Tolerance vs. Intervention: Strategies for dealing with negative wholesale electricity prices

Abstract

The incidence of negative electricity prices is appearing regularly in competitive wholesale markets as a result of increased intermittent renewable sources. Confronting this issue, some regulators argue that it causes large price fluctuations and increases system costs, but others believe that it is a market signal for flexible production. This divergence raises a key policy question: should governments intervene to mitigate negative pricing, and if so, which instruments are most effective? This study develops a theoretical model, calibrated with empirical data from the British electricity market, to evaluate three regulatory approaches—tolerance, subsidy removal, and price floors—in terms of their effects on producer surplus, consumer surplus, and overall social welfare. The results indicate that subsidy removal or moderate price floors can improve producer surplus and, when historical subsidies are large and policy preferences place greater weight on producer earnings, can also enhance total welfare. In contrast, tolerance consistently yields higher consumer surplus by preserving low market prices. Empirical validation using offer-level bidding data confirms the model's predictions under realistic conditions. These findings provide fresh insights on negative electricity prices from the government's perspective, emphasizing the necessity to balance producer and consumer interests in policy options.