COLUMN-Ensuring back-up power when solar, wind fall slack: Wynn
By Gerard Wynn
LONDON, July 10 (Reuters) - Keeping ageing power plants in reserve may be a better way for European countries to deal with rising renewable power than more costly and elaborate energy market mechanisms.
Many European Union countries are investing in new power plants to replace ageing assets, to meet EU pollution limits and, in the case of Belgium and Germany, to accommodate a nuclear phase-out.
The trouble is that this increasingly urgent new investment coincides with an upheaval in European electricity markets as a result of ambitious renewable power targets for 2020 and an economic slowdown.
A shift to more wind and solar power requires flexible, conventional back-up capacity. On a still, cold, winter evening, for example, gas would have a faster response time to fill the gap than coal and nuclear.
Most European governments plan to intervene in energy markets - or already have - to ensure that new back-up capacity is built.
But that policy risks actually creating power shortages, if electric utilities postpone investment plans in the hope of getting a subsidy.
Renewable power, with its low marginal cost, has priority access to the grid. As its generation capacity increases, the role of gas-fired plants will shift more to providing flexible back-up power, which means their operating hours will tend to diminish and their profitability shrink.
They have already been suffering recently, partly as a result of the increase in renewables and also because of weak power demand and high gas prices.
The margin in Germany from gas-fired electricity generation, or so-called spark spread, has been negative for the past year, while in Britain, with its higher power prices, the margin has been only narrowly positive.
Chart on clean spark spreads:
Policymakers are worried that utilities may become increasingly reluctant to build gas plants as more renewable power connects to the grid and the profitability of gas-fired generation falls.
For gas plants to get a sufficient return on investment at times of peak demand when renewables are unavailable, wholesale power prices would have to be allowed to rise to extremely high levels.
Some generators fear that policymakers would then step in and cap prices, creating what is termed a "missing money" problem.
There are two basic approaches to solving the problem - using energy market incentives through a so-called capacity market or setting aside a strategic reserve.
Under a capacity market, the regulator would identify any shortfall in a country's back-up capacity three to four years ahead and arrange delivery through the existing energy market.
It could oblige electricity suppliers to pay for the extra capacity, buy the capacity itself, or invite bids from generators to make it available through an auctioning approach.
The extra capacity would continue to participate in energy markets, rather than being reserved just for emergencies.
Spain, Portugal, Greece and Ireland already have some kind of capacity market, while France, Britain and Italy are working on plans for one.
A strategic reserve approach is much simpler.
The network operator, for example, could buy generating capacity, possibly including older power plants nearing retirement, and set it aside for emergency use only.
Finland and Sweden have strategic reserves for deficits in spot electricity markets.
Germany allows grid operators to pay generators not to close older capacity in order to provide a reserve in winter. It has also discussed the possibility of moving to capacity markets in future.
One advantage of a bidding approach to capacity markets is that these auctions could be technology neutral and in theory drive down costs.
But capacity markets are elaborate. Complexities include deciding on eligibility, devising an auctioning platform or supplier obligation, and establishing market rules including penalties for non-compliance.
In the three years that Britain has been developing its electricity market reform, including a capacity market, its power supply outlook has deteriorated, watchdog Ofgem said two weeks ago.
That is partly because of the imminent withdrawal of 2,000 megawatts of ageing gas-fired capacity, which would appear a perfect target for a strategic reserve.
A strategic reserve is simpler, quicker to implement and would be separate to energy markets and so distort them less.
Even Britain's grid operator, National Grid, has questioned the need for a capacity market.
"Capacity payments, even if made via an auction which could help to find the best 'market' price, could prove unnecessarily expensive to consumers if inappropriately designed," it said in a memo to an "Energy and Climate Change" panel of lawmakers for a report published in 2011.
"The mechanisms currently employed by National Grid as system operator to procure balancing services could be extended or amended to provide additional back-up capacity."
Britain's Department of Energy and Climate Change (DECC) itself said a strategic reserve would be cheaper, in an assessment of impacts published last November.
"A strategic reserve has the advantages of being a small intervention in the market and of having a smaller impact on bills," DECC said.
"Although the modelled (cost) impact was more positive than a capacity market, the strategic reserve option was rejected on qualitative grounds. It does not address the 'missing money' problem. The latter problem in particular is seen as an enduring problem with energy-only markets and which will become more significant as the power sector decarbonises and as flexible capacity expects to run less frequently."
Given that Britain currently has one of the lowest rates of renewable power in the European Union, it could be argued that its plans for a capacity market are premature.
On balance, a strategic reserve is preferable.
And there are many ways in which countries can increase the efficiency of existing assets to complement such an approach.
Such measures include increasing cross-border interconnections to better link supply surpluses and deficits and using smart meters to improve demand response, when energy consumers have the option of lower tariffs during off-peak hours.
In addition, wind and solar farms could be forced to provide more balancing services - meaning they are taken off the grid when there is excess power supply - from which they have so far been excused under wider measures to support low carbon power.