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Electricity markets need fixing

IEA boss Fatih Birol discusses the need and the tools for bettering the business case for renewable energy. Special report part 3/3

INTERVIEW

The International Energy Agency (IEA) recently published its first report on electricity market design, RepoweringMarkets. There is no field where clean energy and energy security interact more powerfully than electricity regulation and market design,” states IEA boss Fatih Birol in the report’s foreword. In conversation with FORESIGHT, Birol elaborates on the report’s key findings.

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Influential Fatih Birol has been Executive Director of the IEA since 2015. He has been named among the most influential people on the world’s energy scene by Forbes magazine

INVESTMENT SIGNALS

Q: You say that energy market revenues are not attracting the required low carbon investments in a timely manner. Purchase prices set in wholesale markets are lower for electricity from low carbon technologies, which makes it harder for these to recoup their investment costs. How do you suggest we solve this problem?

A: Merchant renewable investments exist and we will see more of them, even if at this stage they remain the exception. Despite tremendous cost decline of wind and solar technologies, electricity prices will probably remain too low to attract the level of investment needed.

Maybe it’s possible to quietly reach a few per cent of wind and solar in the mix over the next decades. But this is neither compatible with a two degree scenario nor with less ambitious targets. If you want to reach 30-40 per cent of wind and solar power in the mix in a given market (not only in a very well interconnected small country), you have to invest faster than the natural replacement rate of existing capital stock. This creates excess capacity, displaces power plants and depresses prices.

Even if we manage to put a proper price on CO2, the renewable targets are so high that it is unlikely that we will be able to reach them without additional policy support.

We suggest continuing to support low carbon investment with long term arrangements, whether this is FIT [Feed in Tariff] PPA [Power Purchase Agreement], a slightly more sophisticated certificates system, or obligations that push electricity retailers to enter into long term PPAs with project developers, such as in the US. This is not new. This is precisely what governments are already doing and we expect this will continue. In the coming years, such support schemes can be reduced as we fix and increase carbon pricing. It will become more and more important to integrate renewables into electricity markets that are well designed and send efficient investment signals.

Q: You stress that solar and wind are qualitatively different from conventional fossil energy production from a regulatory point of view. How should this be reflected in future regulation?

A: What matters from a regulatory perspective is the capital intensity of wind and solar and the fact that they can be deployed rapidly, in fact faster than the rest of the system can adapt. Their cost structure is mainly fixed while their revenues come from volatile and uncertain electricity market prices. This does not fit very well together and can increase the cost of decarbonisation because investors will ask a high risk premium to invest, or will not invest at all.

Solar PV can also be small scale and modular and can be installed on roofs, close to consumption centres in a more distributed fashion. Such distributed resources can radically change the way the electricity sector functions and will need to be regulated. Consumers are becoming prosumers” who both take electricity from the grid and sometimes send electricity back to the grid. This has major implications for the business model of network and generation companies and the overall market design and regulatory framework.

Q: You have called stop-and-go policies the biggest killer in relation to the energy transition and advocate a steady walking pace” rather than an inefficient crawl then sprint” model. With governments having all sorts of policy objectives (health care, education, and so on), what do you think is required before more governments opt for more ambitious walking pace” policies?

A: Decarbonisation is a very ambitious policy that will require a complete transformation of the energy system. Therefore it will need to attract investors. We also know that the opportunity window to reach a two degree scenario is rapidly closing. In a report on climate change published in 2015, we indicated that the opportunity would close in 2017. Even if energy demand growth is lower than we projected, in particular in China, the need to reduce CO2 emissions is very urgent. Of course, policies tend to change with governments and so it will be important to find ways in practice to commit to long run policy directions that can give a framework of stability for investors. One of the issues for carbon pricing has been that the track record of stop-and-go policy commitments has damaged the credibility of carbon pricing.

CARBON PRICING Q: The IEA continuously stresses the importance of a high carbon price, but most countries are hesitant about introducing a levy that might hinder economic growth. What is the most realistic solution to solving this global game of after you, sir” where countries are reluctant to introduce effective carbon pricing?

