How can wind investors cope with price cannibalisation?

Renewable energy developers are eating into their own revenues.

This is the phenomenon called price cannibalisation, which we keep hearing more about. What is it? And how does it affect decisions by wind investors?

Price cannibalisation starts because of a simple imbalance of supply and demand. On windy days, most or all wind turbines send power to the grid at the same time, and the same happens with solar panels on sunny days.

The result is that the grid can be overwhelmed by too much electricity and, if it is not absorbed by consumer demand, wholesale market prices fall to zero or lower. When wholesale power prices fall below zero, power suppliers have to pay their wholesale customers to buy electricity.

As wholesale prices are highly sensitive to available production and transmission capacity, the problem for project owners only gets larger as more renewable energy projects come online.

The phenomenon is particularly visible in Germany, where renewables currently account for 40% of its energy mix. For example, last Christmas Eve the average hourly intraday wholesale market price fell by as low as -€63.37/MWh, due to an excess of wind energy production. This meant that energy producers had to pay utilities €63.37 to take each MWh of produced power. Not a happy Christmas.

Christian Kjaer, chief executive of the Danish Wind Turbine Owners’ Association, has said that every percentage point increase in renewable share reduces on average the wholesale electricity price by €0.40/MWh in the European Union.

So far, government subsidies including feed-in tariffs have protected wind and solar companies from the negative effects of this phenomenon. The payment of subsidies means that renewables generators receive revenue even when wholesale prices are low or negative. However, as the number of no-subsidy projects in mature markets increases, so does the investment risk for wind firms.

This would be an issue in the UK, for example, where the developers of new onshore wind farms will not be able to bid for government support; in Spain, where the next construction wave of onshore wind farms is set to be subsidy-free; and also for the developers of offshore wind farms to be built in Germany and the Netherlands.

A recent report from consultancy Cornwall Insight showed that for a representative 10MW onshore wind project, the combination of lower wholesale prices and higher output could cut revenues from the wholesale market by as much as 34% by 2033 compared to 2018. The price cannibalisation effect could make really hard for renewables to recover their capital costs through the wholesale market.

But there might be ways for wind companies to protect themselves against price cannibalisation.

For example, Contracts for Difference for renewable energy, such as the ones used by the UK government for offshore wind projects, reduce the exposure of developers and investors to volatile wholesale prices.

Cornwall Insight argued that in a scenario of falling costs to build projects and falling wholesale market prices, companies should be able to bid for a floor price, rather than the fixed price payment, to make the project viable. A floor price would be lower than fixed strike prices currently bid into CfD auctions, representing an incentive for the government while giving protection for developers and investors.

Another solution is corporate power purchase agreements. However, Nigel Williams, channel manager of renewables at UK utility Opus Energy, told A Word About Wind that price cannibalisation represents “a key risk for off-takers and may inhibit their appetite to offer the level of certainty over a developer’s desired term”. In fact, some PPAs already factor price cannibalisation effects into their offer.

Arguably though, the best form of protection should come from the market itself.

In a scenario where renewables represent a growing share of the global energy mix, markets should be able to adapt and respond to the amount of renewable energy flowing into the grid. In order to achieve this, commitment from governments would be key. Investments in smart grid and energy storage systems should be part of the solution too.

A solution must be found quickly as renewable energies risk to become a victim of their own success.