Wind Turbines in Spaniards Electricity Bill

Transcription

1 Wind Turbines in Spaniards Electricity Bill Alejandro Velez Isaza Energy Economics and Policy ETH - Zürich

2 Introduction Electricity has become one of the most important products we use in our lives. We could say that it is a necessary good and we have lost the ability to carry out a normal day without it. Nevertheless, we are not always aware of the infrastructure behind the delivery of electricity for our everyday use. The fact is that we pay a price for this electricity and for all the processes that make it possible. The production and commercialization of electric energy are industrial activities that have been around for a long time. However, recently we have as a community started to be concerned about the processes which deliver electricity in terms of environmental impact. Renewable sources of energy for the production of electricity are a hot topic today and will be in the near and far future. Every country has responded to technological development in the renewables sector differently. Spain, as an example, has placed a bet on wind energy to produce electricity. In 2010 about 15% of electric energy was generated with wind turbines. In the light of the massive entry of renewables and especially wind energy in the generation of electricity, we will discuss the effect this has on the price the final consumer pays when turning on the light. The paper will start with a discussion of the electricity generating industry, including its liberalization in 1998, the operational aspects of the market, the policies concerning trade of wind produced electricity, and a short comment on the market structure. All these elements are relevant for the model set up and analysis conducted in section 2 about the effect of wind energy in the electricity bill of a domestic consumer. The analysis will be done by exploring each element comprising the final price of electricity and its relation with wind harvested energy. The paper concludes with a short argumentation of the value of the analysis and with some recommendations for future work.

3 1 Electricity production in Spain With 2020 closing up, European countries see the agreements of producing 20 % their energy pressing on. Each country has approached the situation according to their strengths and opportunities. Spain has placed a bet on production of electricity with renewables such as wind and photovoltaic. The bars in Figure 1 show us the situation on energy consumption for As we see, Spain is not there yet with the 20% and is still highly dependent on imported resources such as oil. In 2001 Spain imported 62% of the total energy it consumed [Dahl]. On the other hand, in the electricity production, the Iberian country scores very well in the use of renewables: in the same level as natural gas, renewables accounted for 33% of the production of electricity. With respect to 2009 Spain has seen a strong increase in the final consumption of gas (13.2%), coal (18.6%) and renewables (11.3%), especially biogas, and solar thermal. It has also experienced a moderated increase in the consumption of electricity (2.1%) and final energy (2.3%), although the bigger picture shows a drop of the economy of -0.1%. Primary energy and electricity production per sector Electricity production (300.2 GWh) Primary energy (1534 GWh) 11% 33% Coal Oil Natural Gas Nuclear Renewable Figure 1: Distribution of primary energy and electricity production per technology (graph elaborated with data from the Spanish Ministry of Industry, Tourism and Commerce [MITYC]) Renewable production of electricity is therefore becoming one of Spain s most ambitious projects for the coming years. Wind accounted for 45% of all the renewable production of electricity [MITYC]. As of figures from 2010 almost 15% of the electric generation was produced by wind turbines. On the 9 th of November 2010 wind energy accounted for 46% of the electricity production in the whole peninsula [REE].

4 1.1 The economics of the Spanish electricity market and its liberalization The electricity industry is a complex one with many stakeholders and segments. In the electricity industry of many industrialized countries we can distinguish two time periods divided by a historical moment referred to as the liberalization of the electricity market. The liberalization of the market is especially relevant for the Spanish wind energy and for renewables in general, since it reinforced policies which tried to promote investment in the sectors. Before liberalization, the Spanish electricity industry was mainly composed of vertically integrated firms that controlled all three main segments of the industry: generation, transport and distribution. Due to its structure, the oligopolistic electricity industry was composed by firms that reflected natural monopolies. As we can see from Figure 2, in a natural monopoly there is a deadweight loss (black dots area). Figure 2: Dead-weight loss in a natural monopoly [Thompson] The idea behind having the natural monopolies, incurring in social welfare undesirable consequences, was to maintain a stable system where investments could be done without compromising the financial health of all the stakeholders. The revenues from the sales of the electricity were redistributed among the concerned firms in order to cover at least all incurred costs. The government, on the other hand, had an organizational role. It had, for instance, the tasks of constructing new network infrastructure or planning construction of new generating capacity. For the incumbents, this closed type of industry with fixed retributions, was also an incentive to reduction of costs since this then translated in an increase

