sources. Despite the technological limitations on supply, it has been estimated that RES can supply the world’s demand for energy several times over, with the largest shares of the generation mix being wind and solar (Ellabban, Abu-Rub, &
Blaabjerg, 2014). Energy is a time- and space-heterogenous good so it matters when and where it is produced. Consequently, when the shares of wind and solar power increase the variable nature of the technologies create shifts in the energy market, often referred to as integration costs. The integration costs are largely not internalised by the intermittent energy producers, but the costs are rolled over on producers of dispatchable energies, the system operators and consumers.
The FiT scheme has been successful in term of increased deployment of VRE technologies.
However, integration costs are becoming more apparent in the energy markets which raises the question if it is time to pay more attention to the dynamics between the FiT scheme and the market development. I will through a literary review discuss the economic reasons for having a policy which promotes technologies which cause further problems. I will analyse the integration costs and the dynamic development of the integration costs as the share of VRE technology increase. Furthermore, I will focus on how the design of a FiT scheme will affect the energy market and the generation portfolio as wind and solar power penetrate. I will discuss how different FiT designs change incentives for VRE producers to internalise the integration costs they put on the energy market and if this internalisation is a good strategy.
The thesis will also address how the FiT design will affect consumers and social welfare.
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2 What is a Feed-in Tariff?
One of most wide-spread policies introduced to incentivise investment is Feed-in Tariff (FiT) schemes. The target for an efficient scheme is to maximize deployment of new wind and solar plants and the generation of green electricity. There are many ways to design a FiT scheme, the details of which can differ between countries. However, the main implications are the same. The FiT offers long term contracts to renewable energy producers which normally last between 15-25 years. Long-term contracts decrease the total cost of the investment, ensure cost recovery and lowers the risk for investors (Lipp, 2007). The reason FiTs have been so successful in accelerating VRE investment is because the purchasing agreements offer a specified price per KWh produced which is above the market price. The FiT acts like a subsidy to suppliers of renewable energy to ensure the payment received give sufficient revenue to cover the costs. The policy makers subsidise the gap between the market price and the FiT, which is raised through taxes levied on the consumers.
Mendonça, Jacobs, and Sovacool (2009) argue that the FiT schemes which are most efficient in terms of new instalments of wind and solar plants have a payment system which cover the cost of the VRE project with an additional profit. This is called an aggressive FiT system. It allows for less-competitive technologies to be a part of the portfolio and encourage smaller investors to install sites. However, with an aggressive FiT there is a possibility of over-
compensating, which can make the total cost of the FiT scheme too high (T. D. Couture et al., 2010; Lesser & Su, 2008; Lipp, 2007; Mendonça et al., 2009). Tariff rates can also be set more moderately, which might not make the support scheme as efficient in deployment of new instalments but have a lower total cost of the support scheme. Such tariffs can be set as close as possible to the generation cost for a specific technology (T. Couture & Gagnon, 2010). Whether having an aggressive or a more conservative tariff design, it is common to differentiate tariffs according to technology, project size, location of the installed plant and resource quality (T. D. Couture et al., 2010). Differentiating the tariffs will lead to a broader portfolio of what types of VRE technologies and where they are located. Milligan et al.
(2011) argues that such differentiation is necessary to ensure energy security with large shares
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of VRE in the generation mix. Diversity in technologies and locations reduce the correlated variability which leads to lower risk and less fluctuating supply.
There are two main types of FiT schemes, a fixed FiT and a premium FiT. The choice of which contract is used will determine whether the FiT payments depend on the market price of electricity or not. A fixed price FiT payment has been the contract which most countries offer. Figure 1.1 shows how the payment received by VRE suppliers is independent of the market price and is fixed for each KWh produced. The producers will receive the fixed tariff during hours where the spot market price is below the tariff rate and will receive the spot market price during hours where it exceeds the tariff rate. It is a low-risk approach which offers stability for the investors since the tariff remains the same for the duration of the contract. The fixed FiT can offer contracts which are independent or dependent of all
variables, for example inflation, the consumer price index and fossil fuel prices (T. Couture &
Gagnon, 2010). If the contract is independent of inflation the real payment received by the VRE producer will relatively decrease over time.
Figure 1.1: The fixed FiT price model.
Retrieved from T. Couture and Gagnon (2010), Fig. 4 Spot market price gap model. Page 959
A premium FiT, or a Feed-in Premium approach is becoming more common. Such a contract makes the producer market dependent since it offers the VRE producers the spot market price plus a premium. The premium can be designed to be sliding or constant. A constant premium,
5 seen in Figure 1.2, is easier to design but is riskier for the investors. The risk comes from the difficulty in anticipating long-term energy prices especially over the duration of the FiT contract and the costs of the VRE occur at the beginning of the plant’s lifetime. The constant premium follows the spot market price during all hours of the day. A low spot-market electricity price can make the premium insufficient to cover costs, which will drive away investors. However, there are also potentially higher profits when the market price is high than under a fixed or sliding FiT scheme. Spain has implemented a price floor and price roof to ensure that the revenue received by VRE producers are not over- or under-compensating them (T. D. Couture et al., 2010). There is a consensus in the literature that a premium FiT is more costly per KWh because producers must be compensated with an additional risk
premium for being exposed to market price volatilities (T. Couture & Gagnon, 2010; Held et al., 2007; Mendonça et al., 2009; Schallenberg-Rodriguez & Haas, 2012). A higher costs per KWh produced means that the total cost of the FiT is higher under a constant premium than under a fixed or sliding FiT scheme.
Figure 1. 2: The constant premium FiT price model.
