A couple of years ago, a visitor to our department here at Canterbury told me
how sometimes in Texas, windfarms are able to generate so much electricity that
the price of electricity goes negative. This recent article in the Economist
(HT: Tyler at Marginal Revolution), gives a similar example from Europe. In
both cases, I find this puzzling, and so I am seeking enlightenment from those
who know the physics of electricity generation better than I do. To explain why
it is a puzzle, let’s consider some examples of the economics of negative
prices.
First imagine a pure-exchange world (i.e. one where commodities just exist rather than being created, so that economic activity consists of trade and consumption, not production). If all commodities are desired by all consumers, then competitive markets will result in all prices being positive, with prices reflecting the relative desirability and abundance of each good. If, in contrast, one of the commodities is not only not enjoyed but would be positively disliked by all consumers, the extent that its price would reflect that dislike would depend on whether there was “free disposal”, meaning whether the owner of the commodity could costlessly avoid consuming it. If there is free disposal, the price of the commodity would be zero. Without free disposal, the competitive price would be negative, again reflecting the relative (lack of) desirability.
A related situation arises when a firm produces a main product and an
associated by-product. For instance, consider a motel that produces
accommodation services during the peak holiday season. To provide this service,
it has to incur the capital cost of building motel units that exist during the
peak period, and then, as a by-product, these units exist during the off-peak
times. If off-peak demand is low, some of these units might well be consistently
vacant during the off-peak times, even if the price fell to zero. There again
is an implicit assumption of free disposal here. If, for some strange reason,
there was a requirement that motel units be occupied at all times to prevent
depreciation of the capital stock, one could easily imagine the off-peak price
going negative; that is, it could be worthwhile to motel owners to pay people to stay in
their units during the off-peak times in order to ensure they were available
for renting out at positive prices during the peak period. In effect, the
opportunity cost of maintaining the units during the off-peak time would be
negative, which could be reflected in the price. Again, the key assumption
allowing negative prices is no-free-disposal. It does not make sense to see
sellers choosing to sell something at a negative price if they could simply
dispose of the good or service for free.
So now consider electricity. It is a key attribute of thermal power
plants (particularly those using coal as the fuel source), that it is cheaper
to keep the plant running 24/7 then to shut it down and heat it back up every day. This is just an on-peak/off-peak problem. Even if one only
wanted to generate power during the peak periods each day, it would be cheaper
to keep the plant running than to shut it down at off-peak times, giving a
negative opportunity cost of generating power during those times. In the
examples given above from Texas and Europe, wind or solar generation was able
to meet regular demand at off-peak times, but shutdown costs made it economic
for thermal stations to keep producing, sending prices negative. But, as we
have seen, negative prices require an assumption of no-free-disposal.
My question then is: What is the physical or political constraint that
implies an absence of free disposal in the electricity market? Why is it not
possible to run a plant spinning the turbines, but simply not connect the
station to the grid? In the case of Texas, I have heard that it is a purely
political constraint: in a heavily regulated market, it is not palatable to have
stations burning coal and not then produce any electricity. Is that all there
is, or is there something about the physics of electricity generation that
makes it imperative to force power onto the grid when a station is up and
running?
