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

Moving beyond today‘s electricity demand : Flexibility and efficiency for reliable, affordable, and climate friendly energy services 1

Transport

Mining and manufacturing

Commerce and Services

Household

Power (non

RE)

Power (RE)

Other RE

Gas

Oil

Disctrict heating …

. Coal

Basierend auf: AG Energiebilanzen (2016)

2 Make use of renewables to stabilize energy costs

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)

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.

Illustration excludes system costs

Annual expenditure CO2 at 30 Euro/t Domestic fossil fuel Imported fossil fuel

Annuitized Investment (at 5%) for wind and solar generation at scale to replace fossil fuels

3 Financing costs increase with (i) country situation (ii) policy design not addressing market imperfection and policy risk

Based on DIA-CORE (2016): The impact of risks in renewable energy investments and the role of smart policies

Weighted average cost of capital for wind reported by European investors in 2014

4 Power market and renewable policy needs to focus on risk management

8% Sweden (Certificate Scheme)

4% Germany, revenue guarantee with feed-in

10% ex-post adjustments, country risks

The case for long-term technology differentiation 5 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

High

(homogenous technology, competition for entry)

Low

(inhomogeneous assets, large incumbent players, information asymmetries)

Other aspects RE trajectory required - For grid investment - Supply chain / planning

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

2. Policy can reduce financing cost for wind and solar by ensuring long-term stable revenue streams.

8% Sweden (Certificate Scheme)

4% Germany, revenue guarantee with feed-in

10% ex-post adjustments, country risks

1. Cooperation can reduce financing cost for countries.

3. RE benefit from hedge at times of low power prices: Ensure consumers also benefit at times of high power prices.

Art 6 new directive Stability of financial support

Art 5: 10-15% joint projects MFF 2020: EU fin instr.

Short-term market design open for all technologies 7

Data from Ignacio de la Fuente, Red Eléctrica de España

0 5 10 15 20 25 30 35 40

Hours before real time

% forecast error w

ind

2005 2006 2007 2008

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,

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!

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www.diw.de\fpm

No need to shift risks for investors – avoid them! 9

Cos

ts

Performance/operation Regulatory uncertainty Future market evolution

Cos

ts

Performance/operation Regulatory uncertainty Future market evolution

Risk from:

Revenue requirement (Financing costs)

Proj

ect r

isk

and

de

velo

pers

mar

gin

Feed-in

Polic

y de

sign

TG

C

TGC

mar

ket p

rice

Green Certificates

Ener

gy p

rice

risk

Bala

ncin

g co

sts

Tran

smis

sion

con

stra

ints

Premium Floating Fixed

Cost of even small risk exposure for financing 10

Risk-free 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.

Risk-neutral 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.

Risk-averse 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 site-specific reductions in revenue of 7 percent.

Asymmetrical 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 %

Considering locational cost-element in tariff / PPA contract: Example German remuneration - adjusted for wind output 11

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.

Considering local value in selecting PPA contracts Example Mexico 2016 auctions 12

• 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 ∆PMLZG 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

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 land-

owners) 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

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Why to care about system friendly technology choice? 14

Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

Why to care about system friendly technology choice? 15

Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

Ex-ante announced adjustment factors for production 16

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

Ex-ante adjustment of remuneration for system value 17

Based on May, N., 2015. Policies and Technologies: The Impact of Wind Power Support Schemes on Technology Choices. DIW Discussion Paper.

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

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