Market Value of Renewables

Definition

The market value is a metric measuring the specific value of electricity fed into the grid by a particular plant, a generating technology, or a primary energy source as a whole. The current spot market prices on electricity exchanges, are used as a reference value. The market value is an important indicator for calculating the economic value of power plants.

Related key figures are capture price and capture rate. All three help to understand why a higher proportion of renewable electricity tends to lead to lower returns and what consequences this has for the energy transition.

Cost vs. Value

The costs of variable renewable energy (VRE), i.e., primarily wind and solar power, have fallen significantly over the past decade (see figure). While this undoubtedly seems like good news for the effort to reduce greenhouse gas emissions from our energy system, investors who finance or operate wind and solar power plants look at it from a different angle. To assess the competitiveness of a renewable energy plant and its potential profits the relationship between life cycle costs and returns is crucial.

More renewable in-feed, less valuable electricity per output

Their massive expansion of VRE in the last decade has displayed a negative correlation between price and production volume. In fact, this is the standard relation between supply and demand: if supply increases for a given level of demand, the market price per unit falls and vice versa.

In the case of wind and solar power plants, however, this effect is amplified by the fact that their production potential depends on the weather. As a result, all systems - at least within fairly large geographical areas - generate either big or small amounts of electricity at the same time. As a result, the supply of wind and solar power generation usually rises and falls considerably at the respective times, which in turn systematically leads to strong price fluctuations in the electricity market.

Hence, electricity from VRE plants is worth particularly little at times when they can generate a lot of it (for more details, see Hirth, 2013). And the more VRE capacity is installed, the stronger this effect becomes. This is why experts also speak of the "cannibalisation effect" of renewable energies. This effect occurs not only on a national scale but also across country borders when grids are interconnected, as seen in Europe.

Observe the value drop

The graph above shows this correlation in the last week of March 2024, as an example. On Monday morning, the day-ahead price of electricity (green) rises because people wake up, factories start production, etc., thereby increasing demand (white). Then the sun rises higher, the PV systems feed electricity into the grid (yellow) and the price falls. In the afternoon, demand remains high, but PV production falls. To make matters worse, the already weak wind also decreases. In consequence, the price of electricity reaches a week high €175 per megawatt-hour (MWh). On Tuesday, however, the electricity price falls to €27/MWh despite higher consumption because high solar radiation coincides with stronger winds and so on.

The flip side of this development is shown in the chart below. It shows how the wholesale electricity price in one week of April 2022 developed almost in parallel with the residual load (the electricity production of all types of generation except wind and solar power). When a lot of electricity is produced from wind and solar power, the residual demand falls and so does the price. A residual load of zero means that the entire demand is covered by VRE plants. The price can then fall to or even below zero. This even happened at times during the recent energy crisis, which was otherwise characterised by very high elecriticity prices.

This value (close to zero) reflects the variable production costs of VRE electricity. The price of renewable energy itself (solar radiation and wind) is zero; the costs of wind turbines and solar panels are almost independent of the amount of electricity they produce. In contrast, in thermal power plants fuel costs are incurred for every megawatt hour of electricity. Therefore, as can be seen below, the price of electricity rises as soon as they have to be put into operation; or rather, the price of electricity has to rise for the operators to put them into operation.

To maximise production, VRE asset owners build their plants in locations with favourable weather conditions for the respective type of generation. This inevitably leads to an accumulation of the respective plants at such locations. Southern European countries therefore rely primarily on solar power, northern European countries on wind power. According to the German Wind Energy Association, more than 75 per cent of Germany's wind energy generation capacity in 2022 was installed in the largely flat and windy northern half of the country - not including offshore turbines. The geographical concentration further inflates the negative correlation between price and production volume, as this means that a larger proportion of the generation capacity is exposed to similar weather conditions.

What is the value factor, alias capture rate?

All of this means that the market value of VRE plants is generally considered lower than that of conventional power plants. By comparing the market value of wind and solar to the baseload market price (price at which a 24/7 baseload plant would get on average), we get the so-called value factor, also known as capture rate. It clearly shows why we talk about "cheap electricity" from renewable sources.

The figure below shows the capture rate (y-axis) of solar (orange) and wind (blue) power in different countries in relation to the source's shares of electricity production (x-axis). The 100% horizontal line marks the base load market price. It points out that the capture rates of both RVEs are below 1, i.e. below parity to the base price, in almost all listed countries at almost all times. Despite some variation among individual countries, the trend is clear; the higher the share of renewables in electricity generation, the cheaper the electricity and the less valuable the plant. Wind and solar energy plants therefore systematically receive lower payments on the free electricity market than conventional power plants.

Dealing with the value drop

The systematic disadvantage of VRE power plants is ultimately nothing else than a consequence of the usual market mechanisms between supply and demand. However, it has far-reaching effects on a wide range of areas related to electricity market design: negative prices, battery storage, load management, support programmes (subsidies), long-term contracts, and bidding zone splitting, to name but a few.

For the owners of renewable energy assets, this constant loss in value, which is further intensified by the ongoing expansion of variable renewable energies, harbours future price risks. Many renewable energy plants are currently shielded from price risks to a certain extent by subsidies. However, subsidies are not a long-term, let alone efficient, solution because they distort production behaviour (e.g. through negative prices) and can place an unnecessary burden on consumers.

At Flex Power, we believe that developers and operators of wind and solar energy plants must manage the price risks themselves, e.g. through long-term supply contracts, also known as PPAs (Power Purchase Agreements). To reflect the specific generation profiles of renewable energies in such contracts, it is crucial to understand the underlying value of the electricity and to accurately forecast longer-term developments.

What this can look like can be seen at enwex, where daily updates on various energy market indices are published, including the market values of wind and solar power. In addition, the German transmission system operators provide a monthly updated overview of the current market values of the various renewable energies in Germany.