National Grid, seeing the problem of needing to tell wind farms not to produce, and faced with opposition to running pylons through swathes of Scottish and borders landscape, decided to build the Western Link, a subsea interconnector that does the job of moving this power to where it is needed. Unfortunately, it has been subject to several significant failures over the two years it has been in operation. The downside is that payments to Scottish wind farms to stop producing are higher when the link is not working. The upside for research is that, after controlling for other factors, we can evaluate how much the link saves in payments to Scottish wind farms when it is operating. The first pass answer our research suggests is around £45 million a year if it worked all the time. This is worth having, but pales beside the cost of the interconnector, said to be around £1.2 billion. Why is it not saving more? Here we enter one of economists’ favourite areas, the role of incentives. A naïve view would be that when a wind farm can produce it will, because the wind is free. But this neglects the subtlety of the system, in which the incentive of a wind farm is to maximise its revenue. We show that wind farms offer to produce more relative to a forecast based on wind speeds when the price obtained is relatively high, when the penalty for failing to produce what was offered is relatively low, and when predictions of the price paid to a farm forced to switch off are high. In fact, the last of these — payments to persuade them to switch off — have been running at very high levels, and continue to do so, so that it can be more valuable to commit to produce, but be told not to, than actually to be paid for generating electricity.
LSE 16th Oct 2020 read more »