We’ve all heard the pitch about how wind is free and that once a windpower facility is constructed, the cost of generation is appropriately set low thanks to no fuel expense. We’re also often reminded that no fuel cost means wind will help insulate consumers from wildly fluctuating energy prices.
The concept is easy to grasp, and rural communities considering whether to host a wind facility are likely to conclude that the project will produce local and regional benefits in the form of lower electricity bills.
The fact is, the price of electricity within a grid region is set at a single price known as the market-clearing price (MCP). In most organized electricity markets, electricity generators are encouraged to participate in a daily or day-ahead auction process whereby a uniform market price–the MCP–is established. The MCP is the offer price of the highest-priced generation accepted within the market.
Ross Baldick states in his paper, Single Clearing Price in Electricity Markets:
Consider a simple electricity system with baseload coal generators having low production costs of approximately $25/MWh, and gas-fired peakers having higher production costs of approximately $100/MWh. Off-peak, when demand is lower, only the coal generators may be necessary to meet demand. The market-clearing price for energy is set by the coal offer price, which can be expected to be around $25/MWh. However, on-peak, when demand is higher, both the coal and the gas-fired generation may be required to meet demand and the market-clearing price will be set by the offer of the gas-fired generation, which can be expected to be around $100/MWh. On-peak, both the coal and the gas-fired generation receive the market-clearing price.
How It Works
The New England ISO (ISO-NE) and New York ISO (NYISO)[i] typically operate using a day-ahead auction where generators are required to offer firm levels of production for each hour of the next power day. The energy price, in turn, is determined based on those bidding into the system; all generators receive the same price per megawatt hour of generation. Significant penalties are applied if a generator is unable to meet his commitment.
Since wind is an unreliable, intermittent energy source, power pools such as the ISO-NE and NYISO cannot rely on its flow at critical times. This is particularly true during the afternoon summer hours when peak loads are the highest. Since the production from a wind resource cannot be reliably forecasted, the ISOs do not require wind to schedule any of its production in the day-ahead energy market. Instead, wind resources are permitted to operate exclusively in the real-time market i.e. a pure spot market carrying no penalties for non-performance and where prices are generally less than the prices paid for the day-ahead energy market. Those selling into the real-time market are paid at the clearing price of the real-time market.
The day-ahead market for both the ISO-NE and NYISO represents roughly 90% of the available generation with the real-time market holding only a 10% share.
Since the price paid for ninety-percent of the generation is established twenty-four hours in advance of the power day, any low-cost participation from wind will have only a marginal impact on prices limited to those resources operating within the real-time market.
To illustrate the point further, we looked at the press release from the NYISO from February 2009 titled “NYISO Marks Wind Power Milestone”. The release discusses how during the 6pm hour on February 19 “the combined total output of all wind plants in New York reached 1,000[ii] megawatts (MW)” representing “nearly 5% of the roughly 21,000 MW of total system demand.” While touted as a milestone for the State the benefit to the consumer was far more elusive.
According to the NYISO a wind storm came through the area causing wind generation to spike up to the 1000 megawatt level at three instantaneous moments in that hour. Although the generation was not sustained there was likely temporary downward pressure on energy prices within the spot market, however, the 90% of reliable generation that bid in day-ahead was still guaranteed the market clearing price. (Those reliable generators able to back down would do so to save fuel costs).
Perhaps you’re now thinking, “Can’t we just change the rules?” But before you change the pricing rules for electricity to enable wind storms to have a greater opportunity for reducing energy prices it’s important to understand where the wind market is headed.
Wind is reliant on state and federal subsidies to compensate, in part, for any losses due to its fluctuating, intermittent nature. And more and more developers are under pressure from investors to secure power purchase agreements with utilities that will ensure long-term guarantees that their power will be purchased at a fixed price. Even with these purchase agreements in place, wind will still sell into the real-time market (absent better wind forecasting methods). These agreements assure the developers, and their investors, that they will be paid a stable price for each megawatt hour of generation.
And here’s the rub.
Power-purchase agreements for wind energy projects typically lock in the purchase price of wind for 20-years at 2-3 times more than the wholesale price of other, more traditional sources of generation. In New England, these purchase prices are based on the anticipated future pricing of natural gas.
While above-market, long-term power purchase agreements may have a stabilizing effect on energy prices for wind, they do so at an excessive price to the ratepayers. When the utility sells the wind energy to the grid, the energy will be sold at the lower cost spot energy market price, but the wind developer will be paid the above-market price. Guess what price the utility will base your electric rates on?
Before you accept at face value that wind is a low-cost option for electricity, it’s important to understand how electricity is priced in your region. When a wind project comes to town, ask the wind developer and your electric utility two basic questions:
(1) What is the long-term price the utility is committed to purchasing the wind power?
(2) What is the wholesale price of electricity in your region?
These figures will tell you just how expensive wind can be. And remember: this is for an inferior product given the necessity, expense, and environmental issues of fill-in (fossil-fuel) generation, the subject of other posts at MasterResource.
[i] The day-ahead market operates similarly in the PJM and MISO control areas.
[ii] Total installed wind capacity in New York was 1275 megawatts.