5 of profits. In this configuration, however, the end consumer did not see in the least any increase in welfare due to industrial advances[agosti]. In 1998 the liberalization of the electricity generation sector started. The idea behind this process was to open up the segment of generation and turn it into a competitive market. In theory this would suppose an increase in the economic efficiency of the industry and the social welfare. In the idealized case, there is no deadweight loss when the industry is organized as a perfect competition (Figure 3). The objective of the liberalization was to move the industry in this direction. Figure 3: Perfect competition, no dead-weight loss. [Flatworld] Liberalization of the industry is sometimes referred to as unbundling or deregulation. The latter tends to be somewhat misleading and confusing. After 1998 the only segment of the industry open up to competition was generation, meaning that transportation and distribution were still to a certain extent natural monopolies with need of regulation. Apart from this, since the liberalization many policies regulating the electricity purchased and sold in the new open market have been created. We will explore one of these in the coming sections and see how some of its effects on the market Trading electricity in Spain The market is the one where the price is established at which the generation units sell their electricity to the distributors. The market

6 operator called OMEL (Operador del Mercado de Electricidad) accepts two mechanisms through which transactions occur [Agosti]. Bilateral contracts. This type of transaction occurs directly between an electricity generating firm and a distributor such that no other third party can influence price or quantity. Pool. This market is structured such that supply and demand are matched successively until an equilibrium price is reached. There are two different types of markets in the pool The daily market. This market determines the marginal price of the market (equilibrium price) and the dispatched quantity for every hour the next day by matching supply and and demand. The intraday market. Since the daily market is based on a one day lead forecast, the intraday market gives the chance of correcting for discrepancies the same day, especially in the demand of electricity. The intraday market occurs several times during the same day of dispatch. This market is especially relevant for wind energy due to the difficult task of forecasting wind production. When the markets are carried out the generating companies make several bundles of a certain quantity of energy that they offer at finite price. Analogously, the distributing companies make offers for purchase. The offers are ordered forming aggregate supply and demand curves Policies to promote investment in wind energy Renewable sources have historically been promoted with financial incentives established by the government. The Spanish policy concerning support schemes in the wind energy industry are several. In the domain of electricity generation Spain bets for a price-driven regulatory mechanism. Inside this mechanism we can distinguish two different approaches: A fixed regulated feed-in-tariff This consists of paying the electricity at a predefined price independent of the market equilibrium. The electricity has, in any case, to be bid in the market at zero price for further matching and setting of the marginal price in the market. There are two different tariffs as specified by Royal Decree 661/2007 (Real Decreto 661/2007) [ReDe]. First 20 years: 7.32 c /kwh From 20 years: 6.12 c /kwh There are several modifications to the Royal Decree but we will keep these tariffs in mind as a reference for the subsequent analysis. A fixed premium In this scheme the generating unit gets paid the marginal price of the market plus a premium. The revenue of the plant owner is therefore dependent on the volatile market equilibrium making it more difficult to predict income. As collected in the aforementioned Royal Decree, if the producer opts for the premium option, she will only receive the premium the first 20 years

7 at a value of 2.93 c /kwh above the market price. A cap is placed at 8.49 c /kwh and a floor at 7.13 c /kwh [ReDe]. Incentives presented in this form have a twofold purpose. They promote investment in special regime technologies such as wind energy and PV. If the marginal costs of production falls under the price + premium or FIT, then the surplus is supposed to recover capital costs of investment. On a second level, generating technologies that can apply to these premiums and FITs enter the market bidding at zero. This creates a priority order of dispatch not necessarily determined by the merit order curve which we will explore in page 12. The end result is that more electricity from renewable sources is dispatched and governments can better predict their accomplishments in agreements such as the Kyoto Protocol and the 20/20/20 European. 1.2 Who are the big players and how is the Spanish electricity industry structured Concerning the industry structure, the unbundling of the sector occurred at a moment where the biggest firms had a strategy of market conquer and several acquisitions took place. This meant that concentration of the market was especially high at this moment. To be more concrete, the two biggest companies, Iberdrola and Endesa, accounted for around 55% of the whole installed power in Spain. After the change, the industry was mainly still comprised by the same highly vertically integrated companies but with the difference that the generation sector was open to competition. Table 1 shows the state of the industry in terms of installed capacity in Spain in 2004, six years after the change. To have a measure of the concentration the Herfindahl-Hirschman Index (HHI) is calculated in terms of capacity and production and shown at the bottom of the table. Remembering that monopoly corresponds to HHI = 10,000 and perfect competition corresponds to HHI = 0, we see that the electricity generation market can be properly referred to as a fairly concentrated oligopoly.

