CERE’s Andrius Kazukauskas provides us with an article of Christmas past from a Swedish electricity point of view. Who does pay for our colorful Christmas lighting? Happy Holiday’s!
I have the brightest memories about Christmas time from my childhood. For me Christmas Eve was a very special day. At that time Christmas was associated with miracles and things for free, such as Christmas presents delivered by a mystical Santa Claus. This was a time for candies, oranges, nuts and other things. Luckily for me, Santa Claus was not associated with any budget constraints.
On one such night, the midnight of 25th of December 2015 to be precise, a miraculous gift was given to all of us living in Sweden. In one hour that night, electricity was sold for almost 0 €/MWh on the Nordpool day-ahead market (electricity wholesale market). Electricity for free! This is the lowest price on record during the last five years (maybe ever, I did not check the older data). As I am not a naïve child anymore, I wonder where this “present” came from. And a very low price of electricity around Christmas time is not a random coincidence since the electricity price tend to be low the last week of the year. Figure 1 depicts the average wholesale prices of electricity from week 48 till week 9 (winter season). Thus, a relevant question arises: who pays for our colorful Christmas lighting decorations? (click on headline to read more)
Figure 1. Average electricity prices in EUR/MWh from week 48 till week 9 (winter season) on the day-ahead market at Nordpool for each price zone in Sweden (Umeå is in zone SE2 and Stockholm is in zone SE3)
Data sources: Nordpool and own calculations.
Sweden as well as the other Nordic and European countries have recently experienced a decade of lower electricity prices. In Sweden, the day-ahead price of electricity has decreased by about 40 percent during the period 2006-2017 (see a trend line in Figure 2). It has been argued that this development of the day-ahead prices of electricity is mainly explained by a combination of increased generation of electricity from wind turbines and a lower demand (Hirth 2018).
Figure 2. Average annual day-ahead prices of electricity in Nordpool 2006-2017
Data sources: Nordpool and own calculations.
The large investments in wind power capacity – thanks to the introduction of the Act on Electricity Certificates in May 2003 – could be one of the factors which may explain the low prices of electricity around Christmas. On some days, Sweden produces more than 40 percent of its electricity from wind. And this is what actually happened on the above mentioned midnight of the 25th of December 2015. During that night, wind share in total electricity consumption reached the record-breaking figure (at the time) of 40 percent.
Of course, renewable electricity is not free. In Sweden, electricity retailers are obliged by law to buy renewable electricity as part of their overall electricity portfolio in the form of green electricity certificates. The price of green electricity certificates varies over time depending on supply and demand conditions. Electricity suppliers’ cost of buying these green electricity certificates are included in electricity bills of final electricity users. According to the Swedish Energy Agency, a volume-weighted annual average price of green electricity certificate in 2017 was 12 EUR (1 certificate is given for 1 MWh of green electricity produced). This corresponds to an estimated average cost of 3 EUR/MWh for all electricity consumers in Sweden. So, renewable electricity is not for free, but obviously the cost increase due to the subsidy is partly or fully offset by the negative effect that more generating capacity has on the electricity price. So, are the households’ cost for subsidizing wind power bigger or smaller than the benefits of lower wholesale electricity prices?
Electricity prices in the Nord Pool day-ahead market are determined by the so-called “merit order” – the sequence in which power stations contribute power to the market, with the cheapest offer made by the power station with the lowest operating cost sets the starting point. Power from renewable power installations such as wind turbines and photovoltaic installations have to be sold on the day-ahead market too, but these suppliers have almost no operating costs (since they do not need fuel or much labor). When the generated amount of electricity from renewable resources increases, it will lead to less production from thermal heat driven production technologies due to their higher operating cost. Figure 3 below illustrates an increase in wind power generation and its effect on the price, i.e. the so-called “merit order effect”.
My quick econometric estimations show that an increase in wind power of 1 MWh in 2017 can be associated with a decrease in wholesale electricity prices of 0.002 EUR. In 2017, wind turbines produced, on average, almost 2000 MW in one hour. This means that electricity supplied by wind power plants decreased electricity prices by about 4 EUR/MWh in 2017. Thus, while final electricity users paid for wind capacity expansion via Tradable Green Electricity Certificate scheme (about 3 EUR/MWh more in 2017) they benefited from paying less for electricity because of the above explained merit order effect. Thus, the net effect for the final consumer in 2017 is positive, i.e. on average consumers did not pay more to have more wind power in Sweden. This is great news for wind power electricity providers who can argue that subsidized wind power does not cost much for final consumers.
Figure 3. How wind power influences the power electricity price at different times of day.
Source: EWEA (2009).
But is this really good news as it sounds? To rephrase Dire Straits lyrics of one of their popular songs: wind for nothing and green electricity for free? I am afraid that it is not Santa Claus who provides us with such “gifts.” The costs of such “gift” are mainly borne by conventional profit maximizing electricity generating companies with binding budget constraints (e.g., nuclear power producers).
According to Mount et al. (2012), even modest price drops can cause “hidden system cost” by endangering the profitability of conventional power plants that are needed to maintain reliability of electricity supply when intermittent renewable energy sources are absent. The financial burden of price drops is particularly large for companies owning inflexible baseload power plants. In Figure 4 I present how profitability has changed for the largest Swedish energy firms with assets which are dominated by baseload power plants over the last decade. It is evident that electricity price fluctuations have a large effect on the profitability of these firms. The average profitability of the 24 firms represented in Figure 4 has declined for years until 2015. In the last two years, the electricity prices and therefore the profitability have somewhat recovered.
Figure 4. Weighted average (by turnover) profitability (ROCE1) of largest 24 electricity producers in Sweden vs. Nordpool system spot electricity prices.
Source: Amadeus database and own calculations.
As the midnight approached, my family traditionally used to leave clean plates and food on Christmas Eve dinner table overnight. It is a pagan tradition to remember and honor departed family members, relatives and ancestors. I believe that on the night of Christmas in 2040, as Sweden assumingly reach its 100 percent renewable electricity target, we will remember and honor the services of past inflexible baseload power plants as nuclear power, and we will thank them for all that cheap (and sometimes free) electricity they will still provide for us over the years to come.
1Return on capital employed (ROCE) is a profitability ratio which tells how a company is using its capital. Return on capital employed is useful for investors to decide whether this capital-intensive energy company would be good enough to invest into.