When the switch flips on electricity prices

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By Feng Zengkun

SMU Office of Research & Tech Transfer – Compared to fossil fuels, renewable energy sources such as wind and solar power can help us generate electricity in more environmentally friendly ways.

But the proliferation of renewable energy installations could also lead to unintended consequences, says Helen Yangfang Zhou, Assistant Professor of Operations Management at the Singapore Management University (SMU) Lee Kong Chian School of Business (LKCSB).  

“With more wind farms generating electricity, for example, you could have more instances of negative electricity prices, and that could incentivise developers to build high-electricity consuming elements for the sole purpose of being paid to waste electricity,” says Professor Zhou, who specialises in energy and sustainable operations research.

When pricing turns negative

In their 2015 paper, ‘Electricity Trading and Negative Prices: Storage vs. Disposal’, published in Management Science, Professor Zhou and her Carnegie Mellon University (CMU) collaborators elaborate on the causes of such unintended consequences, and how policymakers can address them.

Unlike other commodities, electricity prices can become negative when supply outstrips demand. Due to technological limits or high costs, managers of coal or nuclear power plants might pay others to purchase their excess power, rather than adjust their plants’ electricity generation downwards.

The result: short-term supply gluts in cities or countries that prioritise renewable energy generation and disallow curtailing it, or in cases where electricity suppliers lack the transmission capacity to direct excess power outside of their immediate market.

Furthermore, production tax credits can induce renewable energy generators to offer negative electricity prices, as they will profit nevertheless.

“It is widely believed that with the increasing use of wind power, negative electricity prices are likely to become more frequent and larger in magnitude in the future,” says Professor Zhou.

Solar power, meanwhile, is less likely to result in such negative prices as it is generated during the day when energy demand is higher, she added.

Why waste a profit?

Energy merchants typically buy and store electricity at low prices, and sell when prices go up. But with negative prices becoming more common, an alternative strategy might prove more profitable.

“A merchant might buy negatively priced electricity surpluses and dispose of them using specialised load banks, which are designed to mimic real load applied to power sources and can be used to consume electricity for general purposes,” Professor Zhou says.

In fact, once negative electricity prices occur at least ten percent of the time, the value of this disposal strategy becomes substantial, although still less profitable than the storage strategy, the researchers found.

“However, because devices for disposing of electricity, such as load banks, are much cheaper than efficient batteries, a merchant might find the disposal strategy more attractive and profitable,” Professor Zhou explains.

If governments want to reduce deliberate waste, they have three avenues, says Professor Zhou: enacting policies to promote storage; modifying production tax credits to encourage generating energy only when it is needed; and allowing renewable energy to be curtailed to address imbalances between supply and demand.

Still, some may see this waste as economically efficient, adds Professor Zhou – it could be better than ramping power generators up and down in the event of oversupply, and is less of an investment than batteries.

Rethinking energy trading

With negative electricity prices becoming increasingly frequent, merchants who trade in energy would do well to rethink their buying and selling strategies, says Professor Zhou.

In her paper ‘Managing Wind-based Electricity Generation in the Presence of Storage and Transmission Capacity’, currently under minor revision for the Production and Operations Management journal and co-written with the same CMU collaborators, Professor Zhou notes that most wind energy merchants are used to making decisions based on positive electricity prices.

But this assumption can lead to sub-optimal profits. Merchants might fill up their energy storage devices when prices are low but positive, and be unable to capitalise on negative prices when these occur.

Furthermore, most merchants usually rely on a simplistic formula for their electricity trading decisions.

“Most merchants have two numbers that they decide on each month. If the current electricity price is lower than their low number, they will buy from the market. If the price is higher than their high number, they will sell. If the price is in the middle, they don’t do anything. We found that this simple heuristics could lead to a big loss of profits,” says Professor Zhou.

The researchers compared this predominant fixed-price decision method to two other models. The first took into account multiple factors, including the amount of electricity stored in merchants’ batteries, the current wind speed, and the price information. While this comprehensive model could generate optimal decisions, its calculations took too long – five and a half hours, on average – to be practically useful.

The second model was one the researchers developed themselves. “The heuristics that we developed and tested are useful and practical in reality. Rather than simply relying on the price information, it takes into account how much electricity you have in your battery. It can generate decisions in just over ten seconds and is more profitable for the merchant, so we believe that it can be widely used,” says Professor Zhou.

While Professor Zhou and her colleagues developed this model for wind energy transactions, it can be modified for solar power and other renewable energy sources, she said.

Professor Zhou continues to explore other questions in sustainable operations. One of her current projects involves examining the environmental impact of putting energy storage devices in commercial buildings. “These are usually used to minimise the cost of purchasing electricity from the market, and I’m looking at whether they increase or decrease carbon emissions from the power grid,” she elaborates. 

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