Designing Energy Markets for the Future Presentation at IWEA Dmitri Perekhodtsev, FTI Compass Lexecon Energy IWEC 17Clayton Hotel, 28 March 2017
Outline Who we are Market design in the RES world Evolution of the EU RES support Conclusion 2
Who we are
FTI provides a wide range of support on energy regulation and market design and across the clean energy value chain FTI Consulting activity FTI Clean Tech FTI Consulting s Clean Energy Practice supports clients across the clean energy value chain, providing a wide array of advisory services addressing the strategic, financial, operational, reputational, regulatory and capital needs of clean energy companies with a focus on wind, solar, and biofuels/biomass, energy storage and emerging technologies. INTERNATIONAL SCOPE Over 4,200 professionals in 24 countries on 6 continents PROFESSIONAL EXPERTISE Reputable consultants in a variety of domains with respect to international clients ENERGY EXPERTISE FTI-CL Energy experts have advanced expertise in the issues of electricity market design Collaboration of energy experts from FTI Consulting and Compass Lexecon that is a wholly owned subsidiary of FTI Consulting. Strategy Public policy and regulation M&A and Due Diligence Clean Energy and Renewables Value Chain FTI Compass Lexecon Energy Competition Economics & State Aid Economic expertise in commercial disputes 4
Market design in the RES world
Two recent studies on market design in presence of RES Towards Target Model 2.0 Current EU Target Model was designed in the early 2000s with different policy priorities and a dominance of variable cost technologies New policy priorities to fight climate change whilst maintaining security of supply and a costs structure evolving toward fixed cost technologies call for a rethink Policy proposals to address long-term investment incentives and flexibility remuneration issues http://www.fticonsulting.com/ftiintelligence/energy/research/eu-power-markets/toward-thetarget-model-2 RES-E-MARKETS: Electricity market design and renewable energy deployment Will the evolution towards a power system with high shares of variable renewable energy sources (VRE) require a new electricity market design? Practical, relevant and implementable policy recommendations differentiated between jurisdictions with and without liberalised wholesale electricity markets, for a time horizon of 2050. http://iea-retd.org/archives/publications/res-e-markets 6
Lessons from international case studies: Applicability to Europe of competition in two steps Investment planning (years ahead) Operations planning (days /hours ahead) Competition for the market Tendering of long term capacity contracts Can be technology neutral or specific Puts competitive pressure where it matters: CAPEX Can be used to stimulate new entrants and development of competitive market Ensures coordinated system development Competition in the market Well integrated and liquid forward, day ahead and intraday markets Optimizes short term dispatch and minimizes costs for consumers Level playing field with balancing obligation No distortions as subsidies not based on production Alternatives to implement two step competition based on long term contracts : Mandate an independent organization to define the type of contracts and to procure them through a centralized auction (e.g. capacity auction, CFDs, etc.), or Implement a decentralized process with contracting obligations on suppliers (e.g. capacity obligation, renewables obligation, etc.) 7
Three main challenges of VRE to power systems Capital intensity Limited predictability and variability Decentralized and scattered generation Cost recovery: Credible investment incentives Credible investment signals Implications for the design of energy markets, capacity markets, support schemes Cost of capital: limiting risk exposure Exposure to risk, including policy risk, is a fundamental factor determining total system costs if the system is capital-intensive Trade-off between policy flexibility and regulatory risk Price volatility More volatile prices Product definition (e.g., peak/off-peak) looses relevance Spot market design Reduced gate closer Higher frequency Both day-ahead and intra-day Assurance of system stability Need for new AS products, e.g. providing system inertia Redesign AS to allow VRE participation Coordination between generation and grids Increased investment demand requires new approach to TSO and DSO regulation Locational price signals for generators needed Prosumers Retail prices becomes investment signal Base for taxes and grid fee erodes Many small producers need access to wholesale markets 8
The diversity of power systems and implications for market design Vertically integrated monopolist Vertically integrated monopolist + IPPs Single Buyer as a national genco, disco or disco, or a combined notional gencotransco or transco-disco + IPPs Many discos and gencos, including IPPs, transco as a Single Buyer with Third- Party access Power market of gencos, discos and large users, transco and ISO 9 Source: FTI-CL Energy analysis based on various sources including World Bank