Retrieved from T. Couture and Gagnon (2010) Fig. 5 Premium price model. Page 960
Figure 1.3 shows a sliding premium FiT scheme. The premium received by VRE producers will vary with the market price. If the spot-market price is high the premium received is lower and if the spot-price is low the premium increase. To avoid over- or under compensating producers top and bottom limits can be introduced. When the spot-market price drops below a certain threshold the producers receive a floor-payment level, and similarly if the market price
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goes above a certain threshold. When the market price is sufficiently high, the producers receive no premium but the market price per KWh. A sliding premium makes expected profits more stable, exposes VRE producers to lower risk and acts similarly to a fixed FiT contract because it guarantees certain tariff-levels. However, they require closer monitoring to make sure the premiums are not too high or too low.
Figure 1.3: The sliding premium FiT design.
Retrieved from T. Couture and Gagnon (2010) Fig. 6 Variable premium FIT policy design. Page 960
Another key provision in the FiT contracts is physical dispatch insurance, or the priority rule.
It guarantees that every KWh produced by VRE sources is fed into the grid. The argument for having this purchasing obligation is to lower the risk for VRE suppliers, which can lower the payment needed to cover the costs. Having assured access to the grid can also help replacing dispatchable energy sources, especially peak-hour technology. However, demand for
electricity is time-heterogenous and the market needs to be in equilibrium at all hours of the day. That energy produced by VRE is guaranteed grid access means that they might supply energy at times of low demand and creating excess supply and negative prices (Brandstätt, Brunekreeft, & Jahnke, 2011).
An important part of the design of the FiT is how the tariffs should be degressed over time.
Contracts include a pre-determined tariff degression, normally annually, whereby the tariffs
7 are adjusted down. The reduced tariffs only apply to new instalments. Degressing tariffs is a way for policy makers to reduce the risk of over-compensating the producers. Furthermore, the tariffs decrease annually so the later a new plant is installed, the less subsidy they will receive (Klein, Held, Ragwitz, Resch, & Faber, 2008). Degression acts as an incentive for technological development and reduces costs. Growth in investment or technological
innovation are reasons for the tariffs to be degressed according to market development (T. D.
Couture et al., 2010). Reducing the payments over time is necessary for innovation and for the VRE technology to become competitive. However, Del Río (2012) argue that pre-determined degression rates can lead to inefficiencies, either if costs increase so that the payment received becomes too small, or if the costs decrease more than the degression leading to over-
compensation. There are now adjustable degression rates which are set in place, which for example change with the rate of inflation.
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3 Why subsidise?
The installation costs of VRE are higher than the costs of investing in dispatchable
technologies, so without a support scheme it would not be a natural market development for investing in VRE. Even if the market would not invest in VRE does not mean it is not economically efficient. Market agents do not take into account social welfare and overlook externalities. To justify a FiT scheme, it is necessary to look at the economic reasons behind giving a subsidy.
If the main motivation behind increasing investment in VRE is to combat climate change and reduce emissions of greenhouse gasses (GHG) in the energy production sector, policies can either target the producers using fossil fuels directly through a Pigouvian tax or subsidise VRE. Both policy tools are price-based incentives. The market price will not reflect the social optimum because GHG emissions are a negative externality which is not accounted for in the market price if it is not corrected for. Both policies will make energy produced by polluting generators relatively more expensive than energy produced by renewable sources. Electricity produced by renewables and electricity produced by emitting sources are perfect substitutes.
Theoretically, a relatively lower marginal cost of production for VRE energy should set the price of energy produced by these generators lower and all demand would be for VRE
produced energy. However, it is not possible to discriminate between electricity in the market since the price is the same, independent of which technology produced it. Demand will therefore not be able to substitute towards green electricity, since there is no information of where the energy consumed is produced.
Following the “polluter-pay principle” the carbon tax must target the producers of
dispatchable energy sources who are creating the negative externality of emitting GHG. By doing this, the producers’ marginal cost reflects the marginal social cost of production. The quantity of energy produced by emitting sources will go down and the price will go up, with the size of these shifts depending on demand and supply elasticities. In addition to the market correction, taxes accumulate revenue for the government. If the tax burden falls on the
9 consumer or the producer depends on their respective price elasticities. Subsidising VRE will increase the quantity of energy produced and lower the price. A subsidy is an expense rather than a source of revenue for the government, and the funds needed will be levied through taxes put on the consumers. These taxes can distort the consumption bundle away from the first best solution. If the electricity prices decrease with a subsidy, the income effect will make the consumers relatively richer, which might shift demand towards using more energy, creating inefficiently high demand. Kalkuhl, Edenhofer, and Lessmann (2013) argue that subsidising to reduce emissions is risky because setting the subsidy slightly too low compared to the optimum, for example 2 %, it would increase emissions substantially. Similarly, if the subsidy is set 2 % above the optimum, there would be great welfare losses. Taxation is a more efficient way to reduce the emissions in the energy sector than a subsidy because it is a source of revenue for the government. Furthermore, a subsidy creates further distortions to the consumption bundle due to the taxes levied on the consumers.
Most countries have policies which both tax the emitting technologies and support schemes for VRE technologies. Since a policy directly targeting the emitters is more effective if the goal is to reduce GHGs there must be another reason to have an additional subsidising policy.
A reason to subsidise investment through FiTs would be if the VRE instalment creates positive externalities. The argument which is frequently mentioned in the literature is that the positive externality is learning-by-doing (Abolhosseini & Heshmati, 2014; Del Río, 2012;
Kalkuhl et al., 2013; Menanteau, Finon, & Lamy, 2003). Learning-by-doing means that investing in VRE technologies decrease the cost for all future instalments, or that the fixed costs are decreasing in the quantity of VRE. If the fixed cost level is reduced sufficiently the VRE technologies will become cost-competitive with conventional technologies. The competitiveness of different technologies is often measured by their levelized cost per KWh supplied. The levelized cost is a measure of the total life cycle cost per KWh supplied, these costs include capital and operating costs. Joskow (2011) argues that using levelized cost to compare energy technologies is flawed because a levelized cost treats every technology equally to the same price. However, electricity is a time-heterogenous good and technologies have different limitations. He suggests evaluating competitiveness based on the expected market value of the energy supplied, total life-cycle costs and expected profitability. This will include the integration costs of renewable energy. The degression of tariffs included in the
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FiT contracts are to adjust the tariffs to the decreasing costs. When the renewable
technologies become competitive, the goal is to introduce them to the energy market without subsidies or other support. Learning-by-doing would be an economic reason to subsidise VRE, but there is debate over how big the learning effect is. Gan, Eskeland, and Kolshus (2007) argue that theoretically, there is a learning-by-doing effect but empirically, there have not been any great results documented of the effect so far. They argue that there is greater need for subsidising R&D rather than instalments of VRE itself.
