RENEWABLE ENERGY AUCTIONS
Compared with auctions of renewables, which have driven prices so low that cost is no longer a big barrier to the energy transition, fixed power prices have become a blunt tool for leveraging renewables into mature energy markets. But auctions come with their own set of problems and pitfalls. Policymakers must learn to avoid them.
Next year, all being well, the electricity system in Denmark will receive power from a new wave of solar projects. Five of these projects, a combined 50 megawatts of capacity, stand out from the rest. All are owned by Denmark’s European Energy and all have signed contracts valuing their output at €53/MWh, a near record low for European solar energy, which as recently as 2010 typically hovered above €200/MWh. Even more remarkably, it will be German, not Danish, electricity consumers paying to support them.
The projects are the winning bids in a pilot of Germany/Denmark cross-border auctions for solar energy supply. The energy from the projects in Denmark will contribute to Germany’s renewable energy targets and a surcharge on German electricity consumers will top up their Danish power market revenues.
The eye-catching low prices are among a succession of announcements of ever-cheaper renewable energy emanating from auctions of clean power purchase contracts for various technologies. Auctions, also known as tenders, are now the predominant tool with which governments around the world are enabling renewables deployment.
The International Renewable Energy Agency estimates that by 2016 nearly 70 countries had adopted auctions as their primary means for leveraging renewable energy into electricity markets. Each announcement of auction results trumpets lower energy prices. Back in 2005, just six countries were experimenting with auctions as an alternative to offering direct price-subsidies for renewable energy.
A SIGN OF MATURITY
The shift to auctions illustrates a growing acceptance that specifying premium purchase prices, often in the form of so-called feed-in tariffs, is too blunt a market instrument with which to direct the growth of renewables. The trend towards auctions is especially important in mature markets with sizeable fleets of renewable energy installations already in place.
Some of the prices resulting from auctions are impressive. In April, German and Danish utilities EnBW and DONG Energy accepted contracts to build North Sea offshore wind farms in the most recent German auction for zero subsidies. To be commissioned in 2024, the facilities will sell their energy at wholesale electricity prices. Meanwhile in Spain, onshore wind developers are signing up to build projects at prices nearly as low as €40/MWh, just the latest confirmation that electricity from renewable energy is often cheaper than from fossil fuels.
Price discovery
By inviting prospective renewable energy project developers to tender for a limited number of contracts, while awarding only the best and most often cheapest bids, governments encourage competition between bidders. They have an incentive to meet all the tender’s criteria at their lowest feasible price, a figure unknown to the auctioneer. Through this “price discovery” process, policymakers seek to minimise costs while at the same time keeping a firm handle on the rate of renewables deployment.
By providing policymakers and regulators greater discretion over the location and nature of renewables deployment, auctions may mitigate some of the challenges of integrating renewables into markets. This also offers a neat solution to cross-border coordination, by emphasising some of the hidden costs of renewables growth, such as grid expansion, in the bid valuation process.
BRIDGE TO SUBSIDY FREE ENERGY
Auctions for renewable energy production promise to act as a bridge between feed-in tariff type instruments that have driven much of Europe’s growth in renewables and a future in which financial support is entirely withdrawn and all energy sources rely on wholesale markets.
The European Commission has mandated auctions across Europe and other countries also regard them as the standard mechanism for pushing renewable energy into the market. Auctions fulfil investors’ demands for stable revenues and the obligations of governments to protect consumers from undue cost by bringing competitive market forces into action.
NOT ALL GOOD NEWS
Low-cost green energy is good news and auctions are part of that story, but they are not a panacea for all the ills of electricity markets and their transition to cleaner energy sources. To what extent auctions are driving down costs, or simply benefitting from reductions that would happen anyway, is far from clear. Neither are auctions a solution to some of the biggest challenges facing renewables deployment. Moreover, they bring a few new problems of their own.
The energy production promised in an auction may not arrive. Ever since auctions were used in the 1970s to allocate access to American oil reserves, the problem of the “winner’s curse” has seen overexcited bidders offering prices so low that when they come to deliver, they cannot make the numbers stack up and are forced to abandon their projects.
Renewable energy has not been exempt from this folly. Projects bidding in to the UK’s Non-Fossil Fuel Obligation tenders in the 1990s were similarly at risk and some fell under the curse. Since then, policymakers have learned some understanding of why this phenomenon occurs and how to reduce the risk of projects never reaching construction. But worries about so-called “low realisation” persist.
Commenting on the low bids in the recent German offshore wind auction, National Economic Research Associates (NERA), a consultancy firm, contends that the successful bidders could well have bought an option to “wait and see” how technology costs and electricity prices have developed when they come to make their investment decision some time next decade. If, at that point, the project looks to lose more money than the government-imposed penalties for abandoning it, the rational decision is simply to walk away, says NERA.
CITIZEN POWER
At the other end of the renewable energy spectrum, citizen groups with intentions to invest together in clean energy production are struggling to get to grips with auctions. Community-led organisations and green power investment cooperatives are seen by some policymakers as an important component to democratise the energy transition. These legislators are concerned about the ability of citizens to participate in auctions, which given the size of the initial capital investment can be risky undertakings, let alone win them against professional participants.
But by tweaking auction design, Germany has demonstrated at least one way to ensure the broadest possible participation in auctions. The government is not under any illusion that Germany’s famed grass-roots community energy cooperatives are able to compete on a level playing field on prices alone. In recognition of this, its ongoing series of onshore wind tenders provide smaller players with special rules, such as longer lead times, lower qualification hurdles and more generous pricing than corporate bidders.
This approach has been shown to work. In the first auction, more than 90% of the winning bids were put forward by supposedly community initiatives at an average price of less than €60 per megawatt hour.
But these measures do not come without a cost. What the lower standards required of these projects means for eventual project quality and completion rates remains an open question, as does whether the backers of the winning bids were truly community-owned.
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PRICES THAT COVER COST
It has long been known that large volumes of wind and solar depress prices in the markets they are sold into. By underbidding fossil competitors, which have fuel costs to cover, solar and wind become victims of their own success, cannibalising their market revenues by driving down average wholesale market prices and accepting lower than average prices for their production.
The only way to counter this erosion of the business case for renewables is to structure both the electricity system and its markets so that prices are upheld. The electricity system must become part of the wider energy system to become sufficiently flexible to accommodate rising renewables supply at prices that cover its cost, however cheap that supply turns out to be. •
TEXT Oscar Fitch-Roy, University of Exeter