A couple of years ago, a visitor to our department here at Canterbury told me how sometimes in Texas, windfarms are able to generate so much electricity that the price of electricity goes negative. This recent article in the Economist (HT: Tyler at Marginal Revolution), gives a similar example from Europe. In both cases, I find this puzzling, and so I am seeking enlightenment from those who know the physics of electricity generation better than I do. To explain why it is a puzzle, let’s consider some examples of the economics of negative prices.
First imagine a pure-exchange world (i.e. one where commodities just exist rather than being created, so that economic activity consists of trade and consumption, not production). If all commodities are desired by all consumers, then competitive markets will result in all prices being positive, with prices reflecting the relative desirability and abundance of each good. If, in contrast, one of the commodities is not only not enjoyed but would be positively disliked by all consumers, the extent that its price would reflect that dislike would depend on whether there was “free disposal”, meaning whether the owner of the commodity could costlessly avoid consuming it. If there is free disposal, the price of the commodity would be zero. Without free disposal, the competitive price would be negative, again reflecting the relative (lack of) desirability.
A related situation arises when a firm produces a main product and an associated by-product. For instance, consider a motel that produces accommodation services during the peak holiday season. To provide this service, it has to incur the capital cost of building motel units that exist during the peak period, and then, as a by-product, these units exist during the off-peak times. If off-peak demand is low, some of these units might well be consistently vacant during the off-peak times, even if the price fell to zero. There again is an implicit assumption of free disposal here. If, for some strange reason, there was a requirement that motel units be occupied at all times to prevent depreciation of the capital stock, one could easily imagine the off-peak price going negative; that is, it could be worthwhile to motel owners to pay people to stay in their units during the off-peak times in order to ensure they were available for renting out at positive prices during the peak period. In effect, the opportunity cost of maintaining the units during the off-peak time would be negative, which could be reflected in the price. Again, the key assumption allowing negative prices is no-free-disposal. It does not make sense to see sellers choosing to sell something at a negative price if they could simply dispose of the good or service for free.
So now consider electricity. It is a key attribute of thermal power plants (particularly those using coal as the fuel source), that it is cheaper to keep the plant running 24/7 then to shut it down and heat it back up every day. This is just an on-peak/off-peak problem. Even if one only wanted to generate power during the peak periods each day, it would be cheaper to keep the plant running than to shut it down at off-peak times, giving a negative opportunity cost of generating power during those times. In the examples given above from Texas and Europe, wind or solar generation was able to meet regular demand at off-peak times, but shutdown costs made it economic for thermal stations to keep producing, sending prices negative. But, as we have seen, negative prices require an assumption of no-free-disposal.
My question then is: What is the physical or political constraint that implies an absence of free disposal in the electricity market? Why is it not possible to run a plant spinning the turbines, but simply not connect the station to the grid? In the case of Texas, I have heard that it is a purely political constraint: in a heavily regulated market, it is not palatable to have stations burning coal and not then produce any electricity. Is that all there is, or is there something about the physics of electricity generation that makes it imperative to force power onto the grid when a station is up and running?