There are spillover effects directly linked to the subsidising scheme. Increasing the sector of renewable energy improves energy security, as it will make the individual country more autarkic. Countries will be more autarkic because diversifying supply means they do not need the same levels of import from other countries and can potentially increase exporting volumes of electricity. Import of coal and gas can decrease as the shares of these technologies go down. Moreover, another positive spillover is the foregone local environmental damages.
When dependency of fossil fuels goes down the extraction of these from local areas will be reduced, for example coal mining. In addition, there will be a reduction in local air pollution which causes health damages (Ottmar Edenhofer et al., 2013). Furthermore, job creation and a
“green” sector is another motivation. The European Commission (2012) estimated that if the growth in renewables is large, the sector can create 3 million jobs within 2030. However, this means that there must be a reduction in the labour force in other sectors, which the
Commission do not refer to. The net gain in labour supply is therefore ambiguous.
There is an obvious political motivation behind subsidising renewables to combat climate change through an energy transition into a future generation mix with more green energy.
Targeting the energy sector can drastically reduce emissions and help governments reach their set climate goals because the energy supply sector is the sector which emits the most with a global share of 35 % (O. Edenhofer et al., 2014). This transition can be done faster with a dual policy, by taxing producers who emit CO2 whilst also subsidising the technologies the policy maker wants larger shares of.
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4 Penetration of variable renewable energy sources and integration costs
Wind and solar generators are intermittent sources of energy because of the generation profile and the stochasticity of the wind and sun, and hence are variable in supply. Increasing the share of VRE in the generation mix creates problems in the energy market which are often referred to as integration costs. The integration costs are not externalities but natural market processes cause by a new set of technologies entering the market. They cause problems because the energy market is special in that supply must equal demand during all hours of the day, the inflexibility of baseload technology and the voltage in the grid must be correct to otherwise damage the grid. These integration costs are split into three components: the variability of supply (profile costs), uncertainty1 (balancing costs) and location costs (Hirth, Ueckerdt, & Edenhofer, 2015). Profile costs are not necessarily financial costs, but rather problems which create inefficiencies in the market, change the market equilibrium and decreasing the market price. Balancing costs and grid-related costs are more direct costs which can be measured by the prices in the balancing-market and cost of grid extensions.
4.1 What are integration costs?
Profile cost, or the variability of supply, creates a problem because electricity is a time- heterogeneous good and it is important when the energy is produced. The cost refers to the foreseen variability in the generation profile of VRE sources. For solar PV sources this can be that they will not produce during the night and will produce less during the winter months.
For wind, the generation profile is more vague but can be estimated to produce more during the winter months. The term profile costs is not generally defined in the literature, but Hirth et al. (2015) define the profile cost as: the spread between the load-weighted average price and
1 Uncertainty is the term most commonly used in the literature. I understand it as the uncertainty refers to the stochasticity of the VRE sources in that the variation of the wind and sun is random. Stochastic and uncertain will be used interchangeably throughout this thesis.
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the technology-weighted electricity price over all time steps during one year. The load-
weighted average price is the annual average of the wholesale price. The technology-weighted average price can be interpreted as the long-term marginal cost of the technology. Profile costs reflect the marginal value of electricity at different moments in time and the opportunity costs of matching VRE generation and load profiles through storage. If the VRE are
producing energy during periods with low demand the supply in the grid is too high resulting in a shift in the residual load curve. The residual load curve is demand minus the electricity produced by renewable generators. Consequently, there is a decrease in the price which results in very low or even negative prices (Hirth, 2013).
As the share of VRE increases, the possibility of negative prices will become more frequent.
Often referred to as the merit-order effect, it is bound by two conditions. The first is that dispatchable energy sources are inflexible, at least in the short-term, because of the high costs of shutting down and restarting generators. The second is that energy storage is too expensive and is not yet at a capacity to mitigate these time-fluctuations. As the share of VRE increase, the merit-order effect pushes down the price of electricity which implies that the per KWh value of VRE decreases (Hirth, 2013). Furthermore, there is the correlation effect which refers to how VRE production correlate with energy demand. If the correlation is positive the VRE can be utilised efficiently as peak-load technology, for example with solar PV producing more energy during the summer when the demand for air-condition is high. However, if the correlation between production and demand is negative it will create negative prices even more frequently. Hirth (2013) argues that at non-marginal investment levels of VRE the merit-order effect will dominate a positive (or negative) correlation effect. The larger the share of VRE the larger the price drop, and hence also the market value of VRE technology.
Another problem which occurs are forecasting errors and resulting balancing costs. Balancing costs are the unforeseen or stochastic variability in the generation. For solar power that might be small clouds which are unforeseen on an otherwise sunny day and for wind power
unforeseen changes in the strength of the wind which is lower or higher than forecasted. Hirth et al. (2015) define the balancing costs as: the reduction in the VRE market value due to deviations from the day-ahead generation schedule. The costs reflect the marginal cost of balancing deviations from the schedule in the hourly intraday market. Energy produced with VRE is uncertain upon realisation, and the predicted generation might or might not be met.
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intermittent and there are forecasting errors. These balancing costs can be large and are generally born by system operators which are again rolled over in the consumer price (Hirth et al., 2015). Balancing costs are similar to profile costs because they are the result of the intermittency of the wind and solar technologies. However, they differ in time-scale.
