WP 2011-01
January 2011
Working Paper
Charles H. Dyson School of Applied Economics and Management
Cornell University, Ithaca, New York 14853-7801 USA
THE HIDDEN SYSTEM COSTS OF WIND
GENERATION IN A DEREGULATED
ELECTRICITY MARKET
Tim Mount, Surin Maneevitjit, Alberto J.
Lamadrid, Ray D. Zimmerman and
Robert J. Thomas
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assure the continuation of such equality of opportunity.
The Hidden System Costs of Wind Generation in a
Deregulated Electricity Market
Tim Mount
∗
, Surin Maneevitjit, Alberto J. Lamadrid, Ray D. Zimmerman
and Robert J. Thomas
Abstract
Earlier research has shown that adding wind capacity to a network can lower the
total annual operating cost of meeting a given pattern of loads by displacing con-
ventional generation. At the same time, the variability of wind generation and the
need for higher levels of reserve generating capacity to maintain reliability standards
impose additional costs on the system that should not be ignored. The important im-
plication for regulators is that the capacity payments [“missing money”] for each MW
of peak system load is now much higher. Hence, the economic benefits to a network
of using storage, controllable load and other mechanisms to reduce the peak system
load will be higher with high penetrations of wind generation. These potential bene-
fits are illustrated in a case study using a test network and a security constrained OPF
with endogenous reserves (SuperOPF). The capabilities of the SuperOPF provide a
consistent economic framework for evaluating Operating Reliability in real-time mar-
kets and System Adequacy for planning purposes. The scenarios considered make it
possible to determine 1) the amount of conventional generating capacity needed to
meet the peak system load and maintain System Adequacy, and the amount of wind
dispatched, 2) total payments by customers in the Wholesale Market, and the amount
of missing money paid to generators to maintain their Financial Adequacy, 3) changes
in the congestion rents for transmission that are collected by the system operator, and
finally, 4) the total annual system costs paid by customers directly in the Wholesale
Market and, indirectly, as missing money. The results show that the benefits (i.e.
the reduction in the total annual system costs) from making an investment in wind
capacity and/of upgrading a tie line are very sensitive to 1) how much of the inher-
ent variability of wind generation is mitigated, and 2) how the missing money paid
to conventional generators is determined (e.g. comparing a regulated market with a
deregulated market).
∗
tdm2@cornell.edu, 215 Warren Hall, Cornell University, Ithaca, NY, 14853
1
In a recent study initiated by the US Department of Energy (DOE 2008), the effects
of increasing dependence on wind energy to 20% of the total generation of electricity by
2030 are evaluated. The study is relatively positive about this scenario and states:
Until recently, concerns had been prevalent in the electric utility sector about the dif-
ficulty and costs of dealing with the variability and uncertainty of energy production from
wind plants and other weather-driven renewable technologies. But utility engineers in
some parts of the United States now have extensive experience with wind plant impacts,
and their analyses of these impacts have helped to reduce these concerns [...] winds vari-
ability is being accommodated, and given optimistic assumptions, studies suggest the cost
impact could be as little as the current level - 10% or less of the value of the wind energy
generated.
The DOE study focuses on the initial capital cost of installing the wind capacity and
upgrading the transmission network and compares these costs to the lower operating costs
when wind energy displaces fossil fuels. The objective of this paper is to show that there
are other, hidden costs of wind power associated with the need to maintain the “Finan-
cial Adequacy” of conventional generating capacity. Since wind capacity is essentially a
non-dispatchable source of energy, it may contribute relatively little capacity for meeting
the reliability standard of Generation Adequacy. Nevertheless, wind generation, when it is
available, is essentially free and it displaces most conventional sources of generation. As
a result, the capacity factors of conventional generators are typically reduced when wind
capacity is added. This happens even though the total amount of conventional capacity
needed to maintain reliability may actually increase. Consequently, these conditions lead
to increasing amounts of “missing money” for generators that are generally paid through
some form of Capacity Market in most deregulated markets in the US.
1
For example, gen-
erating units in New York City have typically been paid over $100,000/MW/year.
2
This
paper argues that Financial Adequacy should be treated as an additional criterion for plan-
ning purposes that would complement the standard engineering criterion of maintaining
“System Adequacy”. The case study presented herein shows that the total system costs
charged to customers increase if a new wind farm replaces an existing coal unit on a
network. With the wind farm in place, the increase in missing money is larger than the
decrease in total operating costs in the Wholesale Market. For an investment to be econom-
ically viable from an economic planning perspective, the total annual cost of maintaining
the existing system must go down and this decrease in cost must be bigger than the annual-
ized cost of financing the investment. If some form of storage capability such as a battery
mitigates the variability of wind generation, the total annual cost of the existing system
1
Some energy only markets do not have a Capacity Market, and some other way of maintaining the
financial viability of conventional generators, such as tolerating high, scarcity prices, is used.
2
Figures 10 and 11 on p. 15 of (NYISO 2007).
2
does decrease. The battery charges when the wind speed is higher than the forecast and
discharges when it is lower than the forecast, and in this way, the net wind generation is
smoothed over time.
3
As a result, there is an effective floor on the amount of generation
from wind capacity when the indirect generation from discharging the battery is included.
The presence of this floor reduces the total amount of conventional generating capacity
that is needed to meet the peak system load and maintain System Adequacy, and as a re-
sult, the amount of missing money is also reduced. In addition, the total amount of wind
that is spilled (i.e. wasted) is reduced when batteries are coupled with the wind farm.
4
The
overall objectives of the paper are to demonstrate through a case study 1) why Financial
Adequacy is an important concept that should be considered by system planners, 2) why
the social value of storage and controllable load increases when intermittent sources of
generation are added to a network, and 3) how the cost of missing money to customers
differs between a regulated and a deregulated market. The structure of the paper includes
four additional sections. Section 2 describes the SuperOPF and shows how this analytical
framework relates to the NERC standards for Operating Reliability and System Adequacy.
Section 3 presents the specifications for a case study that considers the effects of replac-
ing a coal unit by a large wind farm with three times the installed capacity of the coal
unit. Since the wind farm causes more congestion on the network when the wind blows,
a series of additional scenarios show the effects of upgrading the capacity of a tie line to
reduce this congestion. Since congestion rents on the network are treated as one source
of income for transmission owners, reducing these rents implies that there will be more
missing money that must be paid by customers outside the Wholesale Market to ensure
that the transmission owners are financially viable. The missing money for both gener-
ators and transmission owners contributes to the total annual system cost of maintaining
System Adequacy and Financial Adequacy. The results for all of the scenarios are pre-
sented in Section 4 and the implications of these results for the cost of missing money in a
regulated and a deregulated market are discussed in Section 5. The overall conclusions of
the analysis and some suggestions for regulators are summarized in Section 6.
1. NERC Reliability Standards and the SuperOPF
Federal legislators have formally recognized the importance of maintaining Operating Re-
liability in the Energy Policy Act of 2005 (EPACT05), and the major effect of this legis-
3
This type of smoothing also occurs with spatial aggregation of the total generation from wind farms at
different locations. (Milligan, et al. 2009).
4
In one of the scenarios, must-take contracts for wind generation are evaluated by making the cost of not
using available wind generation expensive, and in this scenario, the total annual system cost of maintaining
System Adequacy is substantially higher than the corresponding cost without the wind farm.
3
