Energy prices are rising fast. The costs of renewables like wind and solar are falling. So you would think that would be a good thing- helping out. And the more the better. However, there can be problems when financial support systems use fossil fuel prices as the base for subsidies for renewables. They were assumed to cost more, but that’s no longer true, and so, although it’s not the cause of consumer price rises, there have been some perverse out-comes, with, for example, renewables getting more support than they need and enjoying so-called windfall profits.
That has happened in parts of Europe where, under the marginal cost ‘premium price’ subsidy systems, the cost of the most expensive generator defines the price for all generators. Originally the high costs options were wind and solar, but now it is gas. So some consumers are being overcharged. A critique carried by Euractiv claimed that ‘in Germany (and proportionally in other countries) citizens are funding renewable windfall profits to the tune of €10million to €50 million per day, i.e. around €1 per day per household’.
The disparity in prices certainly is striking. The Euractiv article noted that ‘since September 2021, electricity wholesale prices in most member states have hovered between €150 and €250/MWh with the occasional oscillation up to €620/MWh or down to minus €2/MWh depending on the availability or not of renewables and how much demand needs to be met. This contrasts with renewable auction prices for wind and PV of circa €50-60/MWh and €35-50/MWh respectively (Germany and Spain)’.
It said that this is mainly due to the market support system now in place: ‘From 2014 (in Germany), renewable projects were moved to a direct-marketing system. Under this, a renewable project sells the electricity generated directly to the wholesale market. A “market premium” is then paid to cover the difference between a renewable reference price (defined by the government) and the wholesale market price (averaged per month).The assumption was that for the foreseeable future, wholesale prices would be much lower than the cost of renewable electricity. Hence the need for a “market premium”. No consideration was given to average wholesale prices being higher than renewable reference prices, as they are now’.
Although the article admits that, in 2016-2017, there was a move towards competitive auctions for renewable projects, so that the auction price defines the renewable cost, it says Germany is still using its ‘direct marketing and market premium’ system. Whereas it says, some other countries, have combined auctions with a contract-for-difference (CfD) system: ‘Under CfDs the winners of the auction sell their electricity directly to wholesale markets. However, if wholesale prices at any point are less than the strike price of the auction, the government pays the difference. If wholesale prices are higher than auction prices, money flows from the renewable project owners to the government. Under such a system energy companies make no windfall profits from renewables’.
There has therefore been some pressure to switch to the CfD approach as used in the UK- although clearly that in no way would avoid most of the overall energy price increases we have all been witnessing of late. But it might help a bit. The EU’s Agency for the Cooperation of Energy Regulators (ACER) has been tasked with reviewing the functioning of the wholesale market, given the surge in electricity prices, but so far it has not backed changes to the system or a shift to CfDs. It said that, although the marginal market model was not ‘fully future-proof’, it could shield the EU from even higher volatility as a result of increasing shares of wind and solar, and discourages speculative bidding by incentivising producers to bid their true costs to get dispatched.
That does not seem to have convinced Spain of the benefits. It is facing possibly the highest energy prices rises in the EU, given that about 25% of is power still comes from imported gas. Although renewables have been expanded dramatically, the EU marginal market model isn’t helping them to cut consumer prices. As Energy Monitor reported, ahead of a meeting of EU energy ministers last October, Spain had suggested it might quit the EU’s wholesale power market to be able to set its power prices based on cheaper renewable generation. However, EU energy commissioner Kadri Simson warned of the risks to predictability and competitiveness, and questioned whether such a system ‘would be a better alternative to the current market design’.
Spain, which now has a leftish government, has in general been pushing for radical approaches, opting for more renewables, a nuclear phase out by 2035, supporting the EUs proposed minimum 55% emissions reductions goal for 2030 and calling for the exclusion of gas from the new EU Taxonomy for sustainable investments. It was also not too happy with the idea of expanding European Emission Trading System to cover buildings and road transport because of concern about the social impacts. In any case, some on the left do not see market-based mechanisms like the EU-ETS as the best way forward to support renewables.
However, Spain also faces additional geographic issues. The interim report from ACER shed light on the importance of interconnectivity. It pointed out that the countries with the highest power prices are not only those with the highest dependency on gas, but they also have very limited interconnection levels. In the case of Spain, the report found that only 4% of Spain's total electricity demand was covered by power imports. Basically, like Portugal, it is out on a limb in terms of EU grid power and also gas pipe links- and this ‘energy island’ position may justify special treatment.
Meantime, back in the UK, despite initial resistance from the government, there was a lot of pressure for a windfall tax on the big energy companies, given the vast profits they have made due to the fossil fuel price rises. The CfD regime protects consumers from market price swings to some extent, but most renewables projects are still running under the old Renewables Obligation, which offers generally higher support levels, with in some cases multiple ROCs, on top of the wholesale price. With renewable cost falling they my be getting more than they need. It may only be part of the consumer cost problem, but it is still worth dealing with. The UKERC has suggested that since many of RO contacts will soon expire, the soon to be ex-RO projects could be offered a new CfD ‘pot zero’ option to maintain some support continuity. It would pay them less though (maybe only £50/MWh), but it would cut cost to consumers. The UKERC even thought nuclear plants might be interested. But surely not Hinkley Point C, since it can look forward to a luscious long-term index-linked £92.5/MWh CfD!
In the event, instead, the government finally opted for what it called a ‘temporary targeted profits levy’ to tax the ‘extraordinary profits’ of oil and gas companies (but not electricity companies) at 25%, while still incentivising new oil and gas projects via a new Investment Allowance- they are seen as vital for a while to maintain security of supply. But you may have thought, so would doing something about electricity suppliers…Will it seems a windfall tax for them is still an option.
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