A: Carbon pricing is progressing and has been introduced in many countries, not least this year in China. This is very encouraging. By 2015, emissions trading schemes covering 4600 mega tonnes of CO2 equivalent were operating in 45 jurisdictions, which together accounted for 40 per cent of global GDP. Meanwhile, even a moderate carbon price still can play an important role, not only to signal the commitment to decarbonisation but also to help support switching from coal to gas, to accelerate the retirement of existing polluting plants, and to bring mature renewables into the energy market.

Q: You have said that intense lobbying activity related to carbon pricing has repeatedly derailed informed policy making. Can you elaborate on this and perhaps support the statement with examples?

A: Carbon pricing suffers from the fact that it is a political construct intended to correct an externality. This creates extremely important distributive effects: in other words, winners and losers. Policy makers are careful about these effects. Even where a carbon price exists, very few countries—like Sweden—are likely to introduce a carbon price that would be consistent with decarbonisation pathways, such as $100 for a tonne of C02, or more.

Reasons for low carbon prices differ from region to region, but there are broadly three factors. First, the economic downturn has led to lower than anticipated emissions, resulting in a surplus of emissions allowances. Second, concerns about industrial competitiveness and rising consumer electricity prices have made it difficult to negotiate political decisions (and maintain political will) to set tight emissions caps or high carbon prices. Third, the positive effect of energy efficiency policies has begun to be felt in flattening or falling electricity demand in many jurisdictions and has resulted in reduced demand for emissions trading scheme allowances, such as in the European Union.

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Walk and talk FORESIGHT spoke to Fatih Birol after he presented World Energy Outlook 2016 at the Royal Library in Copenhagen. During his talk, he identified stop-and-go government energy policies as the biggest killer of further renewable energy deployment

FLEXIBILITY AND INTEGRATION

Q: The IEA has stressed that even if we greatly improve demand response and storage technologies and build a more efficient energy system, we still need new approaches to policy and regulation. Why do we need new regulation if better technology usage could stabilise the fluctuations in supply and demand?

A: This is a very good question. Storage and demand response are extremely promising. They have been around for a while, but it is increasingly clear that new digital technologies are unlocking much more potential for flexibility: you can store electricity or shift load on the system to when electricity is abundant at low cost. There is less need to worry about peak demand anymore.

But we are not yet there and there are still uncertainties associated with deployment. Today demand response and storage represent only a small fraction of installed capacity, between zero and a maximum ten per cent of peak demand in some markets. Meanwhile, it remains important to keep the lights on. We have concluded that governments still have an important role to play to regulate security of supply in the coming years.

Q: You say that the low carbon transition requires strengthening the integration of energy markets over large regional areas. The European Commission has just presented its Winter Package, which partly reflects this concern. Apart from in the EU, however, do you think market coupling is high enough on the global agenda?

A: Regional integration of electricity markets is a worldwide trend. On this point, Europe is far ahead of other regions of the world. The internal energy market represents a market of more than 3200 TWh in the EU alone. Electricity prices are coupled from Helsinki in Finland to Lisbon in Portugal. This is a major and unequalled achievement. In North America, power systems and power markets remain much more fragmented and the electricity sector is still not liberalised in many US states.

Regional integration presents clear benefits in terms of security of supply, increased fuel diversity and smoothing out the variability of wind and solar power over large geographic areas with different weather conditions. But regional integration of electricity markets across borders raises significant issues in terms of electricity security that also have to be addressed.

Q: What do you see as the greatest barrier yet to be overcome for the rapid replacement of fossil fuels by renewable energy?

A:
The greatest barrier to overcome is the integration of variable renewables into electricity systems. This will require developing power system flexibility and also a friendly deployment of variable renewables. At high market shares, wind and solar power can create situations of over generation that have to be managed. We have created a dedicated unit in the IEA to analyse this issue and will be looking at this very closely over the coming months and years. •

TEXT Peter Bjerregaard / PHOTO Lars Just