Balancing costs occur within a day and is a cost because it needs to be corrected in the grid instantaneously. Profile costs deal with a longer period of time seasonally or annually and how the generation load of VRE will change the market equilibrium, demand for dispatchable baseload technology and prices.
There are different grid-related costs to increasing the share of VRE. New investments of wind and solar power plants require connection to existing transmission and distribution grids. Kabouris and Kanellos (2010) argue that it is not possible for large shares of VRE to be installed without a substantial expansion of transmission infrastructure. Since wind and solar power depend on nature, the sites which maximize output might be located far away from where the load centres and demand are, offshore wind plants are examples of this. Connecting the sites to the existing grid can accumulate large instalment and transmission costs. The location chosen for new investments should therefore be maximized subject to both output and access to the transmission grid. There are increased chances of “bottleneck” situations because the grid is not developed for larger shares of VRE energy. If the generated energy becomes too high for the transmission networks capacity, certain energy sources will be involuntary curtailed by the system operator. Transmission costs do also occur, as there is a loss of power in transmission when the energy is transported over long distances. Hirth et al.
(2015) define grid-related costs as the spread between the load-weighted average and the wind-weighted average electricity price across all bidding areas of the market. The location costs reflect the marginal value of electricity at different sites and the opportunity costs of transmitting electricity on power grids from VRE generators to consumers. Grid-related costs reflect that the energy produced have different market values depending on where it is
produced. Additionally, there is a negative externality related to the location of instalment which is that people are generally opposed to large power installations close to where they live.
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4.2 Integration costs and the value of VRE through the transitional process
Increasing the share of VRE in the energy mix is a transitional process which will continue to extend into the 21st century. In a short-term perspective, the total installed capacity is fixed and there are no opportunities for (dis)investment. For a mid-term perspective, installed capacity remains fixed but there are possibilities for (dis)investment in technology. Capacity is fixed because an energy plant has a certain lifetime which can last for several decades.
Previously installed coal and nuclear plants are still producing if they are profitable and are not ordered to shut down by the policy makers. Furthermore, policies such as a FiT scheme will incentivise larger investment into intermittent energy sources and the shares will therefore increase in the mid-term. In the long-term, installed capacity is regarded as endogenous and so is (dis)investment. Previously installed dispatchable capacity might be faced out through policy, if they are no longer profitable or because the lifetime of the plant is over. Simultaneously, VRE sources will have become a large share of the energy mix due to policies such as the FiT scheme and because the investment costs will have gone down through learning-by-doing. The short-, mid- and long-term perspectives are not defined by a specific amount of years, but by the exogeneity and endogeneity of (dis)investment and installed generation capacity. The timeframe will be different for each country dependent on the existing generation mix both in terms of renewables and non-renewables, when the technology was installed and which policy goals the government has set.
To understand how the development to a generation mix with more VRE when allowing for (dis)investment in the mid-and long-term, it is necessary to see how the value of VRE
generation can be expected to change. Since energy is a time- and location-heterogenous good the value is determined by when and where it is produced. Hirth (2013) analyses the market value of variable renewables in relation to integration costs, and more specifically how profile costs will change the market value of VRE. He defines the market value as the revenue the
15 technologies can earn on the market without additional subsidies2. The market value is
measured as the ratio of the wind or solar hourly-weighted average wholesale price relative to the time-weighted average price. Or the technology’s long-term marginal cost relative to the long-term marginal cost of the generation mix, this is called the technology’s “value factor”.
A decreasing value factor implies that the technology’s value is decreasing relative to dispatchable and constant technology. Hirth concludes that at a 30 % penetration level the value of wind energy is lowered to 0.5-0.8 relative to a constant source of energy supply.
Similarly, with solar power he estimates the value will fall to the same levels but only at a 15
% market share. These estimates are for a long-term perspective where the installed capacity is endogenous.
4.2.1 Short- and mid-term with exogenous installed capacity
In the short-term perspective integration costs will not have great consequence if the level of wind and solar energies are low and they will not change in the short-term since there is no room to invest. However, if the exciting capacity has a larger share of wind and solar, integration costs will have substantial effects since there are no methods to mitigate
variability, balancing or network costs. Any variability of the installed VRE supply will be felt in the energy market since the installed capacity is exogenous. The effects of which can be seen in intra-day and inter-day electricity markets. The generation capacity will generally not change from one day to the next, but electricity generated from VRE will be intermittent which can result in prices spikes on the intra-day market. Consequently, balancing costs will be high in the short-run and also results in the need for balancing capacity running to
compensate for forecasting errors. Prices will be volatile in the short-run. Furthermore, if a region or country’s share of installed VRE is relatively high, the total system operation cost can be lowered because of reduced variable costs, such as lower fuel costs for coal and gas
2 Hirth assumes a perfect and complete competitive market. The price, or market value is therefore equal to the marginal social value of the last unit of energy produced. Market value and price is used as the same throughout this section.
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plants (Hirth, 2013; Lamont, 2008). Reduced variable costs comes from partial substitution between VRE generated energy and thermal power.
In a mid-term perspective policy such as a FiT scheme allows for investment in VRE sources and the penetration will increase. The value of intermittent energies can be expected to decrease the most under a mid-term perspective because the total capacity is fixed whilst additional suppliers enter the market. Hirth (2013) concludes that the market value is
approximately twice as high in the long-term than under a mid-term perspective. Total supply of energy can be assumed to be higher in the mid-term perspective since the FiT scheme increases incentives for VRE investment which will become additional to a portfolio which is already able to supply enough energy. The occurrence of negative prices will become more frequent. Negative prices are a correct price signal in reflecting the lack of downward flexibility in the dispatchable technologies (De Vos, 2015).3 The price signal can give incentives for the most inflexible technologies to invest more in R&D to develop more flexible technology. Technologies used as baseload such as nuclear and coal plants are too expensive to shut-down and restart and are therefore inflexible dispatchable technologies. The shut-down and restart cost for nuclear and coal producers works as a fixed cost which they will avoid and rather continue to produce even though the price does not cover their marginal cost. There are possibilities for disinvestment of incumbent plants and this will depend on the profits of the firms. If the profits are zero in the mid-term perspective they will continue to produce, but if the profits are negative, they can choose to disinvest. The possibility of disinvesting in incumbent technology and increase the share of VRE sources will be a transition toward the long-term perspective.
