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Energy Systems and Infrastructure Analysis

Price Formation in Zero-Carbon Electricity Markets: The Role of Hydropower


With the decreasing costs of clean energy generation technologies and increasing concerns about greenhouse gas emissions, the United States is likely to see a rapid expansion of zero-carbon electricity generation over the next few decades. One important characteristic of many zero-carbon generation resources is that they do not have a direct fuel cost, and in some cases, they have essentially zero marginal costs of generation. As a result, a power system dominated by zero-fuel-cost generation resources— such as hydropower, wind, and solar—may be characterized by frequent and extended periods of low or zero electricity prices. Lower and less predictable energy prices could make the risk of developing new generation sources prohibitive. Therefore, the changing resource mix creates a need to re-think how electricity markets operate and how prices in these markets provide incentives for operations and investment. Challenges around revenue insufficiency and price uncertainty are partly due to the consequences of electricity markets that were not designed for systems dominated by zero-marginal-cost generation resources. There is a need to revisit dispatch logic, price formation, and corresponding incentives for electricity market participants in zero-carbon systems. To better understand and mitigate revenue insufficiencies and price uncertainties associated with zero marginal cost resources, we need to identify the vulnerabilities in current electricity market structures. At the same time, regulators and policy makers need to consider the pros and cons of alternative market mechanisms. The goal of this paper is to set the stage for such a discussion by providing background information about relevant energy trends, current market paradigms, and possible design changes for future markets. In particular, the paper focuses on the evolving role of hydropower resources, as a large-scale, flexible, renewable resource, in future zero-carbon systems.

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July 2022