The EU’s great power transition – the liberalisation and integration of its energy markets and the expansion of renewables – has reached a crucial stage. According to three seasoned energy experts, the EU’s energy project – one of the greatest missions ever to be undertaken by the European Union – has delivered some positive results, but it is also faced with mounting challenges – political uncertainty being the most prominent one. The transition, the experts warn, may still end up a failure, if policymakers don’t see it through.
Asked what they believe are the greatest benefits the EU’s energy policy has delivered, David Porter of research consultancy Navigant, Simon Hobday of legal consultancy Pinsent Masons and Tim Vink of Honeywell EMEA, agree that it has led to more competition, greater choice and more efficient use of capital. They also note, however, that the EU’s “Great Power Transition” has led to greater price volatility, instability and regulatory uncertainty.
In a roundtable discussion organised by POWER-GEN Europe 2014, the three advisors discuss the many pressing needs the power transition now faces: in particular, the need for investment in infrastructure, more interconnectivity, integration of backup capacity, development of demand response systems and more storage capacity. But perhaps the most daunting challenge today, they say, is the increasing uncertainty that seems to have crept into the political and regulatory process. As Hobday puts it, “many stakeholders have limited confidence in the business model being invested in. In many cases stakeholders aren’t clear whether they are going to be playing in the same game tomorrow as they are today.” In other words, things could still go terribly wrong.
Over the past 30 years European governments have been deregulating and privatising energy markets, separating generation, transmission and distribution: what have been the notable successes and challenges so far?
David Porter: De-regulation and privatisation has ensured competition in power generation and supply and delivered value to taxpayers, made capital investment more efficient, provided greater choice and lower wholesale and retail prices. However, transparency and, more importantly, volatility in prices continues to give consumers cause for concern.
Simon Hobday: One of the major benefits of deregulation has been the introduction of transparency around cost and, through liberalisation and privatisation, a focus on the efficient use of capital in the areas that are competitive. This has also ensured prices are lower than they otherwise would have been, by allowing greater efficiency.
However, while the network businesses see a stable but low rate of return of about 4-6 per cent (as they are a natural monopoly), the economic drivers behind research and development (R&D) don’t flow through in the same way. In the UK, the regulator Ofgem is addressing this issue with the introduction of a Network Innovation Stimulus as part of the move to the RIIO (Revenue = Incentives + Innovation + Outputs) regime.
Tim Vink: The biggest challenge has been to develop and implement a proper regulatory framework to ensure that reliable supply is guaranteed. Volatility in wholesale electricity prices means that new investment will require a risk premium that did not exist before. Possibly the most neglected issue is the role of Demand Response systems. What happens beyond the meter is just as important as the supply to it.
How will the evolution of Germany’s energy market influence that of other European markets, and what lessons have been learned?
Simon Hobday: In terms of the electrical system within Germany, a large number of wind farms have been established across northern coastal areas, placing increasing strain on the transmission systems of Germany and the ‘bootstrap’ corridors either side. This strain is due to the way in which the physics of wind power generation works: where wind speed varies in a short period of time in northern Germany, the concentration of wind generation affects voltage control and grid stability, with knock on effects on and fluctuations in pricing. Given the increasing interconnection of European power markets, this type of fluctuation doesn’t just affect Germany’s power market, but those of surrounding countries, because power prices interact with and flow across neighbouring countries and linked markets.
David Porter: Germany’s Energiewende (Energy Transition), like many political decisions about energy, has had unintended consequences. The phasing-out of nuclear power and the huge commitment to intermittent sources of renewable energy has led Germany to rely heavily on coal-fired power generation to maintain electricity supply and more coal-fired plant is being built. That makes it harder to reduce emissions.
As the experience in Germany has clearly demonstrated, incentivising weather-dependent renewables can displace the ‘on-demand’ conventional generation needed when wind and sunshine are not available.
A further lesson from the experience in Germany is that capacity is an issue when there is an increased level of intermittent energy provided via renewables. In the absence of large-scale storage, the more intermittent generation there is, the more back up capacity is needed. The role of an ‘energy-only’ market is being questioned because many energy companies argue that they cannot keep ‘on-demand’ plant available, or build new, if their running regime and income is going to be so unpredictable. (In an energy-only market, suppliers get paid only for the energy and ancillary services they deliver, not for installed capacity. Editor.)
Tim Vink: Potentially the biggest impact may be that Germany becomes a net-importer of power. That would require additional investment in transport and transmission infrastructure. The other concern is that as the cost of power increases, it may affect the competitiveness of German industry. If anything, these developments show that there is a need for a truly Internal Market for electricity.
“Ultimately a fully operational internal market for electricity is the only viable option, but it will take a decade or more to realise.” Tim Vink
How do you ensure energy independence when you need interconnectivity – is this a ‘catch 22’?
Tim Vink: These two concepts are not necessarily mutually exclusive. The first question to ask is at what level one wishes to have independence (I prefer the term energy security) – at regional, state or even EU level? Ultimately, a fully operational Internal Market for electricity is the only viable option, but it will take a decade or more to realise. In the meantime, it makes sense to focus on ‘natural’ regional clusters – e.g. West Germany, Benelux and East France.
Simon Hobday: Interconnectivity provides the ability to optimise the use of renewables in respect of local conditions (e.g. good offshore wind, or high potential for solar PV) and spread the risk posed to security of supply by external events – at a basic level, if the level of interconnection is sufficient in terms of capacity and geographical size, power can be transported to where it is required should there be no wind or if the sun doesn’t shine in one particular location.
