Subsidies to renewable energy in inflexible power markets Orvika Rosnes June 9, 2008 NOREL Workshop, Stockholm

June 8, 2008 Subsidies to renewables 22 Introduction Renewables – especially wind power – in focus in Europe – Ambitious targets in the EU – Denmark: 20% today, 50% as goal in 2025 Wind power is variable: requires system flexibility – Flexibility of other technologies: adjusting production level is costly Variety of policy measures to boost investments in wind power – Investment subsidies, feed-in tariffs, green certificates, … – Subsidies to renewables influence also the short-term production decision Different subsidies have different impact  How do the production costs of the whole power system depend on wind power support and the flexibility of the power system? – Investment subsidy vs. fixed price per kWh to wind power – Start-up costs and minimum production levels in thermal power plants

June 8, 2008 Subsidies to renewables 3 Main result: Flexibility is crucial for costs and emissions Subsidies have different impact – Investment subsidy yields optimal solution No distortion of wind power producer’s production decision – Production subsidy increases costs Gives incentives to produce for too low prices – Fixed price reduces emissions most, but for highest cost Market signals not passed through to wind power ”Forces” thermal power plants to stop  Subsidies should not conceal market signals in a market with inflexible technologies – Subsidies that promote flexibility is the cheapest way of wind power integration

June 8, 2008 Subsidies to renewables 4 13 June Contents The model Thermal power producer Wind power producer Numerical model Impact of different subsidies to wind power

June 8, 2008 Subsidies to renewables 5 Thermal power plants Marginal production costs: – Fuel costs and efficiency, O&M costs Start-up costs: – Fuel costs – Indirect costs Minimum production level (typically 30% of installed capacity) – Efficiency loss when producing at sub-optimal production level  Price vs. marginal cost consideration not enough  Production decision becomes an intertemporal decision – Mansur (2003), Tseng & Barz (2002), Rosnes (2008) Start-up costs correspond to marginal production costs in: ¾ hour (fuel), 7.5 hours (indirect) in coal-fired power plant ½ hour (fuel), 4 hours (indirect) in gas-fired power plant

June 8, 2008 Subsidies to renewables 6 Thermal power plants: Intertemporal production decision  Determines the producer’s bids to the market organizer Combination of price level (incl. negative) and duration to avoid stopping

June 8, 2008 Subsidies to renewables 7 Time-dependent start-up cost

June 8, 2008 Subsidies to renewables 8 13 June Contents The model Thermal power producer Wind power producer Numerical model Impact of different subsidies to wind power

June 8, 2008 Subsidies to renewables 9 Wind power: Static production decision Production in different periods independent – Flexible Production limited by available wind

June 8, 2008 Subsidies to renewables 10 Subsidies to wind power change the production decision Investment subsidy – Does not change the production decision Production subsidy (feed-in tariff) – Incentives to produce for too low prices Fixed price/priority – Produce independent of market price

June 8, 2008 Subsidies to renewables June Contents The model Thermal power producer Wind power producer Numerical model Impact of different subsidies to wind power

June 8, 2008 Subsidies to renewables 12 Numerical power market model for West Denmark Deterministic dynamic programming Short term focus – Weekly decision (simultaneous optimization for 168 hours) – Infinite horizon (identical week repeated ad infinitum) – No investments 10 thermal units (3500 MW in total) – Coal, gas, heavy fuel oil – Inflexible: start-up costs, minimum production requirements Wind power (2400 MW in total) – Flexible – But availability depends on wind No trade Inelastic demand – Variation over day/night  How to meet demand at least cost?

June 8, 2008 Subsidies to renewables June Contents The model Thermal power producer Wind power producer Numerical model Impact of different subsidies to wind power

June 8, 2008 Subsidies to renewables 14 Fixed price: Wind power produces at max level Wind power does not adjust to market price Thermal units must close when wind power production is high

June 8, 2008 Subsidies to renewables 15 Investment subsidy: Wind power adjusts production Wind power producer responds to market signals Wind power production reduced from the maximal available level in 49 hours Cost savings: 9% higher production at 12% lower cost Thermal power plants avoid starting and stopping, plus more efficient plants

June 8, 2008 Subsidies to renewables 16 Production subsidy: Wind power adjusts production somewhat Production subsidy: market signals distorted Reduces production in 42 hours (-4%)

