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The operational dynamics of fossil-fuel power plants are increasingly being influenced by fluctuations in electricity generation from renewable sources, specifically rooftop solar systems. Researchers have recently created a flexible competitive benchmark that incorporates start-up costs and other operational constraints typical for power units. Their study focuses on Western Australia, a region where rooftop solar capacity significantly increased between 2014 and 2018, reaching some of the highest global levels of solar usage. The findings indicate that this rapid expansion of solar technology may inadvertently enhance the profitability of fossil fuel plants, as competition diminishes during evening hours when these plants are required to restart after being sidelined during the day.
The detailed research, conducted by experts from Carnegie Mellon University and Monash University, has been published in the American Economic Review.
Akshaya Jha, an associate professor at Carnegie Mellon’s Heinz College and one of the study’s authors, stated, “We developed a framework to gauge market power within wholesale electricity markets. This framework takes into consideration technology-specific characteristics like fixed start-up costs and ramping constraints, which are increasingly important as the world shifts towards more variable renewable energy sources.”
Power plants that face fixed start-up costs need to ensure they generate sufficient revenue to cover these expenses over time, which leads to two key challenges when analyzing market competition. Firstly, traditional measures of market power often rely on price markups over short-run marginal costs. However, economists have acknowledged that simply pricing electricity based on short-run marginal costs overlooks the necessity for companies to cover their fixed costs. Secondly, these fixed costs can act as a barrier to market entry; the decision to incur these costs can influence the extent of competition at later stages.
The researchers applied their innovative framework to the electricity market in Western Australia, a leader in rooftop solar deployment. They assessed market power by contrasting the actual power plant outputs and market prices with a hypothetical scenario— a counterfactual scenario of plant outputs and market prices that factors in the recovery of required fixed costs for power generation.
To achieve this, the team expanded upon typical static production function methods by utilizing high-frequency data on gas fuel consumption and electricity output. This allowed them to develop unit-level cost functions encompassing three main elements: variable costs, start-up costs, and fixed costs associated with operation independent of output levels. Their dynamic benchmark aimed to optimize output levels to minimize the total costs of dispatching power plants and to ensure prices allowed for recovery of both fixed and variable costs.
The results revealed a direct correlation between increased rooftop solar capacity and heightened market power rents for fossil fuel plants during the evening hours. Given that retail electricity prices are typically based on cost-of-service regulations, this situation results in a significant transfer of wealth from consumers to power producers.
While the study noted only a minor impact of increased rooftop solar on overall wholesale market efficiency, it highlighted significant external welfare benefits stemming from a reduction in greenhouse gas emissions. In Western Australia, a rise in rooftop solar was associated with notable decreases in carbon emissions due to reduced gas-fired electricity generation during the day, despite small increases in emissions in the evening as gas units ramped up production.
Gordon Leslie, a senior lecturer in economics at Monash University and co-author of the study, remarked on the importance of incorporating various design features into electricity markets that are absent in many areas outside the U.S. Some key recommendations include:
1. Start-Up Bids and Co-Optimization
Enabling suppliers to submit start-up bids alongside their energy supply offers can lead to improved co-optimization across different time periods. This adjustment may boost market efficiency, particularly as the frequency of plants starting and stopping in response to renewable output increases.
2. Financial Participation in Day-Ahead Markets
Previous studies have shown that allowing financial participation in the day-ahead market can yield substantial benefits, especially in environments where operational constraints are likely to affect market behavior and suppliers wield considerable market power. The current research demonstrates that escalating rooftop solar penetration can intensify unit-level start-up costs and physical constraints, thereby enhancing suppliers’ market power during evening hours.
3. Retail Pricing Variation
Globally, numerous electricity consumers encounter retail prices that do not reflect real-time fluctuations in wholesale pricing, often remaining static throughout the day. Implementing retail prices that vary in accordance with hourly wholesale rates could adjust demand patterns, shifting some consumption from evenings to daytime. Consequently, this would diminish the necessity for fossil fuel units to initiate operations during peak evening demand, ultimately reducing opportunities for market power manipulation in late hours, leading to lower wholesale prices and more affordable retail rates for consumers.
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