Ensuring energy security in the age of renewables

The last ten years have seen a remarkable growth in the use of wind and solar power worldwide as nations have sought to make dramatic reductions in CO2 emissions from their energy sectors. From a mere 2.6 GW in 2004, global installed capacity of solar photovoltaics is now estimated to approach 250 GW, whilst wind power grew from 48 to 432 GW in the same period and more than any other energy source in 2015.

Primarily driven by attractive subsidies for renewable energy in parts of the US and Europe, countries such as Denmark, Spain, and Germany are now generating significant proportions of their annual electricity from the wind and solar. More recently, China has taken up the baton, rapidly becoming home to the world’s largest capacities of both technologies. This growth has been key to driving down production costs, to the point where wind power, in particular, can begin to compete on a level playing field with more established energy sources.

On top of this, both the US and Europe have also started to see closures of coal and gas power plants which are no longer profitable, or not sufficiently profitable to invest in the pollutant removal equipment required by increasingly strict emissions regulations. Whilst environmental groups have lauded these trends as evidence of an unstoppable march towards an entirely green energy sector, others have complained of rising electricity costs, or warned of impending blackouts and a threat to the reliable power supply on which developed countries have come to depend. In reality, a careful balance needs to be struck between these often conflicting concerns, with a level of precision which seems to be beyond the market mechanisms which currently determine the energy supply of most countries. As a consequence, policy makers in countries at the forefront of the renewables revolution are now being forced to rethink fundamentally the way in which these markets operate.

The intermittent, weather-dependent nature of the wind and solar power presents a new challenge for electricity grids, which need to precisely match electricity supply to demand at any given moment, regardless of whether the sun is shining or the wind is blowing. In most developed countries, this balance is achieved through energy markets, in which power producers compete to offer the lowest priced electricity at a future date, or in real time throughout the day. Investment in renewables has tended to drive down this wholesale price of electricity, due to the increased supply and the fact that wind and solar farms have minimal operating costs and will carry on producing regardless of the price. This has famously led to periods with significant energy surpluses and negative power prices in countries such as Germany, where the wind and solar production can outstrip actual demand, leading to offloading of the cheap electricity to neighbouring countries. On the other hand, in times of high demand and low wind and solar production, conventional power plants are fired up to meet the shortage, and electricity prices increase.

Adapting to this backup role has proved difficult for many fossil fuel power plants, which struggle to recoup their costs under such sporadic operation and can experience greater wear and tear. Due to their higher fuel cost, gas plants have been struck hardest in Europe, and many have closed while dirtier but cheaper coal plants are left running. With even existing power plants struggling with low power prices, there is little incentive to invest in new plants, and such projects have largely halted in the US and Europe.

As subsidies are withdrawn, even investment in renewable energy will become unfavourable in this environment. In countries such as the UK, which requires urgent replacement of ageing coal and nuclear plants, this situation poses a growing problem. Even a power plant which operates for only a few hours a year still forms a crucial part of a country’s energy supply, and requires some business case. As a result, many countries are introducing energy market reforms which attempt to make power plants profitable, and ensure a constant supply of electricity at all times of the day and year.

The most popular strategy is known as a capacity mechanism, where power plants are paid a constant revenue to guarantee they can produce a set amount of electricity when called upon. In several European states, these already exist in the form of ‘strategic reserves’ of plants which are kept on standby in case of particularly high demand. However, these normally consist of old plants which would otherwise have been decommissioned, rather than encouraging investment in cleaner, new plants which can guarantee an energy supply for years to come. Instead, countries including the UK and France have recently adopted a more market-based approach, in which prospective generators bid to provide a guaranteed supply at a competitive cost. In the UK, long contracts of up to 15 years could be awarded for new gas power plants, with a view to providing a long-term business case for investors.

Unfortunately, the UK’s inaugural capacity auction did not produce the desired results, with contracts mainly going to existing coal plants and small diesel generators which are cheap to build but detrimental to local air quality. The system is currently being reformed to encourage gas plants in the next round of bidding, mainly through making more contracts available further in advance, but the UK example highlights how difficult it can be to get markets to produce the desired balance between investment in a secure energy supply and low CO2 emissions.

Other regions have sought to avoid capacity markets, arguing that they distort the electricity market and result in wasteful, excess generating capacity on the grid. This ‘energy-only’ market approach requires governments to minimise their intervention in existing electricity markets and let backup power plants find sufficient revenue from power sales alone. Currently, at times of high electricity demand and small renewables output, soaring electricity prices are usually capped to a reasonable level by governments to prevent individual suppliers from abusing total power over the market, and because very high prices are politically unfavourable.

In Australia and Texas, the approach has been to raise this cap to the much higher levels required for plants to make a profit from very low running hours, with further limits in place to prevent the plant from making excessive profits over the year. A standard bearer for the renewables revolution, Germany has recently opted for an energy-only approach in energy market reforms aimed at better dealing with its huge expansion in wind and solar power. Power prices will be uncapped, and harsher penalties will be imposed on energy retailers who don’t buy enough to meet consumer demand.

A strategic reserve consisting mostly of old coal plants will still be maintained outside the market for emergency shortages. In contrast to the UK situation, Germany’s reforms are not intended to spur investment in new fossil fuel plants, but the country’s existing plants are much newer and there is much less concern over future energy shortages.

A fundamental problem with energy markets is that consumers are rarely exposed to these increasingly wild fluctuations in the wholesale price of electricity, instead paying a fixed rate which effectively averages the variation over an extended period. There is a growing awareness that future energy markets will need to allow for more interaction between suppliers and consumers, with consumers able to reduce their energy use when prices are high.

This approach helps prevent moments of severe power shortages and the associated spikes in price, reduces the amount of spare capacity needed, and results in more efficient use of green energy resources. Known as the demand-side response, it is already well-established in parts of the USA and Australia, where industry and commercial consumers are paid to give suppliers the option of turning down some of their power hungry processes. Improvements in computing and communication technology could allow this to be extended to residential consumers in the form of smart metering, and European states are increasingly viewing demand-side measures as an ideal means of reducing the need for a backup power plant.

Developing energy storage technologies and providing more electrical links between countries are other promising approaches for improving the flexibility of electricity grids and reducing the need for backup power plant. Germany and Denmark already benefit greatly from connections to Norwegian hydropower plans, which are able to store excess wind energy for later use.

For island nations such as the UK and Ireland, connections to other grids are currently limited, and could provide a particularly effective means of easing the growing strain on supply. However, if all countries aspire to high levels of wind and solar, times of shortage and surplus are likely to coincide largely, and connections may yield diminishing returns. Whilst significant advances are being made in batteries, longer-term and larger-scale energy storage systems, such as the conversion of electricity to hydrogen gas, will be needed to eliminate a significantly alleviate the need for backup power plants.

Significant changes to energy markets will also be necessary to encourage investment in energy storage, which currently has a limited business case based on payments for providing minor adjustments to the power supply.
In the near term, several countries are faced with an urgent need to come up with an energy policy which can provide a long-term, secure energy supply with minimal cost to the environment and consumers.

Although market-based approaches for both energy and carbon are widely seen as the best solutions, ensuring on-demand electricity is such a political issue that markets can rarely be left to their own devices. With so much uncertainty surrounding the future of the energy landscape, encouraging any kind of large investment requires huge guarantees from governments. In the end, the fear of the blackout is likely to prevail, but it remains to be seen at what cost.

Toby Lockwood