Jerome a Paris has a great article in the European Tribune about the economics of wind.
The most important piece of information that was new to me was a paradox in an unregulated free electricity market that makes wind uneconomic – even though wind is by far a better deal than coal, nuclear, or other options.
His explanation follows below. The logic would be similar for other capital-intensive generation such as solar thermal.
In market environments, marginal cost rules, i.e. the price for electricity is determined, most of the time, by the most expensive producers needed at that time to fulfill demand. Demand is, apart from some industrial use, not price sensitive in the very short term, and is almost fixed (people switching lights and A/C on, etc…), so supply has to adapt, and the price of the last producers that needs to be switched on will determine the price for everybody else.

Source: Economics of wind (pdf) by the European Wind Energy Association
If you look at the above graph, you see a typical ‘dispatch curve’, i.e. the line representing generation capacity, ranked by price. Hydro is usually the cheapest (on the left), followed by nuclear and/or coal, and then you have gas-fired plants and CHP (combined heat and power) plants, followed to the far right by peaker plants, usually gas- or oil-fired.
You take you demand curve (the quasi vertical lines you can see on the right graph), and the intersection of the two gives you the price. As is logical, night time demand is lower and requires a lower price than normal daytime prices, and even less than peak demand which requires expensive power generators to be switched on.
The righthand graph shows what happens when wind comes into the picture: as a very low marginal price generator, it is added to the dispatch curve on the left, and pushes out all other generators, to the extent is available at that time. By injecting “cheap” power into the system, it lowers prices. The impact on prices is pretty low at night, but can become significant during the day, and very high at peak times (subject, once again, to actual availability of wind at that time).

As the graph above suggests, the impact on price of significant wind injections is high throughout the day, and highest at times of high demand. When there’s a lot of wind, you end up with prices that get flattened at the price of base load, i.e. the marginal cost of nukes or coal, and wind no longer has any influence on price.
But the consequence of this is that the more wind you have into the system, the lower the price for electricity. With gas, it’s the opposite: the more gas you need, the higher the price will be (in the short term, because you need more expensive plants to be turned on; in the long run because you push the demand for gas up, and thus the price of gas, and thus of gas-burning plants, up).
In fact, if you get to a significant share of wind in a system that uses market prices, you get to a point where wind drives prices down to levels where wind power loses money all the time! (That may sound impossible, but it does happen because the difference between the low marginal cost and the higher long term cost is so big).
There are two lessons here:
- wind power has a strongly positive effect for consumers, by driving prices down for them during the day.
- it is difficult for wind power generators to make money under market mechanisms unless wind penetration remains very low; this means that if wind is seen as a desirable, ways need to be found to ensure that the revenues that wind generators actually get for electricity are not driven by the market prices that they make possible.
That’s actually the point of feed-in tariffs, which provide stable, predictable revenue to wind producers, and ensure that their maximum production is injected into the system at all times, which influences market prices by making supply of more expensive producers unnecessary. And these tariffs make sense for consumers. The higher fixed price is added to the bill for the buyers of electricity, but as that bill is lower than it would have otherwise been, the actual cost is much lower than it appears. As I’ve noted in earlier diaries, studies in Germany, Denmark and Spain prove that the net cost of feed-in tariffs in these countries is actually negative, i.e. a apparent fixed cost imposed on consumers ends up reducing their bills!
The analysis above doesn’t include externalities – the impact of economic behavior or decisions which are not reflected in the costs or prices of the economic entity taking the decision – including the most important externality of all, greenhouse gas emissions.