Renewable energy trading is an emerging topic within the electricity sector that has received relatively little attention to date. Indeed, the phrases “renewable energy” and “power trading” are rarely found in the same sentence.
In many markets around the world, intermittent renewable energy sources — primarily wind and solar — are gaining an increasing share of electricity supply, mainly at the expense of coal and nuclear power. Where this is occurring, pricing dynamics in wholesale power markets are significantly changing — in general, driving energy prices downward. Consequently, firms with long positions in regions becoming more reliant on renewable energy face the risk of declining portfolio value, and thus may be compelled to adapt both their asset strategies and trading operations.
Effects of increased renewable energy on wholesale power markets
Wind and solar energy — the two dominant forms of renewable energy — are both characterized by two important fundamentals quite dissimilar to the fossil fuel-based sources of power generation upon which the electricity industry has historically relied:
Accordingly, wholesale power markets where renewable energy is making significant penetration are behaving very differently than they used to.
Because of large quantities of near-zero variable cost renewable supplies at many hours of the day, energy prices have been falling in many markets worldwide. Indeed, according to a profile of the German wholesale power markets, as discussed on Clean Energy Wire, energy prices can actually become negative (i.e., less than zero) at certain times when there are actually excesses of renewables beyond what grid demands can easily absorb.
On the other hand, when renewable energy supplies don’t “show up” as expected — unforecasted clouds or calmer conditions than anticipated — real-time energy markets can struggle to clear. If this occurs at peak demand moments, such as a severe cold snap during winter or heat wave during summer — energy prices can spike to extreme levels.
These effects can be especially pronounced in localized power markets subject to transmission constraints, which often cannot be easily solved by investments to expand inter-regional transfer capability. Where they have historically existed, transmission constraints are likely to occur more frequently and 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 declines in energy prices. As transmission constraints become binding more often, in which surpluses of renewable energy cannot be exported or deficits of in-region generation cannot be alleviated by imports, deviations in power prices in neighboring markets will increase in frequency and magnitude.
Between lower average prices and higher peak prices, energy markets thus experience increased levels of volatility as the share of renewable energy supply increases. As a secondary consequence, valuation of forward capacity markets becomes more uncertain and (to the extent they are market-based) ancillary services pricing will increase, because of the reduced certainty of how energy markets will balance at any moment in time.
Implications for power trading organizations
For those involved in trading bulk power, the changes wrought by increasing penetration of renewables on wholesale markets are a mixed blessing.
On the positive side, as in any commodity market, greater pricing volatility intrinsically creates more opportunity for traders. For instance, as localized markets become more divergent with increasing frequency of transmission constraints, widening basis differentials will create many new arbitrage opportunities and corresponding trades to execute.
But, naturally, any increase in potential rewards is correlated with greater risk exposure. And, in the case of wholesale energy markets with substantial renewable energy penetration, the risks are highly nonlinear and thus more difficult to translate to trading strategies, mark-to-market analyses and value-at-risk calculations.
Moreover, because renewable energy assets are not dispatchable, they offer fewer degrees of optionality for traders to exploit. On the other hand, as dispatchable generation assets play a smaller role in the overall supply base, their intrinsic optionality will become increasingly valuable — albeit probably more complicated to capture, as these power plants are effectively forced into a shrinking number of critical roles by grid operators.
To cope with this greater degree of market complexity, trading operations will need to perform more frequent refreshes of their analytics and accounting that incorporate more current information, implying tighter integration between trading desks and back offices.
Renewable energy trading can be considered the next era of power trading. For those currently involved in power trading, it’s likely that upgrades in systems responsible for data collection, processing and reporting will be required. Given how quickly renewable energy is increasing share in power markets worldwide, this is not a trend where power traders can afford to lag behind, as any current capability gaps will only widen as time passes.
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