Stylized models of power system organization: 4 different prototypes Real-world market and policy design is diverse, complex, multi-level and path-dependent. To address this diversity in a transparent way, we studied a small number of power system prototypes Each real-world market represents a combination of these prototypes Each prototype allows to focus on a specific aspect of market design Dispatch decisions Investment generation Examples Energy-only Decentralised through wholesale market prices Decentralised through wholesale market prices Texas, Australia, Europe Hybrid Decentralised through wholesale market prices Centralised based on planning and/or risk sharing mechanism Vertically integrated Centralised based on costs and other drivers Centralised based on planning Prosumer Decentralised through retail market prices Decentralised through retail market prices Brazil, UK South Africa, US Germany, Australia, California 10
Energy-only policy recommendations Design of spot and ancillary services markets Locational price signals Development of hedging products Harmonise market designs across time frames Increase price caps and remove barriers to scarcity pricing Market power monitoring Improve balancing markets Improve the operating reserve markets Introduce geographical price differentiation through Zonal splitting Nodal prices Other location signals, e.g. locational connection charges, locational loss charges, etc. Geographical differentiation of balancing prices Introduce measures to improve opportunities for voluntary forward hedging Let the market demand for hedging develop as the intensity of price spikes increases Allow DSR participation in all market segments 11
Significant Limited Engineering the transition to hybrid approaches Challenges presented by high-vre on market designs may require the introduction of hybrid system elements, combining the centralised and decentralised approaches to the short-term and long-term decision making. Transition to hybrid approaches under two drivers Policy-maker s Policy maker s intervention The degree of a policy-maker s intervention and the resulting tendency for centralised solutions. This is determined by policy-maker s attitude to risk and information asymmetry Hybrid capacity remuneration mechanism (CRM) focused on security of supply intervention Advanced energy-only market Technology development of flexibility The development of the generation mix along the decarbonisation path leading to high shares of VRE, especially the flexibility of the mix A mix with higher flexibility reduces the urgency of market design challenges presented by VRE and smooths the transition of the market design. Slow Hybrid investment market focused on specific technologies Hybrid technology neutral investment market Rapid Technology development of flexibility Source: FTI-Cl Energy and NEON 12
Hybrid approach policy recommendations Integrated resource planning Interface between centralised and decentralised processes Organisation of mandatory risk hedging instruments Efficient resource planning and procurement process. Transparent process for determination of investment needs. Efficient governance and incentives of the planning agency. Design products to allow and encourage participation of renewables Ensure product definition and procurement process remunerates capacity irrespectively of the plant s output and short-term operations. Account for specificities of RES cost structure to design mandatory hedging contracts that allow an efficient risk allocation and support capital intensive investments. Award the risk-hedging contracts through a transparent auctionbased procurement process. Design auctions procurement processes so that they encourage participation of renewables and demand response providers. Favour a decentralised procurement to allow contracts to be tailored to meet the specific needs of suppliers and capacity providers. 13
Evolution of the EU RES support
With historically very strong subsidy regimes, state aid rules are moving the EU from FiTs to competitive auctions Strong subsidies are being replaced The European Union has been the main driver of renewable policy development over the past 10 years The primary support mechanism across Europe was the use of Feed in tariffs providing fixed revenue support for long durations State Aid Guidelines have spelt the END for subsidies Support schemes for renewables have also faced difficulties over the EU state aid directives in recent years, as costs have also come down. All new regulatory systems will need to adhere to the state aid guidelines for renewable support There is now a requirement for competition within support schemes (except for small installations), and therefore the majority of regulatory schemes are becoming market based. Fixed Price Market Based FiT Direct Subsidy FiP Tax Credits Competitive Auction Tender Based 15