June 8, 2008 Subsidies to renewables 17 Thermal power production with different subsidies to wind power Fixed price: thermal power plants forced to close in some hours 9% less production in thermal plants than with investment subsidy Trade-off between expensive production and cheap start-up Production subsidy: Some adaptation of wind power reduces starting and stopping in thermal

June 8, 2008 Subsidies to renewables 18 Costs increase with wind power capacity Easier to accommodate small volumes of wind power Capacity increase does not lead to proportional production increase – Cannot always use all of the wind power capacity – some of the capacity increase is ’in vain’ – Example week: Doubling of wind power capacity leads only to 50% increase in wind power production

June 8, 2008 Subsidies to renewables 19 Conclusions: Flexibility is crucial for costs Investment subsidy gives correct production incentives to wind power – Responds to market signals Fixed price (and production subsidy) distort the market signals – Incentives for too high wind power production – Wind power does not adapt to the market – imposes costs on others Coal and gas-fired power plants must adjust production – costly  Subsidies should not conceal market signals in a market with inflexible technologies Investments in additional flexibility – More flexible supply side – More flexible demand side – Trade possibilities – Correct economic incentives is the cheapest way of wind power integration!

June 8, 2008 Subsidies to renewables PO Box 5, 0051 Oslo, NORWAY Biskop Gunnerus’ gate 14A, 0185 Oslo, NORWAY Telephone: Fax: Stavanger Kirkegaten Stavanger, NORWAY Telephone: Fax: Oslo Artillerigatan 42, 5th floor S Stockholm, SWEDEN Telephone: Fax: Copenhagen Nansensgade 19, 6th floor DK-1366 Copenhagen, DENMARK Telephone: Fax: Stockholm

June 8, 2008 Subsidies to renewables 21 Costs of different subsidy schemes Investment subsidy Production subsidy Fixed price Thermal production (GWh) Wind power production (GWh) CO 2 emissions (1000 ton) Production costs (mill. DKK) Fixed price to wind power yields – Lower thermal production (9%) – Lower emissions (10%) – Higher production costs (12%) – … than investment subsidy Production subsidy yields – Lower thermal production (4%) – Lower emissions (3%) – Higher production costs (1%) – … than investment subsidy Even slight flexibility pays off!

June 8, 2008 Subsidies to renewables 22 Impact of wind power availability or capacity Investment subsidy Production subsidy Fixed price Less wind: Thermal production (GWh) Wind power production (GWh) CO 2 emissions (1000 ton) Production costs (mill. DKK) Base case: Thermal production (GWh) Wind power production (GWh) CO 2 emissions (1000 ton) Production costs (mill. DKK) More wind: Thermal production (GWh) Wind power production (GWh) CO 2 emissions (1000 ton) Production costs (mill. DKK) Similar results, but different scale More wind: cannot always use all of the capacity Some of the capacity increase is ‘in vain’

June 8, 2008 Subsidies to renewables June Contents The model Thermal producer Wind power producer Numerical model Impact of different subsidies to wind power Impact of CO 2 - cost

June 8, 2008 Subsidies to renewables 24 Importance of flexibility

June 8, 2008 Subsidies to renewables 25 Emissions with different CO 2 cost levels How do the effects of a CO 2 cost depend on the flexibility of the power system? – CO 2 cost influences both marginal costs and start-up costs – Is fuel switching easier or not with start-up costs? Trade-off between continuous production and shut-down – Clean plants produce more to avoid stopping? – Clean plants produce less (too expensive to produce continuously)? Outcome of the climate policy (introduction of CO 2 cost) depends both on the level of CO 2 cost and flexibility of the system – Emissions from start-up itself low Emissions (1000 ton) with different levels of CO 2 -cost (EUR/tonn) Flexible Inflexible – from production – from start-up0.4

June 8, 2008 Subsidies to renewables 26 Conclusions Start-up costs make the power plants inflexible – Trade-off between continuous production and shutdown (  start-up later) Inflexibility due to start-up costs may hinder or facilitate emission reduction – Start-up process itself causes some emissions – Fuel switching may be more difficult Illustrates the difficulty of emission reduction in a power system heavily dependent on a few technologies – Trade – Various technologies