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The new economics of the power sector

by Jerome a Paris Mon Mar 25th, 2013 at 10:12:17 AM EST

A lot of strange things have been happening in the power sector lately, from negative prices, to utilities closing down brand new power plants and, naturally, action in various places to cut support for renewable energy (done in Spain and even mooted in Germany).

I've long described renewable energy producers as a price takers (i.e., they don't influence market prices in the short term and have to "take" market prices as set by other factors), but we are getting to the point, in a number of places, where the penetration of renewable energy is such that it has a real macroeconomic impact on the prices of electricity, and thus on the way power markets run. There's also been a big political battle brewing, as renewables "subsidies" are targeted by governments at a time of austerity in Europe, egged on by hardly disinterested utilities.

It is worth deconstructing what's been happening.


First, the price story.

In the good old days, wholesale prices of power followed the price of natural gas, as gas-fired plants are the producer of the marginal kWh most of the time. This is still the case in the USA, and it looks like this:


(source: neutroneconomy)

Retail prices tend to follow the average wholesale cost, plus a slice for distribution and taxes which can vary quite wildly from country to country:


(source: eurostat)

But we've seen prices diverging across markets over the past two years, as shown in the following slides:

  • gas prices diverging sharply across continents (notably as a result of the gas shale developments in the US, and increased demand for gas in Japan following the Fukushima disaster, while European prices remain largely indexed to oil):


    (source: fidelity)
  • power prices diverging from gas prices - and from retail prices:


    (source - wikipedia)


    (source: reneweconomy)

The last one, in particular, shows that German wholesale prices have been trending down over the past year, despite the closure of close to half of the nuclear plants of the country, and despite the persistently high natural gas prices on the continent.

These trends are caused by the increasing penetration of renewable energy (mainly onshore wind and solar, in Germany) which tends to provide a now visible share of supply and thus reduce demand for mid-load producers and peakers over more and more periods throughout the year. As the graphs below shows, on good days in the warm season the PV capacity can eliminate the need for intermediate load; in winter, wind takes over:


(source: DoDo (ET)


(source: carboncounter)


(source: wikipedia)

In a country like Germany, new renewables now represent around 50% of the overall installed capacity, and more than 20% of the actual generation, and the contribution of the support regime (the "EEG-Umlage") to retail prices has become a political topic lately, as noted above, despite the fact that retail prices increases have been caused, for the most part (and in particular until 2009) by increases in gas prices. In recent years, Germany has seen a combination of declining wholesale prices and slightly increasing retail prices. This leads us to a first hidden truth: the massive increase in renewable energy production is not paid for by consumers, but by traditional producers who see their revenues decline as the price they earn per MWh goes down. Utilities, which see their margins on the retail side increase, but have very little renewable energy production capacity of their own are caught between two conflicting trends. Unsurprisingly, they are blaming renewables, and do not hesitate to point fingers at their support regimes as the cause of rising power prices, in the hope that these regimes will be weakened. They claim they are victims of unfair competition from "heavily subsidized" sources which have priority over them and can dump power with no worry for consequences into the network.

In a sense, utilities have been consistent: one of their past arguments was that renewables would never reach critical mass and thus were not a serious solution to reduce carbon emissions. And they surely did not take recent investment decisions with the scenario of heavy renewable penetration in mind, otherwise they would not have been so surprised by the impact they have on power prices (the infamous "merit order effect" - which I discussed in detail at least 5 years ago, and which was already the topic of academic papers before that). But they are stuck with old plants, and even more recent ones, which are increasingly uneconomic in today's markets, caught between high fuel prices and lower power prices.

There are some unique factors to the current situation. One is the general stagnation of the region, which is pushing demand downwards and thus prices as well. The other is the temporary higher use of coal-fired power plants, which itself comes form a combination of factors - cheap imports from the USA (where coal use is displaced by cheap shale gas in power generation) made coal more profitable than gas and regulatory incentives mean coal plants have (under the (the Large Combustion Plants EU directive) a limited number of hours to run and operators have every reason to use these up quickly if the plants are profitable (UK coal plants have the additional incentive that a carbon tax will be imposed on them from April 2013).