In smaller locations without interconnectivity and high renewables penetration, additional greater degrees of non-intermittent back up are necessary to cater for maintenance, unplanned outages, or simply lack of the (primary) intermittent energy source than would be required in larger areas with better interconnection where the risk is more distributed. This means the premium that needs to be built into assets to mitigate a particular risk is lower and therefore economically much more efficient. Of course, there is a function around the amount of power that is lost through transmission, but that then becomes a case of location of plant and distance from load.
David Porter: Clearly, energy independence and interconnectivity are still matters of national security. Globally, few countries enjoy true energy independence, and most would want to avoid being ‘held to ransom’ by external parties controlling access to, or the price of, fuel.
However, it is important to recognise that there are a number of ways to deliver energy security and contribute to national security without being energy independent. Typically, energy politics suggests a diverse portfolio of fuel types for power generation, multiple sources of fuel, and multiple routes for sourcing the fuel, or indeed the power itself. France however, took a different view in the 1970s regarding security of electricity supply and to this day, more than three-quarters of its electricity comes from nuclear energy.
“It is possible to have much greater levels of physical interconnectivity of power networks between nation states without it becoming a question of political unification.” David Porter
What are the key challenges in realising greater interconnectivity, and what is more important: energy independence or unification?
David Porter: It is possible to have much greater levels of physical interconnectivity of power networks between nation states without it becoming a question of political unification. Even in a region of independent nation states, it is likely that greater levels of network interconnectivity between them would be desirable. Interconnectivity delivers resilience, and the diversification of energy sources consistent with the objective of national security. The EU, recognising the need for more cross-border interconnection to deliver a single electricity market, is encouraging this with financial support.
Tim Vink: Although I do not believe that the two are mutually exclusive, unification, as in creating a truly pan-European grid, may be more important than energy security, since it is critical in ensuring efficient power supply independently of the ultimate primary source of energy. Politically however, energy security certainly has a high priority.
Simon Hobday: Interconnectivity comes down to a mixture of different issues. One is the physical interconnection: if you are looking to have a market that spans areas with limited connectivity between them you can’t get the physical power flows to react to a market price signal over the wider area. A further issue is that legal and regulatory differences create barriers as do technical standards.
Barriers can also arise from localised vested interests, which can range from the political and regulatory, all the way through to commercial. These types of issues influence behaviour of individuals and entities in the sector, and hence those of the markets themselves. As such, interconnectivity, energy independence or unification all comes down to the same question: where is the line drawn on interconnectivity and independence? At the same time, any answer has both economic and political ramifications, with security of supply also coming into the equation.
“Market uncertainty has been a given ifor as long as the private sector has been involved. Significant political uncertainty however, is relatively new. It is resulting in reluctance to invest, and raising questions that many in the industry never expected to see in Europe.” Simon Hobday
While uncertainty in the market is nothing new, is change being forced too quickly on a system unprepared to deal with it?
Simon Hobday:Market uncertainty has been a given in the European power industry for as long as the private sector has been involved. Significant political uncertainty however, is relatively new to the energy business, and is not only resulting in a degree of reluctance to invest, but raising a number of questions around political risk that many in the industry never expected to see in Europe.
A growing number of banks, for example, are now questioning the market basis on which to model investments and hence what will make worthwhile investments, with the whole mind-set having changed because political uncertainty has altered the dynamics of the industry time and again over the last five or six years. Subsidies, for example, have been introduced, increased, reduced or even withdrawn with limited notice. There have also been numerous often unpredictable changes of policy regarding the type and manner of generation incentivisation.
So while market uncertainty is a given, and markets are adept at harnessing predictable change, difficulties have in the past few years arisen from political uncertainty and the framework within which the markets are meant to operate. Stakeholders in many cases aren’t clear whether they are going to be playing in the same game tomorrow as they are today, and with limited or no confidence in the business model being invested in, it is not surprising to see a reluctance to invest.
Tim Vink: I do not believe that it is the pace of change, but rather that change has been erratic. The key challenge for stakeholders is to have a steady, long-term planning horizon. That can (and must) be fixed. The European Commission’s paper of last year (Delivering the internal electricity market and making the most of public intervention) is an excellent starting point.
David Porter: It is worth distinguishing between two types of change: those which are evolutionary (and would have likely happened anyway regardless of policy); and those which are transformational (driven by policy to meet external factors such as national or political commitments to CO2 reduction).
It really depends on how quickly you want the outputs that the changes will deliver. This is a matter for government policy, which has to balance the desirability of the outputs such as security, decarbonisation and affordability, with risk, efficient delivery of infrastructure and best value for money.
To hear more about some of the critical issues forming the heart of business and political discussion, the forthcoming POWER-GEN Europe conference being held in Cologne on 3-5 June 2014 is the place for the power industry to meet, share information and do business. Track one of the conference looks at strategy for a changing energy sector, with a session on Wednesday 6 June dedicated to decentralised generation and system integration.
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David Porter is a Senior Adviser to the Navigant’s Global Energy Team. He has more than 25 years’ experience with UK energy policy issues and is well-known as a commentator on energy matters and a former trade association Chief Executive.
Simon Hobday is a Partner at Pinsent Masons, he specialises in the regulatory and commercial energy sector advising energy companies, regulators, governments and commercial companies. Simon advises on regulatory compliance and market development, energy projects (nuclear, CCGT, wind and solar) and Community Energy Solutions, including ESCO/MUSCOs and energy performance contracting.
Tim Vink is Director of Regulatory Affairs, Compliance and QA with Honeywell Fluorine Products Europe, Middle East & Africa and adviser to Honeywell’s UOP Renewable Energy & Chemicals business. He holds leading positions in Industry Bodies such as the European Fluorocarbon Technical Committee (EFCTC), EPEE (European Partnership for Energy and the Environment) and CEFIC. He also chairs the Fluorocarbon REACH Consortium Coordination Group.