Electricity Pricing Problems in Future Renewables-Dominant Power Systems

Dharik S. Mallapragada, Cristian Junge, Cathy Wang, Hannes Pfeifenberger, Paul L. Joskow, and Richard Schmalensee

November 2021 (revised February 2022)

Constraints on electric power system carbon emissions will make optimal increased reliance on variable renewable energy (VRE, mainly wind and solar generation), which has near zero marginal operating costs. Using capacity expansion modeling of electric power systems in three US regions in mid-century, we show that under a wide range of plausible demand and supply-side technology assumptions, efficient, deeply decarbonized systems will have many more hours of very low marginal values of electricity (MVEs) and more hours of relatively high MVEs, than today. This result stems from the shift away from systems dominated by thermal generator with well-defined marginal costs to systems dominated by VRE with near zero marginal operating costs as well as energy storage and demand-side resources whose marginal costs vary with time and are often defined by their opportunity costs. While availability of long-duration energy storage resources and demand flexibility reduce instances of near-zero MVE, they do not alter the general pattern of increasing hours of near-zero MVE under tight CO2 emissions constraints. Such dramatically different MVE distributions also imply that, under an energy-only market design, resources are likely to earn most of their revenues on sales in a handful of hours. To minimize the cost of electricity and to encourage cost-effective economy-wide decarbonization, economic theory prescribes that wholesale and retail prices of electricity should equal MVEs.  However, the sharply increased variability of MVEs compared to today means that setting wholesale and retail prices equal to MVEs would likely impose politically intolerable risks at both levels.  Potential solutions to this fundamental problem are discussed.

Keywords: decarbonization, storage, pricing, renewables, efficiency, electrification