Thursday, September 15, 2011

Variations on Merit Order Effect - Alice in Wonderland, Again

What lies beyond that door?

This may seem strange (hence the Alice reference, and the "curiouser and curiouser" aspect), but adding more no-fuel-needed renewable electricity into a system that NY State has LOWERS the spot market price for electricity, despite the high capital costs of such projects relative to using ancient, paid off facilities. On the other hand, adding more fuel-needed pollution sourced (makes CO2 and other air pollution) electricity into the grid RAISES prices for all electricity sold for that time period in which prices are determined (generally one hour intervals) up to the "marginal price" (the most expensive bid in the set of bids needed to supply the hourly demand, determined from lowest to highest price). After all, even hydropower output is difficult to predict on a long term basis, as droughts can really ruin such predictions, and Global Climate Change is not making matters easier, either. And fossil fuel prices - especially natural gas prices - are notoriously unpredictable since 2000, when "conventional" North American gas depletion became noticeable, and continuing production at essentially constant rates required increasing amounts of more expensive "unconventional" gas. Like coal bed methane, and fracking tight sands in the Rockies and tight shales in the Appalachians, for example.

Renewable electricity, and especially wind based electricity, needs to get sold whenever it is made. The amount made each year can be accurately predicted from studies of previous historical wind data at a given site, though predictive wind maps are also pretty good at coming up with the correct answer, too. However, predicting the wind speed for each hour of a given day more than a week in advance is really not practical, and for two weeks in advance, just not mathematically possible. You may as well try and accurately predict when the next nuclear reactor meltdown for any reason will happen - which is also mathematically impossible. But, financing for wind turbine projects IS practical because all that really matters is how much electricity gets made in a year, not necessarily exactly when it is made at any given site.

Because of the need to sell electricity whenever it is made, wind turbine owners that operate in "competitive" markets like NY State have to set their hourly bids in such markets below the price of any other bids. On the other hand, that would be foolish in the extreme for power generation owners where fuel cost is THE MAJOR EXPENSE, and this especially applies to natural gas sourced facilities. After all, why spend more to make electricity than it costs to buy the fuel to generate the electricity? Logic says that fuel should only be consumed when more money will come from sale of that electricity than it costs to buy the fuel to make that electricity. Thus, fuel cost is the majority of their "marginal price".

In other words, the prices of the bids to supply electricity for each hour do not necessarily reflect the costs to make electricity for that hour. Yes, Alice, we have arrived in Wonderland. Another wonder is why a "market" like NYISO Zone A (Western NY) would even be considered "competitive" - coal is still less than 50% of the fuel cost of delivered bulk natural gas (Ngas) - today's price would be the Henry Hub gas price ($3.98/MBtu - see plus about $1.30/MBtu (for pipeline transport), or roughly $5.30/MBtu. Coal prices are estimated by the U.S. Energy Information Agency to be $2.37/MBtu - see - 45% of that of Ngas. And that Ngas price is less than half of the price needed to financially justify new gas wells, and especially "unconventional" (including fracking sourced) gas. And 3 sites - Dunkirk, Huntely (NRG) and Somerset (AES) can supply almost all of the average electricity load which averaged 1762 MW in 2010, and especially ALL of the non-NYPA load. NYPA supplies about 400 MW to local customers (per the Federal Power Act), so the non-NYPA Zone A load would be around 1400 MW. However, wind supplied 85 MW, landfill gas supplied about 25 MW, trash burning supplied another 25 MW and NYPA's pumped hydro unit supplied 57 MW, so Ngas is, on average, not needed.

After all, the conventional definition of "competitive" is that any one supplier cannot affect the price of that product (by adding more supply/withdrawing supply/raising or lowering the price above or below the "equilibrium price"). That simply is not true for WNY electricity. This is neither monopoly nor competitive - it is "oligopy", with its own sets of rules. And in this netherworld of bent reality, Ngas sets the marginal price when demand is above average/generally "peak", and coal sets the marginal price when demand is lower than average/generally "non-peak". Renewables, and especially wind sourced electricity, is bid in below the price that coal is bid in, so that if wind derived electricity is made, it gets sold at some price (and ANY price), a price that is only known after the fact. And this is why spot market prices for electricity drop as more wind sourced electricity is added into a grid, and why prices rise as more natural gas is added in. However, using more Ngas to make electricity raises the demand for Ngas, which in turn raises the price for Ngas, so more Ngas used to make electricity also means higher home heating prices for the vast majority of us WNY'ers who use Ngas for home heat and hot water, as well as for employers and governments (schools, especially) who use it for heat.

So, if you want lower spot market prices for electricity (and the price of most electricity in sold WNY is determined in this manner), then you want to add more wind to the system. If you want to see high heating costs AND higher electricity prices, then use more Ngas to make electricity. It is THAT simple.

Electricity grid pricing systems based on the "competitive" and "marginal pricing auctions" are in effect for about half of the states in our country, and they exist throughout the world. They sort of make sense when fuels are used to make large percentages of the electricity (mostly coal, Ngas), and when the prices of those fuels tend to fluctuate significantly over time. They make no sense for renewable energy, or when long term contracts are used to obtain the bulk of a system's electricity. For example, exports of coal from the U.S. East Coast (mostly West Virginia) this year will be near 150 million tons, or 15% of total coal mined, and this pulls coal price up (now near $75 to $80/ton - and But, when renewables and fossil fuels interact in such systems, the Merit Order Effect shows up, and as more renewables get added in/displace Ngas and eventually coal (which also has fluctuating prices), spot (also know as "pool") prices drop.

