Turkey’s rules for an electricity price ceiling may be well intentioned, but they are creating a price ladder that is causing those prices to rise too fast and too much, say Fuat Oğuz at Ankara Yıldırım Beyazit University and Çağrı Peker at the Energy Market Regulatory Authority, Turkey. When market participants are allowed to sell and buy electricity at distorted prices the effects of external shocks are amplified artificially. The main shocks are the spike in global gas prices and Turkey’s collapsing currency – especially painful for any nation that’s heavily dependent on gas (and coal), imports all of it, and has to buy it with foreign currency. The authors carefully summarise the price ceiling mechanism, and those external shocks. A better price ceiling model and renewables support mechanism are needed. Add to that gas supply diversity, and real incentives to increase electricity generation productivity.
Turkey is in the middle of a deep currency crisis, which started in September 2021. Prices are soaring in every corner of the weakening economy. Electricity markets also bear the consequences of worsening economic conditions. The ongoing currency crisis exacerbates the unintended consequences of not having a competitive power market.
The graph below shows the change in the day ahead market clearing prices in Turkey. A close examination of price changes show that the government does everything to keep prices from going beyond a certain level, using a price ceiling model and other mechanisms to keep electricity prices under control. The graph below clearly shows the government intervention via price ceiling for the last six months.
While there have been a number of reasons for price hikes in power markets recently, the ongoing currency crisis pushes the political control of prices to the limit. The foreign exchange rates increased substantially in the last two months, shattering all past records.
The rise in foreign exchange rates forces the government to monitor and control electricity prices more closely.
Price ceiling policy began in 2015 and was used as a circuit-breaker to stop prices to skyrocket unexpectedly. According to the price ceiling model, the maximum price can’t go over the thrice the average of the last year. A number of issues interact and create an upward spiral in prices. In the rest of this article we will look into these issues.
Ongoing currency crisis
Along with the exchange rate, wholesale electricity prices have also been rising for the last few months. The effect of the currency crisis can be seen clearly in the market-clearing prices in the market. The following graph indicates the gradual increase in real exchange rate. While the government implemented a new policy to control the free fall in the value of the Turkish Lira, the impact of the new policy on prices remains uncertain.
Dependency on imported natural gas and imported coal
The electricity generation in Turkey depends mostly on imported sources such as natural gas and imported coal. The share of natural gas in electricity generation plants increased substantially during the last year. At the end of November 2021, their share increased from 22% to 32.8% in comparison to the same date in 2020. This is the highest number in the last three years. When you add imported coal that takes around 16% for the end of November, the import dependency is around 49%. So any increase in foreign exchange rates raises generation costs and puts pressure on wholesale prices.
Since the price is determined on the margin, natural gas prices determine the direction of wholesale electricity prices. The close correlation between the price of natural gas and electricity price shows the direct result of the dependency on the natural gas power plants. The share of hydro plants fell to very low levels and is expected to remain low for the winter. This grim weather outlook will also increase the dependency on natural gas power plants. Imported coal prices that depend on currency also deepens the crisis
The high dependency on natural gas power plants has its own drawbacks other than just reflecting currency crises. As the cost of generating electricity in natural gas plants is higher than many other alternatives, the effect on wholesale prices will be magnified. Similar to Turkey, Elspot wholesale electricity markets show similar behaviour because of the increasing marginal cost of production due to natural gas prices. The price of natural gas in international markets increased as well. It adds to the existing troubles of the existing issues in electricity generation in Turkey and Europe.
Gas for heating, not just electricity generation
Turkey imports all of its natural gas. It is used for heating as well as electricity generation. Thus, any problem with supply would require sacrifice in natural gas for electricity generation and/or heating. Historically, electricity generation is sacrificed first during winters where the demand for heating purposes increases substantially. The limited availability of storage facilities aggravates the negative impact of the external shocks such as colder than expected weather conditions.
Dutch TTF gas hub price
Last year, Turkeys’ long-run natural gas contracts capacity was fully used and Turkey imported LNG based on the Dutch TTF gas hub price. Therefore, in the second half of 2021 the natural gas prices in Turkey quadrupled due to the crisis in Europe following the tensions with Russia. These price increases affected natural gas power plants, households and industrial users.
The positive developments in the European energy crisis reduced the Dutch TTF hub price during the last days of December. This will alleviate the natural gas price problem in Turkey faster than expected as the currency crisis in Turkey somewhat lost steam.
The distortive feed-in tariffs
While the dependency on natural gas appears to be the major issue, the substitution of natural gas power plants with hydro plants would not change the outcome much. The renewable energy support mechanism pays power plants based on US cents, mostly at 7.3, 10.3 and 13.3 cents/kwh. Thus, the prices would still jump to a very high level. They would follow the feed-in tariff channel rather than natural gas channel.
Turkish electricity market prices have become distorted in the last few years as a result of the faulty design of the renewable energy support mechanism (aka YEKDEM in Turkish). The existing merit order system, along with USD based guaranteed rates allow renewables to ignore market signals. They transfer the cost of generation to customers as no incentive for productivity increases exists for them.
While all these issues make it difficult to establish an efficient generation market and put pressure on wholesale prices, the price ceiling model used by the energy regulator deepens the effects of these factors. The price ceiling mechanism keeps a high cap on prices. The maximum price is determined by the threefold rule: three times the last year’s average market-clearing price. The average market-clearing price is coming closer to the maximum price very quickly, as the rise in foreign exchange rates triggers other cost distortions in the market.
The Last Word
The current price ceiling model creates a price ladder where prices are suppressed to keep prices rising too fast and too much. An inefficient price ceiling model encourages market participants to sell and buy electricity at distorted prices.
As a result, the effects of external shocks are amplified artificially. The government works hard to keep electricity prices under control. While some external shocks play a role, most of the worsening is its own making.
During the last year, high dependency on natural gas, due to poor supply diversity, a faulty renewable support mechanism that is vulnerable to currency volatility, and an ill-designed price ceiling model affect the health of the wholesale market negatively. Negative impacts of the Covid-19 pandemic forced the government to put political preferences over economic efficiency in power markets.
The Turkish experience shows that a high dependency on natural gas, imported coal, and currency dependent renewable support mechanisms along with a very thin foreign exchange reserve may create an upward spiral in terms of electricity prices which would trigger cost increases in the economy.
Fuat Oğuz is Professor of Economics, Ankara Yıldırım Beyazit University, Turkey
Çağrı Peker is an Energy Expert, Energy Market Regulatory Authority, Turkey