But the result is that utilities are not making money on their current fleet - not on gas-fired plants, barely on their coal-fired plants, and they don't have enough renewable energy capacity. And that is the result of policies applied for the past 10-15 years across Europe, so it's not like they had no warning and no notice...

To be fair to them, the system still needs their capacity (because renewables are not available on demand, and do not provide the flexibility required in the very short term), and that needs to be paid for. In the previous regime, where power prices are determined by gas prices, it is possible to pay for the flexibility in the form of price spikes that give the right signal for mid-load and peaker gas-fired (or oil-fired, or hydro) plants to be used, and their frequency of use was relatively predictable over a year, allowing for a sound business model to be implemented. Now, with plenty of renewables, the price signal is completely different. There are many more periods of very low prices when renewables flood the system (and this is particularly the case in places with lots of solar, as it is available during the day, ie when demand is stronger and thus prices used to be higher). This has two consequences: gas-fired plants get much less use than in the past (and less than their business plans expected), and baseload plants like nukes or big coal-fired plants get lower prices during periods when they were cashing in more money. The latter earn less money (but still run); the former suddenly runs a lot less, which has income implications but also consequences for gas consumption and storage - patterns of use become very different, moving from the usual "once a day" pattern (a few hour at peak demand times), to short bursts several times a day (as renewables drop out), or very long periods of use over multiple days when renewables are not available at all.

Given that the penetration of renewables changes every year, it is hard to identify the business model to use for flexible plants - and even harder to know what it will be in 1, 5 or 10 years from now. These plants will be needed, at least to some extent, and they need to be paid for, and that cannot really happen with today's regulatory regime (and stopping support regimes for renewables won't change that now: the existing stock of wind and solar is already big enough in several countries to keep the current market arrangements broken). One solution, thankfully being considered in several markets (and which already exists in places like California), is to put in place a capacity market, where plants make themselves available for rapid changes in output, without actually producing anything most of the time, and get paid for that availability: they sell MW rather than MWh.

The politics of this are messy. You can have articles saying (without any real argument) that "Too much green energy is bad for Britain at the very same time that you have record cold weather, with critical weakness in the gas supply infrastructure and wind actually coming to the rescue... (the UK this week).

People are presenting capacity markets as another subsidy to renewables (whereas system security has always required a significant margin of unused capacity for safety, given that power demand varies from 1 to 2 or one to 3 every day, peaks can be more or less intense depending on weather, and even large plants can go offline on a scheduled or unscheduled basis - that margin was simply paid for in a different way, either by imposing capacity buffers on utilities, or through spot price peaks that are high enough to pay in a few hours for the peaker plants which are idle most of the time). There's naturally a push to stop further investment in renewables - but here's the second hard truth: the cat is out of the bag: once renewable energy reaches a critical mass, its impact on power systems is pretty much irreversible and no amount of lobbying by utilities is going to get them their previous business model back: wind turbines and solar panels are there and they will keep on cranking out zero-marginal-cost MWh for a very, very long time...

And one last point: the more renewables you have in the system, the less it is possible to take out the regulatory support regime, because the more spot prices tend to go towards zero - which makes investment in renewables (or in any other kind of power generation assets, for that matter) impossible. So "grid parity" is an illusory target, in a sense, because it is a moving target. You need to start looking at overall cost for consumers, and that's a different animal again (linked to average costs of production, which becomes a political debate about the cost of money today - which drives the actual cost of wind - vs the cost of gas in the next 20 years - which drives the expected cost of gas-fired power)...

Part of the wind power series.

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European Tribune - The new economics of the power sector
which makes investment in renewables (or in any other kind of power generation assets, for that matter).

Missing word: "impossible" ?

by afew (afew(a in a circle)eurotrib_dot_com) on Mon Mar 25th, 2013 at 12:03:19 PM EST
corrected

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 25th, 2013 at 12:05:25 PM EST
[ Parent ]
Added to the wind series
Twin version on DailyKos

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 25th, 2013 at 12:23:11 PM EST
So "grid parity" is an illusory target, in a sense, because it is a moving target.

A lot depends on pricing structure for consumers.

