“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).
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.