COLUMN-EU polarised on how to avoid blackouts: Gerard Wynn

Fri Nov 23, 2012 9:19am EST

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(The author is a Reuters market analyst. The views expressed are his own.)

By Gerard Wynn

LONDON Nov 23 (Reuters) - The European Union's executive Commission has spelled out clearer opposition to state intervention in domestic electricity markets even as countries including Britain, Germany and France propose capacity markets.

A decision over how and whether to intervene in power markets is central to how the EU manages more intermittent renewable power, retires ageing coal and nuclear fleets, avoids blackouts and limits hikes in retail bills, all at the same time.

This comes against a backdrop of falling credit quality of utilities as poor demand and more intermittent renewables suppress peak power prices, posing the risk of under-investment in baseload thermal power to balance wind and solar when these are unavailable.

Under its "internal energy market", the Commission believes blackouts can be avoided by bolstering cross-border gas and power transmission capacity, sharing and thus balancing risk more flexibly between countries.

By contrast, several member states want to prop up their national energy security by focusing on domestic schemes to buy generating capacity several years in advance of delivery to maintain safety margins.

Britain on Friday confirmed its plans for such capacity auctions. Germany and France are also considering these.

Various kinds of capacity markets already exist in the United States, Russia, Spain, Portugal and Greece.

The present EU debate presents polarised notions of how to avoid supply shortfalls - by increasing self-sufficiency or deepening shared capacity.

The answer is likely both, where interconnection can make better use of existing resources and limited capacity markets can target extra, dynamic capacity to deal with renewable power intermittency.

CRITERIA

The European Commission last week launched a consultation on proposed powers to block capacity markets.

It suggested a combination of continued, liberalised power markets (where private sector investment is driven by wholesale power prices) plus more investment in interconnectors could maintain generation margins.

"Security of supply has often been considered primarily on a local basis. However it can also leave individual Member States to use very conservative assumptions or even discounting the potential for cross border solutions to generation adequacy issues despite increased integration of systems and markets," it said.

"Member States who continue to rely on normal internal market rules are affected by the capacity mechanisms implemented in their neighbours, and might even feel compelled to intervene on their own markets to compensate for the effects of decisions in their neighbours."

The Commission's concern is that measures to boost domestic security will curb cross-border electricity flows and investment in interconnector capacity.

It proposed detailed criteria for allowing capacity markets, including where a country would first demonstrate satisfactory investment had been made in interconnectors and demand reduction.

"The necessity for a capacity mechanisms should be clearly established in the context of ... increased interconnection and ... alternative, less distortionary measures which could be taken, for example steps to improve energy efficiency or reduce electricity demand," the consultation document proposed.

PLANS

Britain on Friday forged ahead with plans for a capacity market in its forthcoming energy bill to help the country cope with the retirement over the next decade of a fifth of its generating capacity.

The market would involve administrators deciding future capacity through auctions or regulated payments.

"(Energy regulator) Ofgem and (transmission operator) National Grid will forecast where there could be shortages in supply and, if needed, auction for capacity in advance to ensure we have enough energy backup to meet consumer demand," the Department of Energy and Climate Change said in a statement.

As an island Britain struggles to fit the Commission's notion of security through shared risk, and may fail criteria based on interconnection.

The country ranks fourth from bottom among the 27 EU member for cross-border capacity, by megawatt (MW), ahead of Malta, Cyprus and Lithuania (See Chart 1).

Britain has around 3,000 MW of cross-border capacity, compared with 30,000 MW in France, according to the Commission.

Its interdependence is set to increase over the next decade, but fairly modestly, with plans reported by the consultancy Redpoint for two more cables linking to France in 2015 and 2018 (totalling 1,500 MW), to Belgium in 2020 (1,000 MW) and Norway in 2022 (1,300 MW).

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Chart 1: link.reuters.com/dux24t

Chart 2: link.reuters.com/fux24t

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MISSING MONEY

It is not just geographically isolated countries which may argue for a capacity mechanism.

The underlying motivation is the concept of "missing money".

Because renewable power has zero fuel costs it has zero marginal cost and therefore earns priority ranking (merit order) in grid access, suppressing wholesale power prices when it is available.

Operators of baseload including gas and coal can only recoup fixed costs by charging ever higher prices when renewables are unavailable, prices they suspect governments will cap to protect end users, creating "missing" returns.

This could discourage investment and leads to concerns of a supply gap.

More interconnection alone cannot solve the problem, if it simply makes more countries dependent on variable renewable power.

For example, France and Germany both saw exceptionally high wholesale gas and power prices last February when a slump in German wind power output coincided with peak French electric heating demand. (See Chart 2)

Capacity markets may not be the answer either, however, unless they can prioritise a particular type of power generation, which is extra-flexible, gas-fired capacity to balance rapid changes in renewable power, as well as rewarding energy-intensive users which can switch off some demand at peak times, called demand response.

One answer could be limited capacity markets to drive additional, flexible supply and demand response coupled with efforts to make more use of existing generating resources through more energy storage, improved renewable power forecasting and more cross-border interconnection.

(Reporting by Gerard Wynn; editing by Jason Neely)

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