If business/industrial electricity prices are fixed and predictable, then grid parity is the threshold where self-consumption becomes attractive. This is surely going to be a big deal in solar.

On the other hand, I wonder if there are industries which are able to make money consuming cheap power on an irregular basis? As a power sink when renewables drive spot prices negative, for example?

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Mon Mar 25th, 2013 at 12:29:35 PM EST
grid parity for solar is actually simple: it is indeed linked to self-consumption and, as most installations are individual ones, the price that matters is the retail tariff (currently at 28c/kWh in Germany, ie rather high and certainly higher than solar costs).

For producers who deliver power on the wholesale markets (most wind farms and the industrial solar plants), it's the spot market that matters.

There are indeed industrial companies that like interruptible power (in France, the cheapest tariff for industrial users is one where EDF has the right to switch off these consumers with limited notice) - either because they have non-time sensitive processes, or because they have back up capacity of their own.

Wind power

by Jerome a Paris (etg@eurotrib.com) on Mon Mar 25th, 2013 at 12:44:26 PM EST
[ Parent ]
Unfortunately the UK is stuck in anti-wind mode and cannot escape. I have no idea why even supposedly intelligent writers such as Simon Jenkins of the Guardian are so hostile to renewables but this is where we are.

Each week idiots, especially the amazingly under-informed James Delingpole churn out buckets of photocopied Corporate Nuclear propaganda personally researched energy market analysis intended to damage anything to do with distributed generation and DFH energy.

keep to the Fen Causeway

by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 25th, 2013 at 01:56:22 PM EST
Despite that, the UK installed 2 GW of wind last year (half onshore and half offshore) and will do the same again in 2013 and 2014, a pretty respectable performance.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Mon Mar 25th, 2013 at 02:59:43 PM EST
[ Parent ]
Yes, but given the lead times, how much of that was commissioned under the current Govt and how much is being commissioned now ?

keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 25th, 2013 at 03:45:11 PM EST
[ Parent ]
the amazingly under-informed James Delingpole

Aah, British understatement, lovely.

Delingpole is well known for his all-round idiocy, and proud of it. A bit like a 'universal genius', but inside out. Somehow it didn't surprise me that he felt 'intellectually raped' by Royal Society president Sir Paul Nurse... savour it.

by mustakissa on Tue Apr 2nd, 2013 at 03:56:37 PM EST
[ Parent ]
It's true that until recently, the increase of retail prices in Germany had little to do with renewables and much to do with gas (and price policies with a lack of transparency). However, it was different last year. The key issue here is that it wasn't just the investment plans of traditional energy giants that was set up ignoring the merit order effect, but the feed-in law, too.

I explained this in detail in the first comment to UK Wind Power "Debate" : Latest (a joint diary with afew), but to recap in short:

  1. As a political compromise between the then governing SPD and Greens, energy-intensive industries were "exempted" from shouldering the supposed extra costs of the feed-in law.
  2. In practice, based on the erroneous assumption that market prices will stay independent of renewables, each year, the difference between expected feed-in tariff payouts and the expected average market price of the same amount of electricity was divided with the expected total consumption by minor consumers, and utilities added this figure as a surcharge to wholesale prices. (The difference between least year's forecast and reality was then subtracted from next year's.)
  3. Now what if renewables decrease market prices due to the merit order effect? Since the gap between feed-in rates for existing plants and market prices widens, the surcharge for minor consumers increases.
  4. The end effect is that minor consumers subsidize energy-intensive industries: the latter benefit from the drop in wholesale prices due to renewables while the former get a senseless surcharge.

This effect became significant last year, when the rise of solar power and its displacement of daytime peaks reduced wholesale prices significantly. If policy would be decided on a technical basis, the only logical consequence would be to scrap the 'energy-intensive industries exception' resp. the surcharge. However, enter politics.

Until early last year, the then environment minister from the CDU more or less protected the feed-in law against the insane neoliberal attacks from the FDP economy minister. Then he made the triple miscalculation (1) to entertain the thought that he is Merkel's crown prince, (2) to believe that he can get state governments to swallow a foul compromise with the economy minister on feed-in law revision, and (3) to view winning a regional election as a trivial career step. Then he fell spectacularly. His successor was a faithful Merkel foot soldier, who had no clue about environmental issues but knew everything about interest groups and political opportunism (anyone who thought that Merkel's post-Fukushima green makeover represented some long-term policy shift was sorely mistaken). And after sitting still for a few months, he began to play good cop–bad cop with the economy minister.

