A fundamental problem facing subsidy-free solar and wind in renewables-heavy grids is emerging as coronavirus cuts energy demand in Europe.

The decline in demand is driving up the proportion of clean energy on many grids and highlighting an issue flagged by researchers in February: that merchant plants may be more expensive to run than subsidized projects once non-renewable generation drops out of the picture.  

The research, conducted by Imperial College in London, indicates that removing support for renewables in Europe could increase the cost of capital for new projects by between 2 and 3 percent.

This would force asset owners to require a higher internal rate of return for projects and “could result in fewer developers undertaking new renewable energy projects,” researchers said.

The increase in cost is due to developers having to assume low power-price risks that are not present under fixed-price contracts such as feed-in tariffs or corporate power-purchase agreements.

Coronavirus brings forward cannibalization challenge

Based on an analysis of day-ahead prices across Western Europe, the researchers found that to cover the risk, a prototypical wind investor would need to get a return of 2.84 percent more from a merchant plant than from a 30-year fixed contract.

A solar investor, meanwhile, would need at least 2.53 percent more.

“Without fossil fuels and without subsidies, we’ll have a lot of volatility based on the cannibalization effect from renewables themselves,” explained Anastasiya Ostrovnaya, a research scientist at Imperial College Business School’s Centre for Climate Finance and Investment.

“When the sun shines, it shines everywhere,” she said. “We have a lot of production; we have very low prices. Same with wind. And without effective storage, which we don’t have at industrial scale yet, that will really be a huge danger to renewables.”

Cannibalization and its attendant price volatility were not expected to become a problem in European renewable markets until early subsidy schemes ran out, around 10 years from now.

This would, in theory, have given policymakers some margin to come up with instruments that could help renewable asset owners hedge against price uncertainty.

"Baseload is dead"

Nobody imagined a global pandemic would kill demand to a point where legacy generation might be driven out of the system in 2020. But that’s what’s happened with COVID-19.

On the weekend of April 11 and 12, for example, a combination of sunny weather, high winds and lockdown-induced demand curtailment pushed coal off the U.K. grid for a record 90 hours. The country’s half-hourly market index price fell to just £25.60 ($31.16) per megawatt-hour.

“Over the weekend, we saw price cannibalization in action, particularly on Easter Sunday,” said Tom Dixon, wholesale team leader at Cornwall Insight, in a research note.

“The trends observed over the weekend are perhaps a sign of things to come as we move into a world with greater levels of embedded and intermittent sources of generation,” he said. “It is likely that many of these trends will be exacerbated.”

Charles Donovan, director of the Centre for Climate Finance and Investment, said the low costs of solar and wind are going to necessitate a change in the way electricity markets work.

“This whole coronavirus crisis is an interesting window into what we thought would be 10 years from now,” he said. “You’ve got way too much power on the system at a given time.”

The solution, he said, is to design markets in which renewable power “is not an add-on to a marginal-cost pricing set by fossil fuels. You have to build a system that rewards intermittency to a degree that is not rewarded now in order for people to bring forward more storage.”

Alongside energy storage, the current state of grids is also highlighting a need for synthetic fuels, greater interconnection capacity and demand-side flexibility. However, “you don’t need more baseload power,” Donovan said. “Baseload is dead. That’s why coal is not running.”

Gerard Reid, co-founder and partner at corporate finance advisory firm Alexa Capital, said the structure of European power markets remained a challenge for renewables.

The markets are engineered to make sure supply and demand are always balanced, maintaining grid stability, rather than optimizing the allocation of resources, he said. “What you’ve actually got is a broken power market situation,” he commented.

“You need to have much more flexibility, in particular on the demand side. When you’ve got power prices constantly in minus, that’s showing you the demand side is not flexible enough.”