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Italy’s Solar Bust: Just Another Data Point

“Intermittent generation may be consistent with a liberalized market, as long as generators are required to bear all the direct and indirect costs of their production. Otherwise, competition is doomed to become an irrelevant feature of a system that becomes more and more politically driven.”

Can an intermittent source be integrated into a liberalized electricity market?

Yes, it is technically feasible, but no otherwise. If subsidies enter into play, intermittent generation might undermine the very design of the market. This is what happened in Italy with the boom of solar power, which last year alone skyrocketed from 3.47 GW to 12.75 GW, with the annual cost of subsidies increasing from 800 million euro in 2010 to 3.9 billion euro in 2011 (about $975 million to $4.75 billion at today’s exchange rate).

These very generous incentives (which have been cut back in the last year for complex legal reasons) led to an over-investment in solar power in the country.

Perfect Storm” for Malinvestment

Italy’s perfect storm of so little electricity at so much cost had three causes:

1) High subsidies;

2) Unlimited demand (meaning that the power grid operator has a duty to dispatch any single “green” kWh, regardless of both the actual demand and the deals that are made with conventional generators on the day-ahead market); and

3) “Implicit” subsidies. Implicit subsidies are the key, here: they refer, in the first place, to the fact that variations in the solar (and wind) production (as compared to what is expected) translate into imbalances that have a technical and an economic cost.

Under the Italian regulations—that are currently being reformed—such costs are “socialized,” i.e. the end consumer will pay for it and the intermittent generator has no incentive to make better forecasts or to adopt technical or financial instruments to cover itself from the “wrong forecasting” risk. Secondly, local distributors are required to connect green generators to the grid and even that cost is “socialized.”

The combination of all the above will inevitably lead solar generators to over-invest and not to take care of the problems that intermittent generators will create on the grid in terms of imbalances. As a result, as Italians discovered n March, the average electricity bill for a household in April-June 2012 increased by 9.8%. Of that, 4% was attributed to the direct cost of incentives, and 2.3% was an estimate for the imbalances costs.

Hidden Costs of Intermittent Energy

Even that is only part of the real costs that subsidized intermittency causes to the system. What is possibly the largest cost of all is that it makes competition less and less relevant, and top-down political decisions more and more decisive. Subsidies-induced growth of solar power in a moment of stagnating demand has the result of making increasingly over-sized the conventional generation portfolio, that is the results of private investments taken in the past decade under the assumption that the rules would not change (the rule being, “each generator will gain or lose depending on its ability to be competitive on the market”).

If some generators do not face price- and volume-risks, of course this will come at the expenses of other generators. This sort of “competition” resembles the idea of socialism that George Orwell made famous: all competitors are equal, but some competitors are more equal than others.

As demand is almost flat, and non-market generation increases, the size of “contestable” market—that is, that portion of the market where generators compete with each other—shrinks accordingly. Between 2007 and 2011, this part of the market fell from 292 TWh to 248 TWh (-15%), and it is likely to keep falling as the amount of subsidized production grows. At the same time, the amount of conventional, non-subsidized capacity has grown from 39,900 MW in 2000 to 53,700 MW in 2010.

This means that conventional generators face a growing difficulty in recovering their fixed costs. In a competitive market this would not be a “social” problem—non competitive generators would just fail. But in the kind of crony capitalism which is created when politics becomes the most influential variable, conventional generators also find it convenient to knock at politics’ door: so they are calling for a “capacity payment” scheme to be introduced, in order to maintain under-used, “reserve” capacity at the expenses of consumers.

Italy’s experience is sad but it is also an occasion for others to learn from our own mistakes. It is sad because the kind of competitive market that we created in the past decade is going to be disrupted by conflicting or concurring requests to get more subsidies (which, in turn, translate into a larger portion of the bill being determined by political or regulatory decision, and a smaller share depending on the actual supply and demand conditions).