Tales from South Australia
Australia is a country with a lot of coal in 3 of it's 7 states (New South Wales, Queensland, Victoria) - a LOT of coal. It is a major exporter to China, India and Japan. Despite an awesome wind resource with a relatively small population over a land mass the size of the US or Canada, coal still rules as the main way to make electricity, with Ngas also in the mix. But, as wind sourced electricity gets added, prices for electricity keep dropping, first forcing Ngas out of the market, followed by coal. Australia, like the U.S., could easily supply all its electricity with wind and have plenty of capacity left over.

Anyway, here is the trend ( from - Transmission and Congestion report (.pdf download)):

The graph may be a bit obtuse, but it has great significance for NY State. It is from a report on South Australia's electricity system as that state starts to displace large amounts of gas fired electricity with wind, and what happens to electricity prices when that occurs. The report also concerns efforts to use "CO2 credits" as a way to mitigate CO2 pollution; Australia has way too much cheap coal usage, as well as a big attempt to use a recently discovered offshore natural gas field located between East Timor and Western Australia (Indian Ocean) to make electricity. The report can be downloaded here:

The graph shows that as more wind is added to the system, electricity prices drop. They also have one of these "marginal price systems", such as the NYISO is, which sets spot market prices based on hourly bids and whatever the last most expensive bid is in order to satisfy the hourly demand (marginal price). Most of the electricity for eastern Australia is provided by burning coal in paid off (as in, generally zero capital cost) plants, despite the enormous wind resource (they also have a humongous solar resource, but, given the wind speeds, solar thermal and solar PV is more expensive, by at least a factor of 3 (the interior often has 300 to 350 days of full sun per year; in WNY, we have less than 180 full-sun-equivalent days/year)). And besides, with less than 8% of the population of the US, going renewable should be a piece of cake, except for those super-cheap coal supplies...

You can take the graph and get a similar result with the profit rates (and also profits) obtained by coal burners making electricity. Replacing gas with wind takes a bite out of coal profits, and coal to electricity profits, as well as profits of companies who own old nukes. The added benefit is less Ngas usage, less demand for Ngas, and lower prices for remaining customers of Ngas, particularly industrial and residential users. This has the added feature of leaving customers with greater disposable income, and making their manufacturing industry more competitive, leading to better economic outcomes.

On the other hand, if you twist this situation and start replacing some coal with MORE natural gas fired generation (or wind turbines with Ngas, or any increase in electricity usage with Ngas instead of wind), coal burner profits will actually RISE, because they can charge more for for the electricity that they do make. And the increased demand for Ngas will raise the price of Ngas, which in turn will raise the profit rate for those burning coal to make electricity! Wow, what a feedback situation. Of course, lowering the demand for coal slightly will drop coal prices, and lower coal prices PLUS higher prices for the electricity profit gives even greater profits. So why on earth would the owners of coal burners object to that? Plus, those supposedly infinite reserves of Ngas aren't infinite; in fact, they are quite finite, and quite temporary. And never underestimate the ability of a steady growth rate in consumption of a finite resource to burn through that resource at a rapid rate - that is the basis for the math behind Peak Oil, after all (the Logistic Equation - see and, and the reason oil prices are near $90/bbl, and not the $25 to $40/bbl that many "conventional" energy experts predicted, even as late as 2007.

The moral to the story is that if you want to replace the use of coal to make electricity in NY, DO NOT USE natural gas, as that will just amp up the profit rates to amazing level of the "baseload polluters" - nukes and coal. And just for good measure, two other bad things happen. Firstly, consumers/ratepayers (most of whom are poor to middle class) get screwed royally when the average cost to make electricity becomes vastly disconnected from the average price of electricity, since price gets set by the marginal bid, not the weighted average of bids for any given hour. And next, the profit rates for pollution based generators, which determine the motivation to continue their operation, remain high, and as natural gas prices increase over time (inevitable, given resource depletion and the gas industry's best wish of increasing gas consumption rates), so do the profit rates for "baseload polluters" increase. And in NY State, the Ngas can only be supplied by a frack attack. So if you want to put a big crimp in the frack attack, work to cut DOWN on Ngas usage NOW, not sometime in the distant future.

The best solution is to not go the Ngas diversion, and go directly to wind turbines and increased efficiency to deal with electricity supply and demand. Finally, the huge volume of fugitive CH4 from fracking renders the Greenhouse Gas argument (use Ngas instead of coal/less greenhouse gas warming from the lower CO2 emissions per unit energy delivered than from coal) pretty much irrelevant. As for air pollution - it's particulates and heavy metal poisoning from coal, or ground level ozone (photo-oxidation of that methane) and radon from the fracking. And then it becomes a fine example of a "Morton's Fork" dilemma - see - that is, a choice between two equally bad options. In reality, this is actually a false choice.

BTW, whenever the phrase "natural gas" pops up, does the pre-programmed word "clean" pop into your head? If so, work on it, as, with practice, it will go away.


1 comment:

Cal Morton said...

Appreciated your post, though a local installer, it helps to understand the machinations of the power market.


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