Solving the intermittency of renewables

by Akshay Jaitly and Ajay Shah, Business Standard, 29 October 2023

In every business, there is a chain of production, transportation, storage, and retailing. There are people who grow tomatoes. There are people who run trucks (ideally refrigerated) to transport tomatoes. There are people who store (ideally cold) tomatoes, or convert them into puree or paste. And, there are people who sell tomatoes, puree, and paste to the end consumer.

There are the businesses of growing tomatoes, of refrigerated trucks, of non-refrigerated trucks, of refrigerated storage, of non-refrigerated storage, of making tomato puree, of making tomato paste, and of retailing. While there are adjacencies within (maybe a person who makes tomato puree can readily buy additional machines and expand into making tomato paste), each of the eight industries involves different capabilities. There are eight distinct operating-profit margins in the eight industries.

If a government tried to push one firm or one facility to perform multiple elements of this business, it would make little sense. Each of the eight industries is dancing to the rhythm of a different price, of a different source of profit. If a central planner forced or even incentivised unifying some subset of these industries, in general this reduces the efficiency of the economic system.

This intuition helps in the field of electricity. Traditionally, we have thought that there are three distinct businesses, generation -> transmission -> retailing (distribution). There are three prices: The wholesale price obtained by the generator, the price of transmission, and the retail price. There is now a new fourth industry: The business of energy storage.

Fossil fuel-based electricity production in India is waning. The financial system will generally no longer fund fossil-fuel plants. The mix of generation capacity is gradually moving in favour of renewables. This causes a problem because renewables production is intermittent. The sun does not shine in the evening peak, and the wind can be fickle. It is increasingly hard to make the reality of generation (that is intermittent) square with demand (which is relatively steady and peaks at an inconvenient time).

The standard solution of many traditional thinkers to this problem is a production unit which bundles storage and generation. This unit would look more like a traditional non-intermittent electricity generator. It would then fit better into the current system.

This can be done, but it is expensive. It is better to instead free our minds from the conventional wisdom, the world of tidy and stable long-term power-purchase agreements that enable the generation company to switch off their business instincts and reap a locked-in regulated return.

At heart is the role of prices. The insight that India needs to deploy in the area of electricity is the idea that prices fluctuate to clear the gap between supply and demand.

In the evening peak demand, when the sun is going down, high demand would drive up the price. This would create incentives for users of electricity to buy less. It is easy to have mobile apps that show the current price of electricity for each buyer. This will encourage buyers to switch off air conditioners when prices are high. In smart homes, ACs will switch off automatically when the price goes above a user-set level, or there will be a rule based on temperature and price that is chosen by each user. High evening prices will encourage firms to reorganise their shifts to align with the sun and have automated systems where production takes place when electricity is cheap.

On the production side, the prospect of making good profits for an hour or two a day will motivate investment in storage and in wind. It is the fluctuations of tomato prices that motivate the profit-seeking behaviour of building cold storages for tomatoes. In similar fashion, it is the fluctuations of electricity prices that will motivate the profit-seeking behaviour of private persons who will build energy-storage companies.

Energy technology is in a state of flux, with new ideas on generation and storage coming up every day. Nobody knows how the future will play out. It is a time for private persons to peer into the future, weigh the uncertainty, form a judgement, and engage in speculative bets. Such decision making is entirely infeasible in a heavily regulated, planned system, where officials will not take a risk and will prevent others from doing so.

Private persons, in contrast, know how to take risks. They live and die by the fluctuations of consumer preferences and technological advances. Every private firm knows that every investment is a risky prospect, and it is normal to recognise failure and shut down a factory or a company. The flip side of this, of course, is that the projects that succeed must make good profits in order to pay for the failed attempts.

Given the modest pace of renewables investment, and the low pace of fossil-fuel investment, there will be major problems in the Indian electricity system under conditions of strong economic growth. Electricity policymakers need to move now to ward off bad scenarios in coming years. First, we need to make the price system work -- as opposed to the tidy bureaucracies of the traditional electricity system -- as a way to unleash private energy, innovation, and risk taking. Nobody knows the precise configuration of demand-side initiatives, storage, and renewables that will be the Indian energy system of the future. The price system knows how to discover the efficient answer.

To allow for risk taking and account for uncertainty, the paradigm of regulated rates of return needs to be thought afresh. In the 20th century, the electricity system of many countries purred along with low risk, and firms in the sector were `utilities' with regulated rates of return. The work was sleepy, so were the rates of return. The 21st century is a different place. This is a world of high risk, where many projects will fail, and imposing traditional low regulated rates of return will be unfair.

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