The Impact of Expansion of Wind Power Capacity and Pricing Methods on the Efficiency of Deregulated Electricity Markets

The remarkable expansion of global wind power capacity in many countries brings forward several key economic questions regarding the performance of impacted electricity markets. Wind forecast uncertainties and rules that penalize scheduling deviations often discourage wind energy producers from participating in day-ahead electricity markets. Instead, wind energy commonly is priced either in the real-time balancing market or via a Feed-in-tariff (FIT) arrangement. In this paper we extend a recently developed equilibrium modeling approach to examine how the integration of wind energy impacts premiums in day-ahead electricity markets. In particular, we compare premiums as wind power capacity expands for different pricing mechanisms. By considering operational costs related to ramping conventional generators we are able to characterize the efficient level of premium needed to cope with the intermittent nature of wind. We find that the way that wind energy is priced is critical. We show that in the presence of imperfect competition pricing wind energy in the market increases firms' ability to extract oversized day-ahead premiums while in the case of market-independent FIT, market power is reduced as wind power capacity expands.