4.2.2 Long-term transition with endogenous installed capacity
3 Negative prices are however not necessarily the correct market signal in terms of the social cost of electricity produced by the dispatchable sources. If they emit high levels of CO2 a negative price will not correctly reflect the negative externality.
17 In the long-term the already installed capacity is endogenous and so is (dis)investment. This means that baseload technology such as coal and nuclear can be substituted for VRE in large shares. For large-scale penetration levels of VRE it is estimated that profile costs will affect the market value of wind ten times more than balancing costs (Hirth et al., 2015).
Consequently, the price-effect or merit-order effect, from the variability of wind and solar supply will be more critical in the long-run than the costs occurring on the intra-day balancing market. This will cause long-term lower system operating costs and lower the average
wholesale price. Variability of supply and balancing are results of the properties of the VRE technologies and will therefore continue to increase as VRE become a larger share of the generation portfolio.
Despite integration costs growing with higher penetration of VRE, Hirth (2013) argues that the market value of VRE will increase somewhat in the long-run from the low values under the mid-term perspective. The increase in market value is because the energy production sector will adjust to larger share of VRE. When baseload technology is replaced by large shares of VRE technology this can raise the marginal value of energy from VRE because supply can be better matched with demand. A more diverse portfolio of VRE can have a system load profile which is more suited to hourly-demand by investing in different locations and systems. With a long-term, dynamic viewpoint the development of the grid and more flexible dispatchable technologies, such as gas, the profile and balancing costs can be
mitigated. More flexible dispatchable technologies will be able to respond to the variability in the wind and solar generation profiles, and therefore reduce the balancing needed.
Furthermore, balancing costs can be mitigated by new developments in the technologies and better forecasting.
Integration costs will grow smoothly and gradually as more VRE is installed while at the same time the architecture of the system will change. The infrastructure will develop in such a way that it is possible to supply with the same amount of grid reliability in the future, and the integration costs will not be highly consequential in the long-run (DeCarolis & Keith, 2005).
Lamont (2008) argues that with a long-term perspective integration costs are second-order effects. He acknowledges that integration costs will cause problems in the electricity market
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short-term but argues that they will not create substantial effect in the long-run. Processes in other areas of the energy market might therefore mitigate integration costs in the long-run, these processes will now be discussed.
A result of lower long-term average price is that it will not cover the long-term average costs for costlier dispatchable technology such as combined heat and power, combined cycle gas turbines and open cycle gas turbines. The producers can sustain sunk costs for a period when the price covers the variable costs but will eventually have to shut down when the average costs become higher than the average price. A lower average price will aid the long-term goal to phase out dispatchable technologies. For example, Denmark’s energy plan is to be 100 % renewable and autarkic by 2050 (Lund, 2007). However, the dispatchable technologies with the highest marginal costs are normally the technologies which are most flexible. Nuclear and coal plants have lower marginal costs and are generally the baseload which operates at all hours of the day. A strand of the literature argues that flexible dispatchable technologies which can respond to rapid changes in energy demand are crucial to be able to have large shares of VRE technology in the generation mix (Denholm & Hand, 2011; Hanley, Mourato,
& Wright, 2001; Lamont, 2008; Pietzcker et al., 2017).
The possibility of a flexible dispatchable generation alongside the increasing share of VRE sources would mitigate the costs caused by the variable generation of wind and solar power.
DeCarolis and Keith (2005) argue that integration costs would be far less with a generation mix dominated by gas and hydro power because of their flexibility. Gas turbines are
becoming more common which might be an indication that a more flexible generation mix is possible in the future. Assuming there is only flexible dispatchable generators, such as gas, and VRE sources in the market, there will be a point where the residual load curve will have a negative shift such that the marginal cost of the gas turbine will be higher than the price.
Since they are flexible, they can stop the production and the energy demanded would be supplied only by renewables. This will make the hours with excess supply occur less frequently.
For natural gas to become a more dominant dispatchable energy source in the long-run the cost must go down. The price of electricity can also increase, but as discussed this is unlikely
19 in a long-term perspective because of increased profile costs with larger shares of VRE.
Natural gas is emitting less than oil or coal and is therefore a preferred dispatchable energy source to reduce the future concentration of greenhouse gasses in the atmosphere. A carbon tax will affect coal and oil energy producers more than gas producers and make their marginal cost higher. This will make gas relatively cheaper but will not create a natural entry into the market if the marginal cost of production is higher than the price. Natural gas prices are expected to increase around 2050 because of the scarcity of natural gas as a fixed natural resource. Increasing input prices will make energy production with gas more expensive and might create problems for a more flexible energy generation mix in the future. Natural gas energy production can consequently be replaced by coal again later in the century (Van Vuuren et al., 2007). Shale-gas production has increased rapidly for the last decades, but will face a similar problem long-term of not recovering production costs if the gas price do not increase (Hughes, 2013).
In addition to a more flexible dispatchable generation share, there are long-term tools which can mitigate integration costs. Storage of energy would smooth out the supply of energy and could mitigate both the profile and balancing costs. Energy prices might not have the same price spikes caused by excess or deficit in supply but will follow the equilibrium with demand more closely. Furthermore, storage would act like “backup” energy for times where the unpredictable variability causes need for balancing. To make investment in more storage possible the installation and capital costs for storage must be lower than it is today. Investing in storage today is still considered to be too expensive for it to be profitable. Hydropower plants are in themselves storage facilities where the resource is untapped when the water is in the reservoir and can pump some water back up into the reservoir a times where VRE supply meet demand. Additionally, hydropower plants can work as a flexible technology which can supply peak-load and balancing energy (Benitez, Benitez, & Van Kooten, 2008).