8 Firm Installed Capacity (GW) Share of capacity Production (TWh) Share of production Endesa % % Iberdrola % % Union Fenosa % % Hidrocantabri co % % Gas Natural % % Others % % Total % % HHI Table 1: Shares of biggest firms in electricity industry in terms of installed capacity and production [Fabra]. HHI showing the concentration of the industry In the renewables sector the liberalization of the generation market meant that private investors could enter the market and incentives to invest in this sector were not only driven by governmental subsidies but also by market competition. In this way any farmer with some savings could invest in a wind turbine and sell the electricity in the generation market. In practice, this does not really happen. Small incumbents are represented in the market by bigger firms to lower the complexity of the market and increase efficiency. 2 Wind energy: from generation, commercialization to consumption, what does this mean for a domestic user Wind energy comes into the electricity industry in the generation segment through the firms mentioned in the previous section. The end user, however, comes into contact with electricity all the way at the end of the line during consumption. To find the relation between the two we have to explore all the elements in between as well. This is not a one way path, since we need to take all the other parties involved into consideration. Electricity generation is, for instance, sold in the aforementioned liberalized market which fixes prices depending on supply and demand.

9 2.1 Building up of the electricity price Let us start, however, by exploring the composition of the cost of electricity for the average Spanish domestic consumer. The final price of electricity can be decomposed into three main parts: access costs, payment for capacity availability, and energy price as set by the generation market. Figure 4 shows this division with some more detailed specifications. In terms of wind technologies, we see that it does not directly appear in the figure since each the components is influenced in a different way. We will model each of them and from there explore the overall effect. In the process we will also learn how the Spanish electricity market works. 21% Distribution of electricity price for a domestic consumer 7% 2010 Access: Premium renewables 36% Access: Others Capacity payment Energy costs: daily market Energy costs: intraday and bilateral 35% 1% Figure 4: Build up for price of electricity for an end domestic consumer (constructed with data provided by Mejia) Payment for capacity availability The payment for capacity availability is included in the price with the objective of promoting investment in generation units and ensuring enough installed capacity to cover unexpected demand. This part of the cost of electricity goes to an annual fund that is distributed among the generation units depending on their capacity availability. The payment for capacity availability has varied with the years, but it it corresponds to a premium to generators of about c /kwh [Fabra]. Wind generators receive payments for capacity availability, but as we see from Figure 4 for the end consumer it only represents 1%. An even smaller percentage goes to wind turbines. As we will see in the coming pages, the relevant effects for the end user come from access costs and the price of

10 energy traded in the liberalized market. We therefore, neglect the payments for capacity availability in our calculations Traded electricity price Let us now recall the first part of this paper discussing the liberalized electricity generation market. From the three mechanisms used by the OMEL for electricity trading, the daily one is the most important. About 85% of all transactions occur in this market. Nevertheless, we will discuss if the energy traded in the intraday market is relevant for the analysis. We start by seeing how the market evolves in a typical day. The diagram depicting how this happened for the 1 st of December 2010 at 1am can be seen hereunder in Figure 5. We will take this day and hour as reference and carry out all calculations keeping this date in mind. The solid lines in the figure correspond to the daily market, while the dotted lines show the trade including intraday market. We see that equilibrium price and final dispatched electricity do not vary greatly. Where we do see a difference is in the supply curves. The curve has apparently a shift to the left. As we will argue later on, this could be attributed to an overestimation in the forecast for production of technologies generating at very low cost. One hypothesis would be that wind did not blow as expected and the wind turbines could not deliver the expected energy. In any case, the overall picture shows no major change in the equilibrium point. We will, therefore, neglect the effect of the intraday market and the bilateral agreements in our model and consider only the solid lines in the figure corresponding to the daily market for our analysis.