Conclusion

Intermittent generation may be consistent with a liberalized market, as long as generators are required to bear all the direct and indirect costs of their production. Otherwise, competition is doomed to become an irrelevant feature of a system that becomes more and more politically driven. The UK, which is debating its new Electricity Bill, should be very careful in jeopardizing the benefits of competition.

5 comments

1 Jon Boone { 07.20.12 at 8:42 am }

“But in the kind of crony capitalism which is created when politics becomes the most influential variable, conventional generators also find it convenient to knock at politics’ door: so they are calling for a “capacity payment” scheme to be introduced, in order to maintain under-used, “reserve” capacity at the expenses of consumers.”

Since any modern grid requires firm capacity, and variable renewables like wind and to a considerable extent solar provide no capacity, “something” has got to give when wind and solar’s sputtering output is given the keys to the grid kingdom. Either consumers must endure unreliable production, with increasing blackouts the norm, or they must pay for one bloated, Rube Goldberg system at the cost of two–keeping firm generators in place while installing new firm generation to keep pace with any installed wind or solar on at least a 1:! basis.

Wind and solar, even in Italy, therefore are a boon to conventional firm capacity interests and a bane to consumers, since their supernumerary costs (which must include those for energy production as well as those to cover their tax sheltering functions) must be born by both rate and taxpayers.

Pitting renewables as somehow inimical to the marketshare growth of conventional capacity generation seems incredibly naive. That virtually every Big Energy corporation includes wind and solar in their “portfolios” these days should be a clue even to economists that something is rotten beyond the renewables situation in Denmark….

2 JavelinaTex { 07.22.12 at 8:09 am }

I am interested in what happens to overall power prices (usage weighted average) as renewables become a major share of generation.

I have been tracking ERCOT prices and this summer for the first time you are seeing price spikes in the Western Demand Zone where most of the wind generation exists while the normal high demand period prices in the other zones (where you have most of the conventional generation and the population). The discrepancies are huge (an order of magnitude). Overall average energy prices are higher; yes they can be very low at night, but when the demand is there the wind doesn’t blow.

My theory is that the wind generation makes it very difficult for any base load type power plant to be in service (under selling them), and puts all but peaking plants out of operation. the net result is huge price spikes in peak periods and higher overall average prices.

The logical conclusion is that you are going to wind up with only a simple cycle gas turbine providing power in peak periods & low or no wind; and wind the rest of the time.

3 Weekly Climate and Energy News Roundup | Watts Up With That? { 07.22.12 at 6:51 pm }
4 Carlo Stagnaro: Italy’s Solar Bust: Just Another Data Point | JunkScience.com { 07.22.12 at 10:11 pm }

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5 Jon Boone { 07.23.12 at 10:55 am }

Good to get your view, JT. Winding up with open cycle gas units in tandem with wind is something both AWEA and ANGA have both anticipated. But what a mess it would prove to be for the rest of us, as it is already in Texas. All that wind flux, which at roughly 30% of load on an annual average would be about four times more volatile and infinitely more unpredictable than load flux, would essentially be added to load as negative demand. On average, more than 70% of the installed wind would be output from the gas units. As you point out, often at peak demand times virtually 100% of the installed wind would be from those gas machines. But even if all that installed wind produced at 50% capacity at peak demand times, imagine how hard those gas units would be working to balance demand fluctuations while also pressed to balance a huge amount of wind skitter.

The gas generators would be operating in a highly inefficient mode, supplying and balancing demand as well as engaging the rather enormous ebb and flow of wind output. Hitched up in this way, how much savings of “fossil fuel” and consequent greenhouse gas emissions do you think a wind/gas tandem would achieve over and above the gas generators by themselves? Logically, in this scenario there would likely be more gas consumed–and more CO2 emitted–with such a wind/gas pairing than if there were no wind at all.

Those huge price spikes and higher overall costs would not be in service of the goals stated for wind/gas.

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