Are we ready for 100% renewables?

Could the National Electricity Market function with 100 per cent renewables? Or would a major market reform, such as the introduction of a capacity market, be required?

There is growing interest in very high penetration renewable markets. With many seeking to understand the many technical factors that will need to be addressed (such as supply-demand balancing, network stability, inertia, ancillary services and so on), people are also now beginning to ask questions about the operation of the market under very high penetration renewables.

Somewhat counter-intuitively, our preliminary analysis suggests that the National Electricity Market design may not actually need to change substantially in order to maintain sufficient investment signals, even though electricity prices could be close to zero in the majority of periods. 

The Market Price Cap is likely to need to increase by around a factor of 2 to 5 times its current level, and alternative market structures (such as a capacity market) would probably only need to be considered if this was judged to be inappropriate.

How high renewables could lead to abnormally low market prices

In periods where there is significant market competition, generators in the NEM should be expected to bid the majority of their capacity at a price sufficient to only just recover the operating cost for their next extra increment of supply (the technical term being short-run marginal costs or SRMC). In determining their bid prices they end up effectively ignoring the cost they’ve paid to build the plant, which is sunk and not materially affected by how much they generate.

This means that for a large proportion of the time in the NEM, prices are quite low because the cost of operating a coal plant (which dominates our supply) is quite low. Nonetheless coal generators still recover costs incurred beyond their operating costs when demand is reasonably high, because higher operating cost gas plant are drawn upon. In addition, while the cost of coal is low, it isn’t zero.  So prices in the NEM are still comfortably above zero for a large proportion of the time.

This is illustrated in the chart below. Market prices are indicated by the point where the demand and supply curves cross. This figure shows that prices will be low during low demand periods, but will be much higher during high demand periods.

Let’s now look forward to our high penetration renewables market.

The majority of renewable technologies have operating costs close to zero, which significantly flattens the supply curve. If renewables were to represent a very large proportion of our power supply then this would lead to market prices close to zero in the majority of periods, and rising rapidly to the Market Price Cap in periods where scarcity occurs.

Where high demand coincides with low supply, small changes in either are likely to cause a dramatic change in price, making market prices highly volatile, as illustrated below. Although it’s worth noting that this market price volatility could be somewhat alleviated by facilitating a much increased demand response to spot market prices.

Note: Wind is meant to be representative of what is in fact a wide array of potential low operating cost, variable generation. It is not a prediction of what is optimal or likely.

While the NEM is not always highly competitive, according to the AEMC’s latest review on the topic market power held by generators is generally transient. Assuming this continues to be the case, in a future 100 per cent renewables market, the market price could actually be very low in the majority of periods. This would mean that generators would need to collect high revenues in periods of scarcity, to cover their costs of constructing a plant.

However, this may not actually be a big problem. The NEM already features high spot market volatility, with a Market Price Cap of $12,900 per megawatt-hour, which far exceeds the short run marginal costs of any installed generator. Market participants manage this volatility through participation in a contracts (derivatives) market.

Contracts can be designed to emulate insurance products, featuring fixed payments that have the economic characteristics of a capacity payment and underwriting investment in new capacity in a volatile market. With an increase in market volatility, the derivatives market is expected to become increasingly important to market participants for managing their risks.

How do you ensure new supply where near-zero operating cost renewables dominate

At present in the NEM the system and market are designed around a Reliability Standard of 0.002 per cent unserved energy per annum, measured over the long term. While the NEM has a Market Price Cap that sets an absolute maximum price generators are paid, it is set at a level that is deemed adequate to attract new generation such that the Reliability Standard is met. 

The very high price cap of $12,900 per megawatt-hour means that there is a strong incentive to build new power plants if it is likely that there won’t be enough existing supply to meet demand. Even though a new power plant may not be required very often or receives very low prices for most of the time, prices at $12,900 per megawatt-hour can still make it all worth it.

In a 100 per cent renewables market, the Market Price Cap is likely to need to increase due to the decrease in the average spot market price. An order of magnitude estimate suggests that with the wholesale price falling to close to zero for the majority of periods, the Market Price Cap may need to increase by around two to five times to allow generators to recover their costs while continuing to meet the Reliability Standard. However, the increase required could be lower if generators can exercise transient market power to inflate prices in some periods.

However increasing the Market Price Cap is not a simple and easy proposition.

As the proportion of variable renewables in the market increases, it is likely to become increasingly challenging to predict the appropriate level for the Market Price Cap. The simulation exercises required for reliability assessments are complex and sensitive to a wide range of assumptions, including the statistical properties of renewable generation during rare peak periods. 

Also increasing the Market Price Cap increases risks to market participants, and therefore increases the costs of hedging instruments. It may also increase prudential obligations and therefore raise barriers to new entrants. These factors would need to be carefully considered before the Market Price Cap was increased. 

If it were deemed inappropriate to increase the Market Price Cap, one option would be to relax the Reliability Standard. At present, the majority of customer interruptions are driven by distribution network outages, suggesting that relaxing the Reliability Standard could have a minimal impact upon the incidence of load-shedding ultimately experienced by customers.

If the Market Price Cap could not be increased, and the Reliability Standard could not be relaxed, then alternative market mechanisms may be required to maintain system adequacy in a 100 per cent renewables market.  This could include consideration of a capacity market, but a range of other alternatives should also be on the table that could be implemented with much less disruptive reform. For example, a reserve ancillary service could be introduced. 

Capacity markets are generally more complex than energy-only markets and rely on centralised decision making to a much greater extent.

For the full paper outlining this analysis, please contact Dr Jenny Riesz at jenny.riesz@aecom.com.

Dr Jenny Riesz is a Senior Consultant in the Energy Strategic Advisory team at AECOM, a global provider of professional technical and management support services to a range of industries and clients worldwide.  Jenny’s focus is on renewable energy and climate policy.