Variable Pricing and the Social Cost of Renewable Energy

Although technological progress has lowered the cost of solar and wind to make renewable energy competitive with fossil fuels on a levelized-cost basis, supply of these resources is highly variable and inelastic, which contrasts with elastic, stable and controllable supply from traditional power plants. As a result, the cost of flat retail pricing in comparison to dynamic, marginal-cost retail pricing – long advocated by economists – will grow. At the same time, computer technology opens up new opportunities for flexible demand and energy storage, opportunities that cannot be fully exploited without dynamic retail pricing and open access to the grid. Implementing efficient dynamic-pricing systems could be institutionally costly, so it is important to evaluate the potential gains. Here we develop a novel model of power supply and demand to examine how much variable pricing can reduce the cost of a 100% renewable power system in Hawai‘i. The model is novel in the way it integrates investment in generation and storage capacity with real-time operation of the system, including an account of reserves, a demand system with different inter-hour elasticities for different uses, and substitution between power and other goods and services. The model, an extension of Switch (Fripp 2012), is open source and fully adaptable to other settings. Earlier versions of the model (lacking demandside integration) have been implemented for California, the Western United States, and other areas. Consistent with earlier studies, we find that dynamic pricing of power provides little social benefit in fossil-fuel systems, only 2.6 to 4.6 % of baseline annual expenditure depending on cost and inter-hour substitutability. But dynamic pricing leads to a much greater social benefit of 8.5 to 23.4% in 100% renewable system with otherwise similar assumptions. The other key finding is that high penetration renewable systems, including 100% renewable, are remarkably affordable. Indeed, the welfare maximizing (unconstrained) generation portfolio under the utility’s projected 2045 costs and pessimistic inter-hour demand flexibility uses 79% renewable energy and improves welfare by 34.6% of baseline expenditure. With dynamic pricing, even a 100% renewable system is welfare improving over a fossil system, excluding gains from reduced pollution externalities. ∗PhD Student in Economics at University of Hawai’i at Mānoa and East-West Center Student Affiliate. Email: [email protected] †Assistant Professor of Electrical Engineering, University of Hawai‘i at Mānoa and University of Hawai‘i Economic Research Organization ‡Professor in the Department of Economics, University of Hawai‘i Economic Research Organization, and Sea Grant at University of Hawaii at Mānoa