Trading In Renewable Energy: Adapting To Increased Supply Intermittency

Firms with long positions in regions becoming more dependent on renewable energy face the risk of declining portfolio value and may be compelled to adapt their asset strategies and trading operations.

FREMONT, CA: Renewable energy trading is an emerging topic in the electricity sector that has received relatively little attention. Certainly, the phrases “renewable energy” and “power trading” are hardly found in the same sentence.

Stay ahead of the industry with exclusive feature stories on the top companies, expert insights and the latest news delivered straight to your inbox. Subscribe today.

In many global markets, intermittent renewable energy sources — mainly wind and solar — are getting an increasing share of the electricity supply, mostly at the expense of coal and nuclear power. Where this is happening, pricing dynamics in wholesale power markets are significantly changing — generally driving energy prices downward. Accordingly, firms with long positions in regions becoming more dependent on renewable energy face the risk of declining portfolio value and may be compelled to adapt their asset strategies and trading operations.

Effects of higher renewable energy on wholesale power markets
Wind and solar energy — the two principal forms of renewable energy — are both defined by two important fundamentals quite different from the fossil fuel-based sources of power generation upon which the electricity industry has historically counted:

• Their unstable operating costs — the costs associated with generating an additional kilowatt-hour of energy — are virtually zero. There are no fuel costs, and additive     maintenance costs are minimal.

• Their output is intermittent, dependent upon the quantity and quality of the solar or wind resource at any time. While that resource is predictable very shortly (i.e., a          few minutes in advance) and is fairly predictable across large and various sample sizes, electricity production from wind and solar is not deterministic.

Consequently, wholesale power markets where renewable energy is making significant penetration behave very differently than they used to.

Due to large quantities of near-zero variable-cost renewable supplies at several hours of the day, energy prices have been dropping in many markets worldwide. However, according to a profile of the German wholesale power markets, as discussed on Clean Energy Wire, energy prices can become negative (i.e., less than zero) when there are excesses of renewables beyond what grid demands can simply absorb.

Conversely, real-time energy markets can struggle to clear when renewable energy supplies don’t “show up” as expected — predictor clouds or calmer conditions than expected. If this arises at peak demand moments, like a severe cold switch during winter or a heat wave during summer — energy prices can pierce to the utmost.

These effects can be particularly pronounced in localized power markets subject to transmission constraints, which often cannot be readily solved by investments to expand inter-regional transfer capability. As a result, transmission constraints are likely to occur more frequently where they have historically existed. Moreover, new constraints are likely to emerge as large swaths of renewable energy are added in locations with favorable resources and fossil plants retire in the face of the corresponding price declines. As transmission constraints turn binding more often, in which surpluses of renewable energy cannot be exported or imports cannot alleviate deficits of in-region generation, deviations in power prices in neighboring markets will increase in frequency and magnitude.

Between lower average and higher peak prices, energy markets thus experience increased levels of volatility as the share of renewable energy supply increases. As a secondary consequence, the valuation of forwarding capacity markets turns unclearer, and (to the extent they are market-based) ancillary services pricing will rise due to the decreased certainty of how energy markets will balance at any moment.

Significance for power trading organizations
For those intricated in trading bulk power, the changes wrought by the increasing penetration of renewables on wholesale markets are a miscellaneous blessing.

On a high note, as in any commodity market, greater pricing volatility intrinsically creates more opportunities for traders. For example, as localized markets become more divergent with the growing frequency of transmission constraints, widening basis differentials will create many new arbitrage opportunities and equivalent trades.

But, any increase in potential rewards is normally correlated with greater risk exposure. And speaking of wholesale energy markets with substantial renewable energy penetration, the risks are extremely nonlinear and thus more hard to translate to trading strategies, mark-to-market analyses, and value-at-risk calculations.

Besides, renewable energy assets are not dispatchable. They offer fewer degrees of optionality for traders to exploit. Conversely, dispatchable generation assets play a smaller role in the supply base. Their intrinsic optionality will become progressively valuable, albeit probably more difficult to capture, as these power plants are efficiently forced into a shrinking number of crucial roles by grid operators.

To deal with this greater market complication, trading operations need more frequent refreshes of their analytics and accounting that include more current information, suggesting tighter integration between trading desks and back offices.

Renewable energy trading can be reviewed in the next era of power trading. For those presently involved in power trading, upgrades in systems responsible for data collection, processing, and reporting will likely be required. However, given how quickly renewable energy is increasing its share in power markets globally, this is not a trend where power traders can yield to lag, as any current capability gaps will only widen as time passes.