There is a gradual introduction of auctions across the EU as existing RES support for individual states comes to an end and is replaced Transport Applications The 2003 Directive requires individual countries to introduce legislation and support schemes that meet minimum proportion of fuel produced from biomass that is used for transport EU Climate Change Plan In 2008, fixed 2020 targets for individual countries and the entire EU were set. The target was 20% RES share by 2020 and 10% in the transport sector. Pilot Phase Member states will start to implement competitive bidding \\\\\\\\\\\ procedures for a small share (>5%) of new renewable capacity. 2001 2003 2008 2014 2015 2016 2017 2018 RES Directive The 2001 RES legislation set the overall EU s target of energy consumption from renewables to 21%. Its aim was to set national RES targets and promote the security and diversification of energy supply. The directive relies on individual country s RES support mechanisms in order to fulfil the target Applications Application of the Energy and environmental State aid guidelines. These replace the previous aid protection that entered into force in 2008. Compensation Obligation Generators need to sell electricity in the market. They will also become subject to balancing responsibilities. i.e. have to compensate for shortterm deviations from their targeted generation. Producers may receive compensation in the form of a market premium. Aid to Renewables All member states shall set up tenders to grant support to all new installations, unless it can be shown that bidding would lead to suboptimal results. Bidding will be open to all other member states to encourage competition. 16
Many EU states are moving towards competitive support systems with a very small number currently with no support Competitive tenders Feed-in tariffs Green certificates Market premium No Support United Kingdom Contracts for difference (Pay as Clear*) Ireland Feed-in tariffs until 2017, new support scheme to be introduced in 2017-2018 Norway Green Certificates Finland Feed-in tariffs Sweden Green Certificates Netherlands Pay as Bid auctions Belgium Green Certificates France Regulated FIP and competitive tenders Spain Competitive (Pay as Bid) auctions to be held in Q1 2017 Italy Portugal Feed-in tariffs (new installations remunerated through open energy market) Notes: Support schemes for new installations, does not consider legacy schemes *Pay as clear auction is an auction where participants are awarded the price of the most expensive offer that is accepted (clearing price). Typically this refers to all technologies that have CfD support scheme. Source: FTI Intelligence, RES Legal, AURES Denmark Market Premium Germany Competitive tenders (Pay as Bid) Poland Competitive auctions (Pay as Bid) Competitive tenders (Pay as Bid) Greece Feed-in tariffs moving to Pay as Clear auctions 17
Although historically considerably higher, solar PV tenders are now broadly at a similar level to onshore wind 2016 low auction price comparison, /MWh 80 70 60 50 40 30 20 10 Average Wind Price, 48.77/MWh Wind Price Range, 66.00 27.10/MWh Solar PV Price Range, 73.71 21.52/MWh Average Solar Price, 44.93/MWh Findings The lowest onshore wind price is 27.10/MWh in Morocco compared to 21.52/MWh in Dubai for Solar PV Solar PV low bid prices have a higher range than onshore wind, this is primarily caused by different climate conditions within markets Mexico, Argentina and Chile all held auctions for both solar PV and onshore wind each giving similar prices for both technologies: - Wind Solar Mexico Chile Argentina Kreigers Flak (Offshore) Borssele III & IV (Offshore) Italy Morocco Canada Peru India Dubai Germany China Source: FTI Intelligence collation of publically announced tender results Tender Price /MWh Solar PV Onshore Wind Mexico 34.81 39.16 Argentina 53.11 61.83 Chile 45.12 45.12 18
Auction price reductions are being driven by reductions in LCOE, with mean levels for both wind and solar falling below 50/MWh Solar PV LCOE Greenfield (Range and Average) ( /MWh) 200 180 160 140 120 100 80 60 40 20 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 Max Min Mean Onshore Wind LCOE Greenfield (Range and Average) ( /MWh) 200 180 160 140 120 100 80 60 40 20 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 Max Min Mean Solar PV s LCOE has decreased steadily between 2009 and 2017 with a 70% reduction in mean values. Average Year on Year decrease has been 13.8% Onshore wind projects have a smaller decrease of 56% with Average Year on Year decrease of 8% On average onshore wind remains marginally cheaper compared to Solar 37/MWh compared to $46/MWh in 2017, although we expect solar to be cheaper by 2021 Source: Solar PV Lazard LCOE, versions 3 to 10 2009 to 2016, 2017 value average of markets considered by FTI Intelligence excluding Turkey for FTI Intelligence 19
