How can renewables support Europe?

Florence School of Regulation, Annual Climate Conference 2016 How can renewables support Europe? Karsten Neuhoff German Institute for Economic Research (DIW Berlin) Technical University Berlin

1 Moving beyond today s electricity demand : Flexibility and efficiency for reliable, affordable, and climate friendly energy services Disctrict heating. Coal Oil Gas Other RE Power (RE) Power (non RE) Household Commerce and Services Mining and manufacturing Transport Basierend auf: AG Energiebilanzen (2016)

DIW Berlin Calculations based on BP Statistical Review of World Energy; Energy Statistics for the EU-28; Bundesverband Solarwirtschaft e. V.; IEA; European Wind Energy Association; Bundesamt für Wirtschaft und Ausfuhrkontrolle, first published in Energy Journal (2016) 2 Make use of renewables to stabilize energy costs Illustration excludes system costs Annuitized Investment (at 5%) for wind and solar generation at scale to replace fossil fuels Annual expenditure CO2 at 30 Euro/t Domestic fossil fuel Imported fossil fuel Similar cost level for serving demand with new wind and solar as with fossil fuel: - Cost of learning investment in wind and solar dominates debate but is sunk.

3 Financing costs increase with (i) country situation (ii) policy design not addressing market imperfection and policy risk Weighted average cost of capital for wind reported by European investors in 2014 Based on DIA-CORE (2016): The impact of risks in renewable energy investments and the role of smart policies

4 Power market and renewable policy needs to focus on risk management 10% ex-post adjustments, country risks 8% Sweden (Certificate Scheme) 4% Germany, revenue guarantee with feed-in

5 The case for long-term technology differentiation Wind and solar PV Fossil fuel based generation and flexibility options Capital costs ~ 80% ~ 30% Main strategic choices New investment decision Location and dimensioning (Re-)investment and retrofit decision Closure Fuel contracting Capacity for government to decide Other aspects High (homogenous technology, competition for entry) RE trajectory required - For grid investment - Supply chain / planning Low (inhomogeneous assets, large incumbent players, information asymmetries) Government choices politically contentious Strategic choices Policy-driven deployment Private sector determined (financed on-balance sheet) Neuhoff, Ruester and Schwenen (2016). Power Market Design beyond 2020: Time to Revisit Key Elements? The Energy Journal

6 Power market and renewable policy needs to focus on risk management 1. Cooperation can reduce financing cost for countries. Art 5: 10-15% joint projects MFF 2020: EU fin instr. 10% ex-post adjustments, country risks 8% Sweden (Certificate Scheme) 4% Germany, revenue guarantee with feed-in 2. Policy can reduce financing cost for wind and solar by ensuring long-term stable revenue streams. Art 6 new directive Stability of financial support 3. RE benefit from hedge at times of low power prices: Ensure consumers also benefit at times of high power prices.

7 Short-term market design open for all technologies 2005 2006 2007 2008 Hours before real time 40 35 30 25 20 15 10 5 0 % forecast error wind Wind & solar Coal & most gas Can & need to adjust close to real time Require early start-up Ensure deep intraday and real-time markets + and consistent day-ahead markets Clearing platforms or auctions are increasingly used in US and Europe for short-term power markets. Neuhoff, Ritter, Salah-Abou-El-Enien, Vassilopoulos(2016) Intraday Markets for Power: Discretizing the Continuous Trading?, DIW Discussion Papers, 1544, Data from Ignacio de la Fuente, Red Eléctrica de España

8 Opening power markets for RE - intraday auctions in the Winter Package Intraday auctions can Improve market liquidity Facilitate contracting for flexibility Allow effective participation of players of all scales and technologies (including flexibility) Ensure technical feasibility Compatibility with current (continuous) trading arrangements Ensure consistency between intraday and balancing Allow for pricing and efficient use transmission capacity between bidding zones Reduce unannounced loop flows. and thus avoid the need for direct marketing as way of strategic sale of electricity. Incentives for good forecast remain an important topic! www.diw.de\fpm

9 No need to shift risks for investors avoid them! Revenue requirement (Financing costs) Risk from: Performance/operation Regulatory uncertainty Future market evolution Green Certificates Premium Fixed Floating Feed-in Costs Project risk and developers margin Transmission constraints Balancing costs Energy price risk Policy design TGC TGC market price

10 Cost of even small risk exposure for financing Risk-free Risk-neutral Risk-averse Asymmetrical There are no new costs or risks. Wind energy generators do not bear the costs resulting from forecast deviations, which corresponds to a EEG without mandatory direct marketing. Generators bear the forecast deviation costs accounting for 3 percent of revenues (corresponding to the calculated historical value), but there are no site-specific revenue reductions. Debt and equity investors adopt a conservative perspective when determining the funding they provide: a pessimistic value of the costs of forecast deviations of 8 percent and sitespecific reductions in revenue of 7 percent. Simulation of the perspective of an equity investor willing to bear additional risk without increasing revenue requirements based on the values of the risk-neutral scenario. The debt provider only offers a share of the funding that can be repaid in the pessimistic scenario. Tariff in /MWh New debt share Risk-free 87.78 83.7 % Risk-neutral 89.16 83.4 % Risk-averse 94.38 82.9 % Asymmetrical 90.50 78.0 %

11 Considering locational cost-element in tariff / PPA contract: Example German remuneration - adjusted for wind output Duration for which high tariff applies dependend on wind output in first 5 years. Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

12 Considering local value in selecting PPA contracts Example Mexico 2016 auctions Bids are adjusted depending on the location s production value Gives strong incentives for generation where it provides the highest value, for instance plenty of winning bids in Yucatán where deployment is encouraged Both wind and solar winners, with ENEL gaining large amounts of solar contracts Locational maximum amounts Pay as bid NÚMERO ZONA PML ZG 1 Hermosillo -3.30 2 Cananea -1.36 3 Obregón 1.00 4 Los Mochis 1.04 5 Culiacán 1.04 6 Mazatlán 1.89 Based on CENACE (2016): Diferencias Esperadas, Factores de Ajuste Horario y Precios Marginales Locales 2016-2033, v2016.05.13

13 Determining local component of remuneration based on cost or value? Static value based remuneration may result in scarcity rents In competitive markets without resource constraints same outcome If high wind speed locations are scarce, then developers (or landowners) capture scarcity value -> Mexico merged with pay as bid auctions and max local volumes Dynamic - challenge for projecting regional specific adjustment values Do LMPs converge to long-run marginal transmission expansion cost? Wind/solar can quickly change regional price patterns -> Optimal long-term quantities more robust than prices patterns Technology specifc remuneration versus generic rules Cost based adjustment needs to be technology specific

14 Why to care about system friendly technology choice? Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

15 Why to care about system friendly technology choice? Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

16 Ex-ante announced adjustment factors for production Hourly adjustment factors in Mexico 2016 in Hermosillo Based on CENACE (2016): Diferencias Esperadas, Factores de Ajuste Horario y Precios Marginales Locales 2016-2033, v2016.05.13

17 Ex-ante adjustment of remuneration for system value Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

18 How can Renewables Support Europe Moving beyond today s electricity demand cross-sector and country integration of RE energy system Shift to RE based power system now economically viable creating European jobs, energy security, and sustainability RE remuneration mechanism key for low cost finance Eliminate regulatory risks, co-operate between MS, use EU finance instruments, align on EU power markets for RE Design RE remuneration for system friendly technology and locational choices according to long-term needs