Renewable energy and electricity prices: indirect empirical evidence from hydro power

Many countries have introduced policies to stimulate the production of electricity in a sustainable or renewable way. Theoretical and simulation studies provide evidence that the introduction of renewable energy promotion policies lead to lower electricity prices as sustainable energy supply as wind and solar have very low or even zero marginal costs. Empirical support for this result is relatively scarce. The motivation for this study is to provide additional empirical evidence on how the growth of low marginal costs renewable energy supply such as wind and solar influences power prices. We do so indirectly studying Nord Pool market prices where hydro power is the dominant supply source. We argue that the marginal costs of hydro production varies depending on reservoir levels that determine hydro production capacity. Hydro power producers have an option to produce or to delay production and the value of the option to delay increases when the reservoir levels decrease and the option to delay decreases in value when reservoir levels increase and producers face the risk of spillovers. Hence, an increase in reservoir levels mimics the situation of an increase of low marginal costs renewable energy in a market. Our results show that higher reservoir levels, more hydro capacity, lead to significant lower power prices. From this we conclude that an increase in low marginal costs renewable power supply reduces the power prices. The second contribution of this paper is that we develop a market clearing price model by modelling the supply curve of power that varies over time depending on fundamentals such as hydro capacity and the prices of alternative power sources and that deals with maximum prices which apply to all power markets that we know. With our result, we strengthen support for the view that an increase in wind and solar supply lowers the power price. This is good news for consumers, but it increases the costs of sustainable energy policies such as feed-in tariffs and at the same time lowers revenues and profits for power producers in case governments would abandon such policies. This effect makes the economic and policy support for renewable energy less sustainable. Policy makers have to account for this if they want to stimulate a sustainable growth of sustainable energy supply.