So the new spin is that retail prices are expensive because renewables are expensive (wholesale prices, what's that?), and the latter are expensive because lots are installed anew (degression, what's that?); and to solve the fictional problem, the new environment minister proposed to cap feed-in law payouts. Now for this to become reality, fortunately, they would have to convince the upper house of the federal parliament, which consists of representatives of the state governments, currently with a left-of-centre majority. Or that's what I'd like to say, however, one never knows about the SPD, what foul compromise they may enter, especially if coal is involved.

Now all of the above is still the before-last trend in the German power sector. But I'll deal with the newest twist in another comment.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Mon Mar 25th, 2013 at 05:41:08 PM EST
DoDo nails this issue, particularly #4, the following Paragraph, and the political analysis.

to date, not even the Greens (not especially the Greens) have made the case that it's the industry exemption that has screwed the pooch. Behind the public comments, the effect is well known, as Trittin told me himself.

i remain unable to comprehend this, as it's clear that a significant sector of the German electorate would understand, and vote accordingly. Instead, everything is taking place in negotiations behind the scenes, as befits an oligarchy.


"Life shrinks or expands in proportion to one's courage." - Ana´s Nin

by Crazy Horse on Mon Mar 25th, 2013 at 06:41:49 PM EST
[ Parent ]
To be precise: the limitation of the energy-intensive industry exemption to a narrower circle is treated as something everyone agrees upon, but only as if it were a technical side issue, rather than a homing in on the core problem.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Mon Mar 25th, 2013 at 07:24:41 PM EST
[ Parent ]
Here are the latest numbers for energy production and consumption in Germany, courtesy of AG Energiebilanzen e.V. (except for the % of consumption figures which I calculated):

Generation mode  Production% of consumption
2012 2011 2012 2011
Brown coal159.0 TWh150.1 TWh26.7%24.9%
Hard coal118.0 TWh112.4 TWh19.8%18.7%
Nuclear99.5 TWh108.0 TWh16.7%17.9%
Gas70.0 TWh82.5 TWh11.8%13.7%
Wind46.0 TWh48.9 TWh7.7%8.1%
Biomass36.0 TWh32.8 TWh6.1%5.4%
Solar28.0 TWh19.3 TWh4.7%3.2%
Hydro21.2 TWh17.7 TWh3.6%2.9%
Mineral oil9.0 TWh6.8 TWh1.5%1.1%
Domestic waste4.9 TWh4.8 TWh0.8%0.8%
Other26.0 TWh25.6 TWh4.4%4.2%
Total production617.6 TWh608.9 TWh103.9%101.0%
Net import-23.1 TWh-6.3 TWh-3.9%-1.0%
Gross consumption594.5 TWh602.6 TWh100%100%

As you would expect from the discussion of suppressed daily peaks, a major increase for solar and lesser changes for other renewables perfectly balance a drop in gas. You also see a drop in overall consumption (including losses and power sector own use), which is about the same as the drop in nuclear power generation. but what's really glaring is a jump in exports, with a corresponding increase in coal power generation, especially brown coal ( = lignite and sub-bituminous coal in English terminology).

The brown coal increase is mostly temporary. In August last year, two new high-efficiency power plant units started service (ones capable of rapid power variation, adapting to the new high renewables penetration reality). Although the addition of these unneeded new dirt-burners was at least compensated by the closure of older plants with a corresponding capacity, those closures didn't finish until the end of last year. But, temporary or not, this increase had a significant contribution to wholesale price reductions, too.

The development on the hard coal front, however, is expected to get worse this year. You may recall that in 2007, German energy giants promised 26, then 40 new coal plants to replace nuclear capacity. When I asked Where is my coal renaissance? two years later, I judged this "a campaign of wishful thinking ... meant to pave the way for the few plants they will actually be able to realise, in the struggle to maintain market share". Indeed most plans were scuppered, but each of those few remaining are still too much, and most are expected to come on-line this year: 5.3 GW is to be added while only 1 GW is promised to be closed.

