Too much of a good thing

MUCH of Europe has seen an unusual development in the first half of this year in the electricity market: negative prices. This has been fuelled by explosive growth in renewable energy (RE) generation, with solar power being the main culprit. At the same time, there has been a significant drop in demand for energy. The mismatch between supply and demand has resulted in a record number of hours of zero or negative electricity prices in wholesale markets in Germany, France, Spain, the Netherlands, Finland and southern Sweden, according to market data from the London Stock Exchange Group.

The reason for this is quite easy to explain and one has to wonder why the energy market didn’t see it coming.

Solar power is booming in Europe because developers can easily secure power purchase agreements (PPAs) with distributors rather than relying on a subsidy model. We have the latter here in the Philippines, where the Department of Energy limits the amount of capacity that can be built within a certain time frame through the Green Power Auction Program, and the resulting electricity prices supported by the feed-in tariff fall too low below market prices.

In most European countries, they have managed to eliminate this – at least so far – due to the forecasted high demand, especially the specific demand for electricity from renewable sources. Accordingly, PPAs were indexed to the wholesale market price on the assumption that demand would remain relatively constant for the foreseeable future. From a generation developer’s perspective, an upfront power offtake contract is a safer revenue guarantee than the more speculative auction and subsidy model and, under normal expected circumstances, will generate higher revenues.

Of course, if the contract price is indexed to the market, the generator is tied to it if the market price falls, which was the case in Europe. Demand for electricity has fallen by a significant amount in many countries, largely due to much milder weather than the past two years of record heat. This alone probably wouldn’t be enough to push prices below zero, but because supply has increased so much, the decline in demand has had a disproportionately large impact. Renewable energy generators that are contractually obligated to sell their power have essentially had to give it up or pay distributors to take it, and the price crisis has spilled over to affect other generators as well.

At least it was good for the environment; there is a surplus of renewable energy, and although it is not available at all times of day, electricity distributors are still able to significantly reduce the amount of energy they buy from non-renewable sources such as gas, coal and nuclear. On the other hand, electricity consumers have not benefited significantly, although it is reasonable to assume that negative wholesale prices will result in much lower retail bills. As in this case, regulators are imposing limits on the extent to which individual elements of consumer bills can be adjusted to prevent bill shock. While this protects against sudden, unmanageable increases in electricity bills, it also works in the opposite direction and limits the possibility of reducing them in any given month.

All of this has several clear implications, the first and most obvious of which is that it will probably slow down the development of renewables. As one German utility executive put it, “We are in a situation where it seems that success is devouring its own children.” Some industry interests, notably the International Energy Agency, have cast the problem in a more positive light, pointing out that this makes investment in energy storage an attractive necessity. A related implication, although no one seems to have really noticed it yet, is that if there were enough storage, many of the assumptions about RE not being able to provide energy around the clock would be discarded. This is encouraging, but comes with the caveat that “sufficient energy storage” is still a hypothetical situation that would be difficult to achieve in practice, given the current state of available technology.

One suggestion that no one really talks about is that the current situation will very likely lead to a return to a more regulated model of capacity caps and subsidies for renewables in the future, at least in most countries. To the extent that anyone is willing to speculate on this – and they really aren’t, because most see this as a step backwards in the context of the “energy transition” – demand is the deciding factor. If this year is a bit off and demand picks up again to more “normal” levels, then renewables generation could continue at about the same rate as they are now. However, if demand remains weak, then serious rethinking of energy planning will be necessary.

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