Dynamic Costs and Market Power: Rooftop Solar Penetration in Western Australia

Abstract

Production from zero marginal cost solar panels reduces the amount of energy produced by fossil-fuel-fired power plants during the day. Yet, we find that the operating profits earned by fossil-fuel plants in Western Australia increased by 15% coincident with the doubling of rooftop solar capacity from 2015-2018 to world-leading solar penetration levels. We estimate that the fossil-fuel plants displaced by solar production during the day must incur substantial start-up and ramping costs to effectively compete at sunset. Results from both a regression framework and least-cost simulations indicate that, due to this reduction in effective competition, increases in solar capacity result in increases in the exercise of market power, operating profits and wholesale prices in the evening. Our findings highlight the importance of designing electricity markets that properly compensate flexibility in production and consumption.

Keywords: Wholesale Electricity Markets, Dynamic Production Function, Adjustment Costs, Start-up and Ramping Costs, Market Power, Rooftop Solar, Intermittency

JEL Classification: L5, L94, Q41, Q42