In the real world, the consequence will be a dumping on power markets which further depresses wholesale prices. In the world of politics, I expect that the effect will be further attempts to blame the feed-in law and kill it before the federal elections in autumn. However, unless they can retroactively eliminate the 20-year fixed rate guarantee for renewables producers (rather unlikely), I don't see how the over-production would go away – and I think the continued low wholesale prices will ultimately hurt the energy giants with their shiny new coal plants.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Mon Mar 25th, 2013 at 07:20:48 PM EST
[ Parent ]
This is old news, but the picture isn't complete without the addition of the grid issue. On the system level, now that the scaremongering about threatening power shortage due to nuclear shutdowns and intermittent renewables doesn't work any more, attacks against renewable expansion now focus on the ability of the power grid to distribute temporary local peaks in production (like strong winds over the North Sea). Most of these attacks are grounded in a biased to highly misleading interpretation of current events (see Enron's disciples in Germany? for an example). However, it's worse that the assessments of future network capacity utilisation (prepared by grid operators) include forecasts of too high coal-fired plant production, higher than even the government plan. So who is really clogging up lines?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Tue Mar 26th, 2013 at 07:50:00 AM EST
[ Parent ]
Uhm. How is this not completely insane, as an overall energy policy?

The  Non-FiT producers systematically going bankrupt due to pressure from forced purchases of from FiT-Producers will kill the grid.

If the lights start flickering,  laying the blame on renewable energy policy will succeed (because it will be correct. Not due to underlying tech, but due to poor policy design) and the babies will all go out with the bathwater. Not a desirable outcome.

The feedin tarrif is just utterly incompatible with a market in power production. A tax on carbon? Sure, that is the kind of adjustment signal markets do well. But the current monstrosity of a cross between dictating what to build and letting markets handle it is not clever.

by Thomas on Tue Mar 26th, 2013 at 03:56:41 AM EST
the regulatory framework is broken and needs to change.

Wind power
by Jerome a Paris (etg@eurotrib.com) on Tue Mar 26th, 2013 at 05:43:17 AM EST
[ Parent ]
But surely you disagree that the lights will start flickering or that what's broken in the regulatory framework is rooted in an 'utter incompatibility'?

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Tue Mar 26th, 2013 at 07:55:29 AM EST
[ Parent ]
Non-FiT producers systematically going bankrupt due to pressure from forced purchases of from FiT-Producers

Nah, they won't go bankrupt from the purchases as long as they can bill it on consumers, they can go bankrupt because of their narrowing market share with conventional plants and the price effect of their foolish fight to retain that market share.

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Tue Mar 26th, 2013 at 07:53:16 AM EST
[ Parent ]
is required. As long as the fossil-fuel plants are needed in order to balance the intermittency of renewables, they are going to be sub-optimal at best in terms of profitability. In private hands, that adds up to a powerful lobby which will militate against the public good.

So nationalise them.

Or is some sort of compulsory cross-ownership to be preferred? Regulation which would impose all fossil-fuel generators to also own an equivalent amount of renewable capacity? That might work. The market for wind parks in Germany seems fairly mature and liquid.

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Tue Mar 26th, 2013 at 08:29:57 AM EST
by Jerome a Paris (etg@eurotrib.com) on Tue Mar 26th, 2013 at 11:04:10 AM EST
So the new government got serious about aiming for 50% wind. If only other governments would follow... but we'd need them to be replaced for that.

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Mar 27th, 2013 at 07:46:19 AM EST
[ Parent ]
> "...this small island on the North Sea."

Meaning Denmark?!

by mustakissa on Tue Apr 2nd, 2013 at 04:17:14 PM EST
[ Parent ]
So "grid parity" is an illusory target, in a sense, because it is a moving target.

Very well said. This parity concept is a red herring, it tells you nothing about the electricity market. In many places in Europe PV and Wind are cheaper than gas but this doesn't mean suppliers are granting them contracts.

You might find me At The Edge Of Time.

by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Wed Mar 27th, 2013 at 09:28:36 AM EST


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