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Abstract
European power markets are in the midst of unprecedented changes, with a record-breaking surge in energy prices.This paper investigates the impact of green power resources on the level and volatility of wholesale electricity prices at a granular level, using monthly observations for a panel of 24 European countries over the period 2014–2021 and alternative estimation methods including a panel quantile regression approach. We find that renewable energy is associated with a significant reduction in wholesale electricity prices in Europe, with an average impact of 0.6 percent for each 1 percentage points increase in renewable share. We also find evidence for a nonlinear effect—that is, higher the share of renewables, the greater its effect on electricity prices. On the other hand, while quantile estimation results are mixed with regards to the impact of renewables on the volatility of electricity prices, we obtain evidence that renewable energy has a negative effect on volatility at the highest quantiles. Overall, our analysis indicates that policy reforms can help accelerate the green transition while minimizing the volatility in electricity prices.
I. Introduction
A plethora of cyclical, structural and geopolitical developments has coalesced into a perfect storm in Europe with a record-breaking surge in energy prices. Russia’s invasion of Ukraine has triggered the worst global energy crisis since the oil embargo of the 1970s, during a period of structural changes in the energy matrix as countries have been diversifying away from fossil fuels by increasing the share of renewable electricity generation in an effort to mitigate climate change.2 Although the majority of electricity in Europe still comes from fossil fuels— accounting for about 42 percent as of 2021, the share of solar and wind has already reached 16.4 percent of total electricity generation. Higher penetration of renewables has significant benefits for decarbonization, but it is also a source of uncertainty on the intermittent and volatile production of renewable assets that could cause supply-demand imbalances, instability in the electricity grid, and more volatile pricing behavior (Figure 1). Therefore, as policymakers in Europe scramble to respond the energy crisis and shield consumers against higher energy prices, it is critical to better understand how renewable energy affects electricity prices.
European power markets are in the midst of unprecedented changes, with a tightening supply-and-demand balance. Wholesale electricity prices in Europe increased by more than 400 percent from an average of €35 per megawatt-hour (MWh) in 2020 to almost €250 per MWh in December 2021 even before the war in Ukraine, which pushed the average wholesale price of electricity above €500 per MWh in March 2022. Under the marginal pricing method underlying wholesale electricity prices in Europe, the most expensive technology needed to meet demand within a given period sets the final price of electricity according to the cost of production, which in turn depends on energy sources used in electricity generation. Therefore, in recent years, even as the levelized cost per unit of electricity from new utility-scale renewable power plants has dropped precipitously, the recent spike in wholesale electricity prices in Europe has broadly been driven by the cost of production at natural-gas power plants.
This study contributes to the debate by providing a panel data analysis how the green transition affects wholesale electricity prices in Europe. While the recent surge in oil and natural gas prices has certainly contributed to higher cost of electricity generation, the volatility of wholesale electricity prices depends on a broader set of factors including availability in generating units and intermittent output of renewables. The objective of this research is therefore twofold: (i) present stylized facts on the energy matrix and electricity markets across Europe; and (ii) explore the impact of solar and wind assets on the level and volatility of wholesale electricity prices. There is extensive literature on energy markets, but evidence on the role of renewables remains inconclusive. Some find a price-dampening impact of renewables (Sensfuß, Ragwitz, and Genoese, 2008; Würzburg, Labandeira, and Linares, 2013; Cludius and others, 2014; Ketterer, 2014; Clò, Cataldi, and Zoppoli, 2015; de Lagarde and Lantz, 2019; Maciejowska, 2020), but these studies focus on a single country using time-series data to analyze the merit-order effect that describes the decline in wholesale electricity prices due to an increase in the supply of renewable energy. In this context, a panel data approach can provide more accurate inference by accounting for both the time and cross-sectional dimensions of electricity prices in a large group of countries. To this end, we utilize monthly data on 24 European power markets during the period 2014–2021 and use alternative econometric methods including a panel quantile regression with fixed effects, which allow us to provide a granular analysis of the level and volatility of wholesale electricity prices and better capture nonlinearity effects of the green transition on various price quantiles in Europe.
