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Carbon In Electricity Markets

Price transparency will drive GHG reductions.

Fortnightly Magazine - August 2009

emissions as effectively as desired. Traditional average-cost regulated pricing will mask price signals and potentially limit their effectiveness.

Carbon Prices and Renewable Investments

Investment in renewable energy is driven by many factors, including resource availability, renewable portfolio standards (RPS) requirements, and regional transmission access, capacity, and availability. The cost of installation, which is aided by federal and state tax credits, is also a principal driver. Taken together, these policies and market dynamics largely determine where, when, and how much investment in renewable energy occurs.

A price on carbon emissions likely will increase investment in renewable energy generation. As carbon-compliance costs rise, there will be an increased incentive for entities with a carbon-compliance obligation to use renewable resources to meet future load growth. Moreover, the increase in electricity prices caused by carbon-related costs will make renewable energy more cost-competitive. Electricity price increases driven by carbon costs also can encourage more diverse and innovative energy applications, such as renewable and distributed generation resources.

When electricity prices reflect the marginal abatement cost of the most carbon-intensive fuel, renewable energy and load management will tend to benefit. Restructured markets dispatch generators in the order of their operating costs; the more expensive units are dispatched later and set the price at which all units in the region earn revenues. Price-taking zero-carbon resources such as wind energy can benefit from this dynamic because they receive prevailing wholesale-market clearing prices even though they don’t have a corresponding carbon compliance cost. In other words, generators are rewarded based on performance in the marketplace.

While roughly two thirds of wind capacity exists in states having organized wholesale markets (see Figure 7) , assessing the degree to which market structure leads to increased levels of renewable energy development is highly complex because of the jurisdictionally fractured, stop-and-start history of renewable resource development. The salient questions are whether or not organized electricity markets are conducive to optimizing and increasing the value of renewable energy on the grid, and whether or not investors have enough information to adequately value future investments in renewable energy.

Reduced uncertainty and risk make investment decisions easier. Without a publicly visible, readily determined dispatch price, valuing an investment in new generation capacity is more difficult. Well-functioning liquid hour-ahead and day-ahead markets provide useful information and data to energy developers that can inform decision makers whether or not prices will support the cash flows needed to meet required investment returns. For CO 2 prices to induce a shift in the capital stock to low-carbon generation sources, investment decisions need to incorporate the impact that carbon costs will have on electricity prices. In markets with transparent pricing mechanisms and market rules, investors will be better able to assess the risk-and-return trade-offs of their decisions.

In theory, coordinated dispatch can optimize the output of large wind farms because grid operators call on the lowest-cost producers available and shift generation away from more expensive units. In practice, the ability to coordinate different control areas and an availability of transmission capacity are needed to optimize resources in markets with a diverse fuel mix and