11 Market curves for 1st of December 2010 Price Euro/MWh Energy MWh Matched supply Matched purchase Purchase Supply Figure 5: Supply and demand curves for the electricity market. Red and blue lines correspond to the daily market. Yellow and green correspond to final sales and purchases including intraday market. (constructed with data from OMEL [OMEL]) This diagram, however, does not directly tell the technology used for generation. To have an approximation of how much energy is produced per technology, we can relate the supply curve here above with the production costs of all technologies involved in generation as shown in Figure 6. The latter curve is referred to as the merit order curve. In a perfectly competitive market the aggregate supply curve is built upon the marginal cost of all the incumbents. In this way we can relate the two curves and assume that the offers made by the suppliers give the operation costs of each technology. In this way we can say that the aggregate supply curve corresponds to the merit order curve. If this was not the case, and incumbents would bid their energy at a higher price than marginal costs, they would risk not selling their energy if equilibrium would fall lower than their bid. As we can see in the merit order curve, wind energy enters the market supply at very low price. The short run marginal costs of an electricity generation plant are given by operation, maintenance and fuel use. For wind energy, these costs are very low almost zero. Just to clarify, it should be noted that the capital costs of the infrastructure in perfect competition are regarded as fixed costs and therefore have no influence in the marginal cost of production. Even though in reality this is not the case, and an investor does take into account capital costs, depreciation and many other financial aspects into account when bidding its electricity, with the current policy for wind energy, these considerations are not relevant. As

12 we saw in the investment promotion section, the Spanish incentives for wind energy consist of feed-in-tariffs(fit) or premiums over the sold electricity which require electricity to enter the market at zero price. Figure 6: Merit order curve showing the marginal costs of production of different technologies[krohn] To explore the effect of wind energy on the market price we take the reference day(1/12/2010) at the reference hour(1:00) and see what was the percent of electricity produced by wind energy. As we see in in the pie chart of Figure 7 wind accounted for 18 % of the total production. With data from OMEL we can reconstruct the daily market supply and demand curves with and without the 5.1 GWh (18% of total production) corresponding to wind energy. We assumed that the buying firms do not modify their behavior such that the demand curve stays the same and only supply shifts. The resulting diagram can be seen in Figure 8. The supply curve has shifted to the right leading to an increase in price and a decrease in quantity traded.

13 Figure 7: Electricity demand. Real(yellow), supplied(green), forecast(red). Pie chart giving distribution of generation per technology and indicating the wind energy contribution(light green). Other colors correspond to nuclear(purple), coal(red), combined cycle(yellow), hydro(blue), other in special regime(dark green), and international import(gray). The bottom left graph shows the wind energy variation through the whole day [REE]. Daily market with and without wind Price Euro/MWh Energy MWh Modified supply Purchase Supply Figure 8: Increase of price and decrease in supplied quantities with no wind energy generation

14 A summary with the difference between the properties at the two equilibrium points is shown in Table 2. We see that in relative terms, the amount sold decreased greatly and we can attribute this to the inelastic nature of the demand curve at every point on the curve. Inelasticity of demand is also responsible for the greater increase in the marginal price of the equilibrium. On the other hand we have the supply curve, whose shift occurs in a relatively elastic region and therefore dampens the effect in price increase. The technologies (probably combined cycle) that define the marginal price have a large contribution to the supply and fairly constant marginal costs resulting in low elasticity of supply. This results in that with the reduction in supply, there is no need for new technologies producing electricity and the technology (combined cycle) fixing the marginal price remains the same since it has enough capacity to cope with the reduction in power. Before continuing with the analysis we should make a small remark concerning the structure of the industry. As we have mentioned before, the Spanish structure is still vertically integrated such that firms like Endesa or Iberdrola are prone to maximize their overall profit by arranging their bids in the market for both supply and demand. These companies would probably change their buying behavior in the case that they did not own any wind parks. In this case, not only would the aggregate supply curve shift but also the demand curve. We can, however, safely assume that supervision is strong and these firms strictly follow the rules of the liberalized market such that they behave competitively and keep their generation and distribution departments independent. Situation Quantity (GWh) Price ( /MWh) Price elasticity of demand Price elasticity of supply Real No wind Difference 518 MWh Table 2: Effect of wind produced electricity on equilibrium price and traded energy The extra /MWh coming from the reduction in wind generation is not entirely passed on to the end consumer. This effect can alternatively be interpreted as the levying of a tax on the generating units. The effect on sellers and buyers depends on the elasticities of supply and demand. We are however, interested in the end consumers influence. For this we turn to Figure 4, where we see that the daily market price constitutes 36% of the cost of electricity for the end consumer. In monetary terms this means an increase of 4.2 /MWh in the electricity bill.