The empirical analysis shows that renewable-based energy lowers the average level of wholesale electricity prices. As expected, renewable energy technologies with zero marginal costs have a statistically significant dampening effect on wholesale electricity prices in Europe during the period 2014–2021. The estimated coefficients on the share of solar and wind in total electricity generation imply that an increase of 1 percentage points in electricity produced by renewables lowers wholesale electricity prices by 0.6 percent on average. We also find evidence for a nonlinear effect—that is, higher the share of renewables, the greater its effect on wholesale electricity prices. Furthermore, the quantile regression approach—estimating the impact of solar and wind-based electricity generation on different quantiles of wholesale electricity prices— indicate that the share of renewables has a negative effect on the price level but at different magnitudes across the quantiles, especially when we conduct a more granular analysis by splitting the renewables into solar and wind. All in all, the price-dampening effect of renewables is economically significant and highly likely to be underestimated because of the relatively low share of renewables in the energy matrix—an average of 14 percent during the sample period.
We obtain mixed results with regards to the impact of intermittent renewable generation on the volatility of wholesale electricity prices. The standard analysis using the ordinary least squares (OLS) method shows that there is no statistically significant relationship between renewable electricity generation and the volatility of wholesale electricity prices, after controlling for total electricity load, crude oil import prices and average temperature. While the coefficient on the share of renewables is negative, the coefficient on its quadratic term is estimated to have a positive sign—an indication that higher the share of renewables, the greater its effect on the volatility of wholesale electricity prices. Furthermore, the quantile regression approach yields mixed results with regards to the impact of renewables on the volatility of electricity prices, but there is still some evidence that renewable energy has a dampening effect on price volatility at the highest quantiles. Nevertheless, the intermittent and volatile nature of electricity generation using renewable resources remains a concern as it may contribute to higher prices because of greater instability in electricity provision. Such uncertainty of electricity production could lead to higher electricity prices to compensate the risk premium incurred by the distribution companies.
Policy reforms can help accelerate the green transition in the energy matrix while minimizing the volatility in electricity prices. The transition to low-carbon sources of power generation is necessary for mitigating the socioeconomic consequences of climate change and strengthening energy security in Europe (Cevik, 2022). Based on our empirical findings, the green transition in the power sector could also help bring a significant reduction in electricity prices. For example, increasing the share of renewables in electricity production in Europe from an average level of 14 percent during the period 2014–2021 to 30 percent would lower wholesale electricity prices by 8.8 percent—and by almost 20 percent if the share of solar and wind reaches 50 percent. However, higher penetrations of renewable energy could also lead greater volatility in electricity production and thus higher wholesale prices. Therefore, to maximize the price dampening effect of green power resources, policymakers need to pursue reforms for modernization and closer integration of electricity grids throughout Europe and increase investment to reduce congestion on transmission lines and introduce volatility-dampening technology solutions like storage.
Building better electricity interconnections is necessary to increase cross-country electricity trade within Europe. This would improve the efficient allocation of electricity, especially considering the intermittent production of renewable sources. Especially in view of geostrategic challenges, Europe can benefit from a comprehensive continental electricity market established under the supervision of a multilateral mechanism for cross-country coordination with a mandate to harmonize energy policies and legal regulatory frameworks, identify strategic projects and secure necessary investments. In the current environment, to mitigate the direct impact of high energy prices caused by reduced crude oil and natural gas flows from Russia, targeted measures such as income support are better policies than an intervention in the wholesale market.3 Last but not the least, our analysis strongly suggests that the intermittent and volatile production of renewable electricity requires countries to achieve a better balance between solar and wind and diversify the energy matrix with nonhydrocarbon and non-weather sensitive technologies like a new generation of geothermal and nuclear power plants taking a more prominent role in providing a stable and consistent stream of electricity across Europe.
The remainder of this paper is structured as follows. Section II provides an overview of the relevant literature. Section III presents the data used in the analysis and stylized facts on the energy matrix and electricity markets in Europe. Section IV presents the empirical methodology and results including a battery of robustness checks. Finally, Section VI offers concluding remarks with policy recommendations.
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