There is also a possibility of changing consumer behaviour so that demand becomes less volatile. Peak-time demand might be shaved off which will reduce the need for high peak- load generation. This can be done by giving the consumers better insight into real-time prices (Pietzcker et al., 2017). If consumers are exposed to real-time spot prices, they can choose to
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use electricity at times where prices are lower. For a generation mix with higher share of VRE this means that prices will be lower at times of much wind and sun and consumers will fit their demand profile closer to the production profile.
There is a possibility of integration costs becoming less of a problem in the long-run, if systems such as storage, consumers behavioural response and flexible dispatchable
technologies change in the future. Additional policy instruments might be needed to make these processes a reality as well as depend on long-term input prices, technological
development and changed incentives. The progress of these transitions is unpredictable on their own, and even more so when looking at the future of the supply and demand in the energy market as a whole. The long-term mitigation of integration costs is therefore not certain and will still be relevant. The possibility of VRE producers to internalise integration costs should therefore be addressed and will be discussed in relation to the FiT scheme in the following section.
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5 Feed-in Tariffs in relation to the energy market and integration costs.
The FiT scheme is set in place to encourage investment and to make VRE technologies cost- competitive in the long-run. The competitiveness will depend on the learning rate of wind and solar technologies, as higher learning rates will bring the costs down faster. As Joskow (2011) argues, the “competitiveness” of a technology should be measured by its expected
profitability, the expected value of the energy it produces and its life-cycle cost. This include the integration costs and the correlation between generated hours and demand. Integration costs will increase with larger penetration of VRE generators, due to the nature of the technologies (Green & Léautier, 2015; Hiroux & Saguan, 2010; Hirth, 2013). The long-term plan for a FiT scheme should consider how integration costs will affect the competitiveness of the VRE technology. If it is such that integration costs are second-order effects in the long-run (DeCarolis & Keith, 2005; Lamont, 2008), there might not be a reason to change the FiT scheme to better reflect the technology’s true life-cycle value. However, since the integration costs reduce the marginal value of energy produced (Hirth, 2013), whilst also creating
damaging spillover effects in the electricity market such as negative prices and the need for balancing, there might be a need for integration costs to be included in the FiT scheme.
The FiT scheme is one of the policies which use price-mechanisms to achieve the goal of increased installation and generation of VRE, compared to other support schemes such as renewable portfolio standard which regulate the quantity of VRE energy generated. In perfect and competitive markets, the price should be equal to marginal economic social value.
Consequently, both fixed and premium FiTs should optimally set a price to VRE producers such that it reflects the social value, which includes integration costs. The FiT schemes have for the most part not included the integration costs as a part of the contracts. A consequence of this exclusion is that the producers are not accounting for the total cost of the energy they are producing. This raises the question if the FiT should be changed to better reflect the social value and cost intermittent energy sources bring to the market.
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The FiT scheme can have contracts so that integration costs are reflected in the payment given, which can create incentives for the VRE producers themselves to mitigate integration costs both short- and long-term regardless of other developments such as storage,
consumption smoothing and energy efficiency. However, the FiT have in most countries do not incentivise the VRE producers to internalise these costs, but rather have the costs being rolled over to system operators, consumers and dispatchable energy producers. The following section discusses how the literature views the different FiT schemes in relation to integration costs and the development of large share of VRE technologies in the market.
5.1 Learning rates and degression
If one of the main economic reasons behind subsidising intermittent renewable energy source is learning-by-doing which eventually will make the technologies cost-competitive, it is necessary to look at which FiT design schemes is more efficient in promoting learning-by- doing. The learning curve characterises how the cost of a certain technology develops with the total installed quantity of the technology. The costs can be assumed to be decreasing for each additional installation and have a negative second derivative. Estimation of the learning- rate depend on the level of investment, what type of technology which is used and at what scale the project is at. Immature renewable technologies are on the steeper part of the learning curve and will have larger learning-by-doing effects for each marginal unit of new installed capacity. More mature technologies are more cost-competitive and are at a less steep part of the learning curve, so an additional unit will have a lower learning effect.
Under a fixed FiT contract, the VRE producer is exposed to less risk due to the predictable revenue stream which encourages greater diversity in technologies and agents who produce (T. Couture & Gagnon, 2010). A more diverse generation of VRE technologies imply that a fixed FiT would affect the learning effects positively, because of the immature technologies steeper learning rate. Although lower risk can lead to a more diverse portfolio, investors would want to invest in the technology which will give them the highest expected profits.
Immature and less tested technologies have higher instalment costs but might produce more
23 energy over the technology’s lifetime. An example of this is windmills with higher tower and better turbines can produce more energy at lower wind speeds (Hirth & Müller, 2016). Del Río (2012) argues that a fixed-premium FiT contract negatively affects the learning effects because the risk of a steady revenue stream is higher. The diversity of technologies will be lower and will mainly consist of mature VRE technologies which have reached the part of that technology’s learning curve with smaller marginal cost-reduction. The potential surplus is higher since the revenue will be higher if the electricity price is high. Higher surpluses can be reinvested in R&D, which can encourage further learning-by-doing and lower cost. However, if the R&D are on wind and solar technologies which are mature and close to being cost competitive, the learning effects can be relatively lower than for immature technologies. For a FiT contract with a sliding-premium the risk for the VRE producers are in between the
constant-premium and the fixed-tariff contracts, so the learning effects are more ambiguous.
A fixed-tariff FiT contract which is independent of the market price seems to be the most efficient FiT policy for having greater learning effects.
When investors anticipate future cost reduction they will wait to invest. For a FiT scheme to efficiently incentivise new instalments of VRE there is need for reducing the tariffs, or tariff degression, at a similar rate to the decreasing costs resulting from learning-by-doing. Reduced tariffs rate only apply to new instalments, and therefore encourages to invest earlier to secure higher tariffs for the duration of the contract (T. D. Couture et al., 2010; Mendonça et al., 2009). Expecting future tariff reductions will incentivise technological innovation and R&D to reduce installation costs. Degression levels will be set too high if the estimated learning rate is higher than the real learning rate, because the real cost reduction due to learning-by doing is lower than the reduction in the tariff received. Consequently, investment incentives will be lower. More immature technologies will have higher degression rates since they are expected to have a faster cost-reduction.
