Market power and grid parity in renewable energy markets

Recent research has demonstrated the existence of perverse cost reduction incentives facing renewable energy (RE) producers in an electricity market operated under a “renewables quotas” (e.g., Currier and Rassouli-Currier 2018). Specifically, it has been shown that competitive RE producers may not have incentives to fully exploit the learning induced technological advances necessary to achieve “grid parity”… a situation where learning induced technological advancements allow RE producers to compete with conventional (i.e., fossil-fuel based) electricity generators on an equal footing without subsidization via a “feed-in tariff” or a “green certificate” system. While competitive electricity markets remain the goal of competition policy in many electricity markets around the world, electricity markets are often served by a dominant conventional electricity producer and a “competitive fringe” of RE producers. In this paper, we study incentives for the attainment of grid parity in an electricity market served by a dominant conventional producer and a competitive fringe of RE producers under a RE quota. We first demonstrate analytically that in this scenario (consistent with previous research), RE producers lack the long-run incentive to adopt learning induced cost efficiencies. However, the dominant conventional producer may have an incentive to enter the RE market. We demonstrate that, when this is the case, adoption of the most cost efficient technology is a Nash Equilibrium in cost padding/reduction strategies. Thus, while competitive electricity markets are typically regarded as a policy objective, our results demonstrate that the presence of market power in RE markets may be necessary to incentivize the cost reductions necessary to achieve grid parity. Competition policy in electricity markets must therefore evaluate the tradeoffs between the benefits of competition on the one hand and the benefits of the attainment of grid parity in the RE sector on the other.

Key Words: Cost Efficiency; Feed-in Tariff; Green Quota; Grid Parity; Dominant Firm