Low prices for renewables are great news, but mean new challenges for industry and policy makers

While low prices mean more support from politicians and the public for renewables, tighter margins could mean trouble for the industry unless policy makers ensure market mechanisms that allow for sustainable growth, says Sven Utermoehlen, Chief Operating Officer of E.ON Climate & Renewables

The recent trend in renewable energies for ever lower prices in competitive auctions is great news for societies and policy makers wanting to foster the energy transition, and for the growth outlook of the renewables industry. The trend, however, poses challenges to market participants and to policy makers wanting to create a sustainable industry.

In the last 24 months, the introduction of competitive auctions and other similar processes has led to a rapid decline in prices for renewable energies. This has happened far more rapidly than anyone predicted and has taken effect across all the main technologies — onshore wind, offshore wind and solar photovoltaic — and across all markets where competitive auctions have been introduced. More markets are following this path and while the exact design of the auctions differs, we can expect that soon virtually all relevant markets will have such systems in place.

For the renewables industry, this has two main effects. On the positive side, it has increased support from policy makers and the public. For years, politicians have urged the industry for more competitive prices and today prices are beating most expectations. Many countries now want more of this relatively low-cost clean energy and many have increased their renewables targets or auction volumes. This is great news for the growth prospects of the industry.

On the more challenging side of things, the massively increased competitive pressure is squeezing margins in the industry across the entire value chain. This is not inherently a bad thing and has boosted efficiency and unlocked innovation and creativity, both technical and commercial. It also means that players not only compete based on capital expenditure (capex) and operating expenditure (opex) for new build projects. Two additional factors come into play, namely return expectations and expectations for future market-based or merchant power prices, and the willingness to incorporate these into business cases.

The impact of future power price expectations depends on the design of an auction. Key is the length of tenure of an auctioned tariff and whether the tariff you see is what you get or whether it is effectively only a floor. In extreme examples, companies have bid at “zero”, without any guaranteed floor price, trusting that future power or power purchase agreement (PPA) prices will carry their business case. Even without such instances, there are likely to be bids which at least partly bank on power price development and use this as a lever to bid for aggressively low tariffs.

Volume and scale

The incentive to be aggressive in auctions has increased because players want to grow and because volume and scale are important factors to achieve low costs in capex and opex. So there is a self-reinforcing mechanism: only those who bid low win volumes, which helps to realise the low costs.

This drive for aggressive pricing is being passed through the value chain, from developers and investors to equipment manufacturers and installers, and beyond. As a result, there is a risk that players will stretch their assumptions to such a point that their business cases will ultimately fail. This could lead to players losing money (perhaps even abandoning the field or facing insolvency) or to projects not being built. Both would ultimately be a disaster, not just for the respective companies and investors, but also for policy makers wanting to foster the sustainable growth of renewable energy and its industry. These risks will only increase if market designs create an environment that drives players into a race to the bottom.

Policy makers should watch the industry very closely and think about market mechanisms which allow for sustainable growth. This means designing auction systems that do not incentivise hyper aggressive bidding, but rather incentivise competitive yet sustainable business cases. High bid bonds, penalties in case the projects are not build, are one potential mechanism. Another would be to design auctions where the tariff is not just a mere floor and where players have to bid what they really need, rather than betting on future power prices.

Just as importantly, policy makers need to think very diligently about power market designs in general. They need to consider how power market prices will be established in a future with ever larger percentages of renewables with no short-run marginal costs, such as costs for fuel compared to conventional power generation, but with significant capital costs, and how those market price-setting mechanisms can then stimulate new build projects.

There are no easy answers to these questions, not least because so many other macro-economic effects need to be taken into account, but policy makers need to think about them to ensure the renewables industry grows successfully and sustainably, provides clean and indigenous power and creates quality local jobs.

This article is part of a series published by FORESIGHT Climate & Energy in the lead up to Global Wind Summit 2018, held from 25-28 September in Hamburg, Germany.