There are two main types of degression. An ex-ante fixed annual degression and a flexible annual degression rate which may change through the years. Long-term there will be changes which affect the costs of instalment other than learning effects. A flexible degression scheme can meet unexpected changes in inflation, market growth, increased input prices or an
unexpected shift in the learning rate. Del Río (2012) argues that a flexible degression scheme
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will limit consumer costs by not setting tariffs too high, can mitigate asymmetric information problems and can encourage further competition to reduce cost. Short-term, it can increase the uncertainty for new investors since they do not know what the tariff will be if they choose to delay the investment. In the long-term, a flexible degression would be better as the tariffs would be following the actual cost of investment closer than under a fixed degression rate.
Mendonça et al. (2009) argue that a flexible degression rate should apply only to technologies where the learning rates are high, such as solar PV. Furthermore, that more mature
technologies, such as onshore wind plants, which already have a steady and low learning rate and a fixed annual degression would be sufficient to control the investors’ profits. Long-term, the degression scheme should be designed such that the tariffs are phased-out smoothly for the last year when the technologies do become cost-competitive. If the expected calculations of the costs are higher than the real investment cost, it would be difficult to suddenly set the tariffs rates to zero as this can create a sudden stop in investments. Transparency is important, and potential investors should have the right information about future tariff rates to correctly make their investment decision.
5.2 Exposure to market signals
A way to incorporate integrations costs into the FiT system is to make the VRE generators respond to market signals. By exposing VRE producers to the price signals they would respond to the changes the increasing share of VRE does to the market price. A fixed FiT sets the investor and producer outside the market because they do not have to take any of the price risks, including both the reduced market price and the cost of balancing on the balancing market. With a premium FiT scheme, the VRE producers are exposed to price signals because the revenue they receive depends on the fluctuating market price. However, in addition to the premium they receive there is a risk premium added to compensate for this price risk. With a premium FiT, producers will not fully take into account the true value of the energy they are producing even if they are market dependent. Producers under a constant premium scheme will be more aware of changes in wholesale market price than producers under a sliding-
25 premium. Throughout this section I will refer to premium contracts, which will be in
reference to the constant premium FiT scheme if not otherwise specified.
The literature discusses if the producers of VRE should be exposed to market signals at all.
Increasing the risk for producers may decrease the rate of investment and subsequently make the political goal of larger share of VRE more difficult to achieve. Furthermore, it may increase the total cost of the FiT scheme itself since producers would demand higher payments with higher risk. Klessmann, Nabe, and Burges (2008) point out that since the marginal cost of production for wind and solar power are approximately zero, they will produce at very low prices, even without the subsidy. Wind and solar producers will not have large behavioural changes if they are exposed to price signals. Which raises the question if there is any reason to expose VRE producers to price signals at all. Furthermore, since the FiT schemes pay for every KWh produced, the VRE generators will want to supply at every hour it is possible to receive a higher payment. Being exposed to market prices will not change this behaviour. Having VRE producers exposed to market-prices is a two-sided issue. Integrating VRE suppliers in the market will expose them to risk, which will require higher tariffs and premiums to stimulate further development. However, it can change investment incentives to mitigate integration costs so that the market price is less volatile which will reduce the risk over time.
Over a long period of time the effects of the market signals can have positively incentivise VRE producers to internalise some of the integration costs (Hiroux & Saguan, 2010). Since electricity is a time-heterogeneous good and a fixed FiT guarantees the same price for all hours of the day there are no incentives for VRE producers to install energy where they provide energy at the hours of the day with higher demand. For a constant premium FiT however, they are incentivised to supply energy at times of high demand when the price is higher. If producers are more demand-elastic, and the production profile is positively correlated to demand it can in the long-run help mitigating the large price volatilities which can be expected in the short-term perspective (T. Couture & Gagnon, 2010).
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A location price signal also follows the market price, where price-discrimination after location will help investors chose where the plants should be. The location for a new
instalment should be chosen after where it is temporally optimal to produce the most output, but also where the transmission capacity is strong enough. The price signal is given after different bid-markets in different areas, congestion pricing and locational network tariffs.
Exposure to location-price signals can both mitigate profile costs and grid-related costs in the long-run (Klein et al., 2008). Since the market price is time-differentiated it can increase the portfolio diversity and the correlation between different technologies. Long-term, a broader portfolio can better energy reliability when the market depends more on VRE and flexible dispatchable generation. Furthermore, choosing locations dependent on the market price directly links it to the demand and can therefore make the correlation between the energy produced and demand more positive. The result of these markets signals may reduce
integration costs and make the correlation between demand and supply more positive which in turn will make the marginal value of energy produced by VRE increase. This shows that regardless of other developments in the market, such as storage, energy efficiency and flexible dispatchable sources, there are possibilities for the VRE producers themselves to alleviate the integration costs. Long-term, having more VRE producers being market-dependent would help harmonize the market and break down the differences between VRE and conventional technologies (T. Couture & Gagnon, 2010; Schallenberg-Rodriguez & Haas, 2012).
An interesting case is the FiT scheme in Spain where wind producers can choose being under a premium FiT or a fixed FiT and they can change their decision once a year. Under the premium option there is a floor and cap for the payment levels given to the producers to avoid windfall profits. In 2009, 96 % of the installed wind capacity was under the premium option.
