To combat climate change, more and more renewable energy sources such as solar and wind farms replace fossil-fuelled power plants. However, this technology change is easier said than done. Renewables do not produce power when people need it; supply depends on the weather. To speed up the energy transition, we need demand response and power storage capacity. My research focuses on understanding the dynamics of power prices such that we can efficiently charge batteries and instruct people when to consume power and when not.
Energy markets were liberalised worldwide at the end of the 1990s. Since then, power contracts can be traded on exchanges such as contracts for other commodities and stocks: the market sets the power price. When we study the dynamics of power market prices, we must understand the key difference between power and other commodities: electricity is not yet storable on a large scale. We need to produce power when it is consumed: supply is demand. Consequently, unexpected frictions in supply and demand immediately lead to enormous price fluctuations. The power price moving from +€1.000 / MWh to -€400 / MWh somewhat later is not uncommon. And, as the market share of supply from renewables increases, these frictions will occur more frequently.
'Prices reveal information.'
A high price signals a shortage; a low price signals an oversupply. The extreme fluctuation of power prices signals that power markets need storage, and that consumption needs to be more in line with the supply of renewables. We have to charge/discharge batteries when prices are high/low or consume less/more. Power markets ‘scream’ for storage and demand response. For as long as there is insufficient storage capacity and power demand remains price inelastic, we will have to deal with the uncertainty of extreme price behaviour; an uncertainty that causes risk for energy companies and investors in renewable energy.
Timing difficulties
Clearly, power storage is needed to better accommodate the supply from renewables. That, however, raises a question: how to operate a battery? It is obvious that one charges a battery in case of oversupply, but it is less obvious when to discharge it. If all batteries are discharged at the same time, an oversupply is created during another time. Batteries (and demand response systems) need to be operated in such a way that they flexibly cover the mismatch between supply from renewables and demand for power.
Ronald Huisman is Professor of Sustainable Energy Finance at Erasmus School Economics. He graduated in econometrics at Erasmus School of Economics and received a PhD in financial economics from Maastricht University. He focuses on sustainable finance and investing with a specific interest in the energy transition.
Price fluctuations
This motivated me to study the dynamics of power prices. If we can predict when prices are extremely high or low, thereby revealing signals about shortages and oversupply, we can operate batteries accordingly. To do so, I applied extreme value theory (EVT) to help understand what drives the occurrence of extremely high or low prices. Consider that you want to know the probability that the power price exceeds a very high (or low) level at some future moment. The normal distribution function will not help modelling this uncertainty: extremely high or low prices are less likely to occur than what is observed in reality. EVT focuses on the shape of the tails. It enables studying the behaviour of extreme prices.
In my recently published paper “Fat Tails due to Variable Renewables and Insufficient Flexibility: Evidence from Germany” (co-authored by Evangelos Kyritsis and Cristian Stet), I apply EVT to study extreme power prices in Germany. We found that during periods with low supply from renewables and high demand, extremely high prices occur more frequently than extremely low prices. The opposite holds during periods with high supply from renewables and low demand: extremely low prices occur more often than extremely high prices.
Benefits of operating batteries
The results help to understand how to operate a battery and demand response systems. A fully charged battery is desired right before a period with extremely high prices. One wants a battery to be empty before a period with (expected) high supply from renewables and when demand is low. In such a way, operating batteries and demand response systems will help power systems to better accommodate the fluctuating supply from renewable energy sources. Moreover, focusing on charging and discharging when prices are low and high improves the profitability of power storage systems, which increases the willingness of investors to invest in the energy transition.
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This item is part of Backbone Magazine 2024. The magazine can be found in E-building or Theil-building for free. Additionally, a digital copy is available here. Backbone is the corporate magazine of Erasmus School of Economics. Since 2014, it is published once a year. The magazine highlights successful and interesting alumni, covers the latest economic trends and research, and reports on news, events, student and alumni accomplishments.
