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In praise of auctions

By Dave Elliott

IRENA, the International Renewable Energy Agency, seems to have been won over to competitive price-based project auctions as a way to stimulate rapid take up of renewables.  It says ‘the main strengths of auctions relate to flexibility, price and commitments. The flexibility of design allows policy makers to combine and tailor different elements to meet deployment and development objectives, while taking various factors into account, such as the country’s economic situation, the structure of its energy sector, and the maturity of its power market’. That’s a bit of a shift: in the past much attention has been paid to guaranteed price Feed in Tariffs (FiTs).

FiTs were very successful in building up wind and then PV capacity across continental Europe, but problems had emerged – as markets expanded, they passed on what were seen as high costs to consumers. That was also sometimes an issue with competitive market price quota target schemes e.g. the Renewable Portfolio Standard (RPS) as used in the US, and the certificate trading versions, e.g. the Renewables Obligation Certificate (ROC) system until recently used in the UK (it is being phased out). They were also all usually less successful than FiTs at building up capacity. For good or ill, FITs are being phased out in the EU, in preference for tendering/auction systems. Whether RPS will survive Trump’s bonfire of support services in the US remains to be seen – it’s a state-level system that runs in parallel with the federal level Production Tax Rebate system.

IRENA now says auctions give us the best of both: ‘The certainty on price and quantity ensures stable revenue guarantees for project developers (similar to the feed-in tariffs) while at the same time ensuring that renewable generation targets are met more precisely (similar to quotas and tradable green certificates)’. That’s debatable, but it may be that FiTs were best suited to (Western) countries with large well-developed electricity markets, and for accelerating the uptake of relatively underdeveloped new technology like wind in them, while now, with the technologies costing less and seeking to move into countries with less developed markets, auctions are best.

IRENA says ‘auctions allow for real price discovery, which is particularly relevant in fast-changing markets with rapidly declining technology and other project-related costs (e.g. due to evolving local supply chains and local market maturity). Finally, auctions lead to contracts that clearly state the commitments and liabilities of each party, including remunerations and penalties for underbuilding and delays to ensure the projects deliver in line with the bid’.

They certainly have done well in some locations e.g. they have resulted in PV solar contracts in South America and the Middle East at under $30/MWh. There were recently some successful PV solar contract bids in less sunny Germany at €54/MWh. Offshore wind is also doing well, with Danish project auction contracts at around €50/MWh and some bids in Germany (for 2025 projects) at almost zero subsidy.

However, IRENA admits that auctions also have potential weaknesses. ‘The risk of project delays or cancellations is attributed to the potential for over-aggressive bidding in the competitive environment of the auction, which has a variety of causes. These include excessive optimism about the rate of technology cost reductions and the underestimation of the financial consequences of a project delay. Another potential weakness is the associated transaction costs, which can be relatively high for both bidders and auctioneer. Small or new players are particularly affected by this.’

The UK now has a competitive contract auction-based system for renewables, the Contract for Difference (CfD) scheme. It initially focused support on the cheapest options, on land wind especially, but with spending accelerating, the government then stepped in to block on shore wind and also some large PV solar, and imposed spending caps. So it is not a fully open market system – and nuclear has so far not been subject to competitive contracts auctions.

The spending cap set for the CfD system under the Levy Control Framework (LCF) is designed to limit extra charges on consumer power bills. It was set at £7.1bn for 2020/21. In 2015, government officials warned that spending was on track to hit £9.1bn because so much green energy was being deployed. So they hit the brakes – cutting support for PV and on-shore wind, and setting even tighter CfD capacity limits. The National Audit Office (NAO) has now revised the LCF spending estimate down to £8.7bn. So the cuts worked a bit. However, that still means it will add £110 to what is forecast to be a £991 average annual household bill by 2020, up £17 on what it would have been if the cap was met. The excess is within the 20% of ‘headroom’ that is allowed over the cap, but the NAO said the expected overshoot meant there was now less money to support further new renewables. A bit of a mess, with the NAO claiming that, combined with an earlier uncapped preliminary CfD phase, with around £1bn being allocated without auctions, the budget was now almost all spent.

Some say that this simply shows that the caps are too low, but the NAO blamed the expected overspend on the energy department being slow to see that more renewable energy was being deployed than expected because of the subsidies e.g. for PV, which has boomed as prices have fallen. Offshore wind farms have also generated more electricity than expected, and wholesale electricity prices generally have fallen. That might seem good news, and is in part due to the reduced use and falling costs of fossil fuel, but the CfD subsidy gives green generators a top-up payment to make up the difference with the strike price, and the cost of this is passed on to consumers. However, the NAO says it may ultimately all balance out a bit since ‘the costs of top up payments under already-signed Contracts for Difference actually become more affordable when wholesale prices fall because increased top up payments are offset by the wider impact on bills of low wholesale prices’.

The NAO adds that the 35 year CfD for Hinkley may cost consumers £30 bn in top-up payments, but that falls outside the LCF as ‘it will not begin generating electricity until 2025 at the earliest’. The NAO accepts that fuel prices vary in unexpected ways so it’s hard to predict top-up prices, but it wants efforts made! Meanwhile CfD project non-delivery rules have been tightened – to reduce the risk that projects would gain CfD support with low price submissions, but not actually be able to deliver. That was what happened in many cases with an earlier UK auction scheme, the Non Fossil Fuel Obligation (NFFO).

It remains to be seen if the new CfD auctions will do any better. The next CfD round has a budget set at £290m p.a. across two delivery periods, 2021-22 or 2022-23, the first opening in April. The focus is likely to be on offshore wind, with so-called ‘administrative strike prices’ for delivery in 2021-22 of £105/MWh and £100/MWh for 2022-23. Successful bids from biomass projects will get between £115 and £135 and wave and tidal stream projects are also eligible, but not PV solar or on land wind. So far there has been no mention of lagoons.

Prices have clearly fallen for some technologies and that will continue, with auctions playing a role. But what of those, now barred from CfD auction rounds, that have already got down to low prices? For large PV, BEIS estimates £60-70/MWh for 2020, and some say that’s high. And there has been speculation that prices of under £50/MWh could be achieved for onshore wind by 2025 but it is claimed that it will need a better route to market than is currently available – like large solar farms, it’s being blocked by planning rules.

Barring electoral upsets/breakthrough, that blocking seems likely to continue, with the Conservative election manifesto continuing to oppose onshore wind. That sits a little oddly with its commitment to low-cost energy, but that commitment may explain why the manifesto makes no mention of evidently auction-adverse nuclear power – leading to this speculative piece.

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