The main reason for this being that the payment received was expected to be higher under the premium option than under a fixed scheme (Schallenberg-Rodriguez & Haas, 2012). For large producers using mature technologies and are equipped with better forecasting to choose the premium option might not be so surprising because they can sustain losses and are possibly more risk-neutral. However, for such a large percentage of the wind producers to choose the premium option means that also smaller producers or even private individuals choose the market-dependent option. These producers are most likely more risk-averse since they most likely do not have the same administrative and financial resources. To convince the more risk-
27 averse producers to choose the premium FiT option the risk premium must be higher for each KWh produced. The large percentage of wind producers, even the risk-averse, choosing the premium option can indicate that the risk premium is set so high that it over-compensates the producers. Another indication can be that the producers perceive the risk as being lower than the policy maker and will therefore be more willing to be market-dependent. A reason for this might be their marginal cost being close to zero, or that the cap and floor set in place limits the risk for under- (and over) compensation. However, with more producers choosing a premium FiT the total cost of the scheme is higher which will directly be rolled over on the consumers. The policy maker must weight having a higher total cost of the FiT scheme against the benefits of wind producers responding to market signals and making production follow the demand profile.
The VRE producers can also be exposed to balancing-market price signals. Balancing costs occur when the system operator needs to feed “reserve energy” into the grid due to
fluctuations from the forecasted load profile of the intermittent energy source. The balancing market opens after the intra-day market is closed and works closer to real-time market management. Most generally, FiTs do not include balancing responsibilities for VRE
producers. By excluding this cost from the contract, VRE producers do not take into account the cost of intra-day management on the balancing market. However, there have been
introduced a different FiT contract which lay the balancing costs on the VRE producers themselves. Spain has introduced a FiT with balancing responsibilities. This contract implies that wind power producers must provide a load-profile before the time of delivery and the imbalances are computed following this load profile. Fluctuations from the profile will result in the balancing cost needed to be paid by the wind power producer (Hiroux & Saguan, 2010).
A FiT with balancing responsibilities will incentivise the suppliers of intermittent energy to invest in better forecasting equipment which will induce the real-time production to better fit the contracts made in the day-ahead market. Including balancing responsibilities is possible in both a fixed and a premium FiT contract, without disrupting other contract designs.
Furthermore, if VRE producers need to respond to balancing prices they would be incentivised to reduce production at times where supply exceeds the generation forecast.
Since wind and solar power are relatively more flexible than baseload generation, turning off VRE production instead of having excess supply would reduce the system cost. Another way
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to reduce the balancing costs which does not involve the FiT scheme, is to change the market structure. Barth, Weber, and Swider (2008) argues that closing the gate for energy contracts closer to real-time would reduce the balancing needed and the balancing cost because the thermal plants needed to be at standby would be reduced.
Negative price signals will become more frequent and will affect all market-dependent energy producers. The FiT contracts are designed such that energy produced from VRE sources is guaranteed to be fed into the grid through the physical dispatch insurance, or the priority-rule.
The design for the FiT scheme itself will create more frequent occurrences of negative prices, during hours with low demand and excess supply. Negative prices are a valid price signal which reflect the lack of flexibility in the baseload. Creating incentives for dispatchable producers to invest in more flexible technology, which is necessary for a future generation mix with larger share of VRE. Despite having the correct price signal which can develop the generation mix further, there are suggestions to change the physical dispatch insurance to allow VRE producers to voluntarily curtail production during hours with negative prices.
(Brandstätt et al., 2011; Green & Léautier, 2015). Arguments for this is that in the long-run negative prices can cause the total system operating costs to increase. Dispatchable producers can to a certain extent reduce production, for the hours of low demand and VRE supply.
However, it takes time to ramp up the production again after these hours are over, which will lead to inefficient sunk cost and higher system operation costs in the long-run.
The priority rule acts as assigning production rights to the suppliers of wind and solar energy after the Coase theorem. To make VRE producers voluntarily curtail the energy they produce they must receive a payment equal to or higher than the FiT (Brandstätt et al., 2011). A scheme like that would not change the risk for the suppliers of intermittent energy since they receive the same revenue stream, so the total cost of the scheme will be unchanged and will not affect consumers any differently. Furthermore, it will lessen the burden for the system operator to manage excess supply in the grid and stop the occurrence of negative prices.
However, this separate all energy producers from the correct price signals which prevents a shift towards a more flexible dispatchable share of the energy mix. A shift which will mitigate integration costs in the long-term, as discussed previously. A voluntary curtailment scheme
29 will leave the VRE sources idle for the periods where they cut off production, which can be argued to be a waste of resources even if their marginal cost is close to zero.
5.3 Consumers and social welfare
In the mid- and long-term the marginal value of energy produced by VRE will decrease which again will lower the average-wholesale price, as discussed previously. Lowering the long- term average wholesale prices will have large consequence for consumers since lower wholesale prices do not mean lower end-use prices. The gap between the wholesale market price and the price the consumers pay is covered by tax levied on the consumers for all types of FiT schemes. In a long-term perspective, this means that the consumer price of electricity is not necessarily lower with large shares of VRE even though they have lower marginal cost of production. The literature show that premium FiT scheme to have a higher total cost than a fixed FiT scheme. The difference in total cost is caused by the payment needed to compensate investors and producers is higher under a premium FiT because they are exposed to more risk being market-dependent (T. Couture & Gagnon, 2010; Klein et al., 2008).
Since the marginal value of VRE is expected to be at its lowest during the mid-term perspective the total size of the subsidy paid will most likely be larger too and can become smaller as the marginal value increase slightly in the long-term. Additionally, the FiT contracts will be terminated when the lifetime of the contract ends, normally after 15-25 years, which will also lessen the tax burden. However, over time the share of VRE in the energy mix will become larger which means there are higher volumes of producers who needs to be compensated with the subsidy. These future instalments will have lower tariffs due to degression which might compensate a little for the larger volumes of producers. It is therefore difficult to say how the long-term total cost of a FiT will be. Green and Léautier (2015) conclude that the subsidy for VRE will never stop. They argue that the integration costs will become so large with high levels of VRE in the generation mix that the market value of the energy produced will fall faster than the decrease in costs caused by learning-by-doing. The