The case of Spain: retroactive cuts on solar subsidies The PV boom in Spain has had the impact of significantly increasing the electricity system regulated costs. As a result a series of regulatory measures were introduced by the Spanish Government to reduce this deficit: 1.Freezing subsidies for new capacity from January 2012; and 2.Retroactive cuts in a series of measures which started in 2010 with RFII and RFIII. Regulatory Framework I Original RD 661/0027 regulatory framework 2007-2010 Regulatory Framework II Changes from 2010-July 2013 RD 1565/2010, RDL 14/2010, LES, Act 15/2012, RDL 2/2013 Regulatory Framework III (RDL 9/3013, RD 413/2014, Order IET/1045/2014) July 2013 onwards Plants received a fixed payment per unit of production ( Feed-in-tariff or FiT ). FiT updated annually according to CPI-0.5 and applicable to all production. FiT varies according to the size of the installation. 20% reduction in FiT after first 25 years. Extension in FiT terms from 25 to 30 years but then falls to zero (vs 20% reduction). Caps on production introduced 2011 2013 and production in excess of caps receives the market price. New 7% tax on revenues effective 1 January 2013. CPI indexing modified resulting in a permanent reduction of 3% in revenues. Under RF III each plant receives three defined payments: 1. Wholesale market pool price payment: for each MWh produced. 2. A regulated operating payment: each plant is assigned a operating payment based on the level of production up to a fixed annual production cap. 3. Regulated annual investment payments: for each MW of installed capacity so as to achieve a set rate of return ( RoR ). Currently 45 pending international arbitration cases against Spain, amounting to billions of US dollars in investment 20
Installations (GW) The EU could follow the US with a rapid growth of corporate PPAs for renewables Strong US market Growth Large volumes of installations in both wind and solar with continued growth Large volume of corporates with increased corporate social responsibility focus Driven by the PTC/ITC schemes providing revenue despite offtake circumstances European Opportunity Historic domination from large utilities shifting towards smaller generators European regulation becoming more liberalised and a move from FiTs FTI believe Europe to be about 4-5 years behind the US leading to large growth with about 1GW contracted today Cumulative corporate renewable PPA capacity contracted in the US (MW) 1 8,000 7,000 7,150 6,000 5,590 5,000 4,000 3,000 2,000 1,000 0 2,150 1,150 130 260 390 520 650 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source 1): Business Renewables Centre, December 2016 21
Conclusion
Conclusions Hybrid market designs Our market design analysis suggests that the world with high shares of RES may require a transition from the EOM to hybrid market designs Renewable support schemes evolution Compliance with the new State aid guidelines on energy drives a considerable change in the renewable support schemes across Europe towards competitive auctions Policy interventions and re-regulation have become the new normal, giving rise to regulatory disputes Regulatory disputes over design and impact of new regulations (e.g. capacity mechanisms, changes in RES support mechanisms, etc.) Potential international arbitration disputes when retroactive changes introduced (e.g. Spain) Contracts are making a come back The market for corporate offtake PPAs for renewables generation is taking off in Europe New business models for energy services involve complex contractual structures for revenues and cost sharing 23
Critical Thinking at the Critical Time Dmitri Perekhodtsev Vice President COMPASS LEXECON dperekhodtsev@compasslexec on.com +33 1 53 05 36 29
Ireland: RES support under the new market for electricity (I-SEM) New support scheme for RES in Ireland The current REFIT scheme was supposed to be close on 31 Dec 2015 but extended to 31 Dec 2017. The Department of Communication, Climate Action and Environment is working on developing a new RES support scheme compliant with the State aid guidelines to promote a gradual move to market-based support for renewable energy. Introduction of a new support scheme is expected in 2017-2018. The public consultation on the new scheme is about to be opened. RES operation under I-SEM Balancing responsibility for all participants, ensuring their notification of generation or demand reflects their actual expectations The I-SEM will include a transitional mechanism to help smaller players to access the market in ex-ante time-frames, without necessarily needing to invest in trading capability of their own. Challenges for variable generators, especially wind farms The reform will introduce new risks for RES operators which could be unable to adequately mitigate the balancing risk in the intraday and balancing markets. They could be required to participate in the imbalance market at potentially punitive rates. Aggregator of Last Resort (AOLR) will help to mitigate these risks for smaller players in transitioning to a new market design 25