Understanding Price Formation in Grids Transitioning to Zero Marginal Cost Generation

Transitioning electricity grids to 100% variable renewable energy (VRE) raises concerns about price formation in energy markets if most generators have zero marginal costs, as well as about reliability if the remaining fossil fuel generators shut down early because they cannot earn enough revenue to cover their costs. In this paper, we investigate what happens to market clearing prices, electricity demand, and producer surplus during the transition to 100% VRE using a five-bus network with price-responsive demand and storage. We employ a quasi-constant elasticity demand curve to simulate demand-side bids and use the DC optimal power flow approximation to model how supply, demand, and storage would be dispatched in the wholesale market. We find that with both price-responsive demand and storage, stable average prices can be maintained throughout the transition to 100% VRE. In addition, producer surplus per unit of installed capacity for dispatchable generators increases as the transition progresses.