15 2.1.3 Access costs The access costs are the third component that makes up the total price an end consumer pays for the electricity. This contribution covers the costs incurred by the whole electricity industry after market trade. As shown in Figure 9, 38% of the access costs were destined to paying the incentive schemes (premiums and feed-in-tariffs) of the renewable energies. A study from 2009 shows that the incentives for wind energy constituted one fourth of all the premiums payed for renewables [AEE]. This results in a final 10% of the bill accounting for premiums going to wind generation. Distribution for the access costs in % 10% 38% 2% 30% 9% Deficit previous years Fixed costs Commercial management Distribution Transport Premiums renewables Figure 9: Build up of access costs(constructed with data from [Mejia]) For the analysis of the effect of wind energy on consumer price, we consider the change in the final price in the two extreme cases in which all firms opt for one or the other incentive schemes described in section FIT: Firms are on the conservative side. They receive a fixed amount of 7.32 c per kwh sold on the daily market independent of the market marginal price. Keeping in mind the 10% contribution of the wind energy premiums to the final electricity price, the end consumer sees c /kwh of its electricity bill contributing to wind energy FITs. Premium: Firms are less risk aversive and forecast the electricity price will always be higher than 4.93 c /kwh (FIT - premium). For the reference day, however, the price + premium is 6.7 c /kwh which is lower than the set floor. The plants get paid the floor price equal to 7.13 c /kwh, which means c /kwh contribution from the end consumer.

16 2.1.4 Final effect on the end consumer The combined effect of variation in the end consumer's cost due to access costs and supply curve shift can be seen in Table 3. Independent of the incentive scheme the incumbents choose, the average domestic consumer paid more for its electricity due to the presence of wind generators on 1 st of December The increase in price accounts for only 3% of total this person pays for the electricity. Price compon ent /MWh Market marginal price FIT Incentive scheme Premium Access costs Total increase Table 3: Increase in final price due to wind generated electricity presence in the grid Many articles and papers contradict our results and argue that wind energy has a price reduction effect. With the model used here we can see how this can actually be true. In the situation we considered, the reduction coming from the shift in supply was not enough to cover the premiums. We could expect this by looking at the high elasticity of supply in the daily market at the equilibrium point (Figure 8 and Table 2). In the hypothetical case that the daily market equilibrium had been reached at a point further to the left corresponding to a lower price (because there was more special regime generation for example), the tax effect in the market marginal price would have been much larger. When shifting the supply curve we would have moved across the very inelastic section of the supply curve corresponding to a change in technology in the merit order curve. We would have therefore reached a much larger price increase. 3 Conclusion The result of the analysis showing an increase in the final electricity price can be attributed to many of the discussed factors throughout the paper. Since the liberalization of the industry aspects like competition and social welfare have been attempted to improved. However, some aspects remain the same, vertically integrated incumbents for example. The analysis of the market shift by reducing the supply of wind energy have shown that the policies of FIT and premiums given to wind generators suppose a slightly higher economic load for the consumer than the benefits from the

17 low production costs. The causes of the low benefit have been identified in the high elasticity of supply for the specific day and specific hour chosen for the analysis. In its turn, the low elasticity comes from the fact that with the reduction in power, the same technology fixes the equilibrium price of the market. Two are the steps that can be taken to analyze more deeply the question at hand. First, the analysis should be done with a market averaged over a whole month or even a year. In this way, the variable nature of wind energy can be discarded. Second, it would be interesting to take a different approach and explore the consequences of an increase in wind energy production, instead of a decrease. This would shift the supply curve in the other direction, placing on the spotlight the highly elastic region of the curve. We leave this as a future exercise in the hope of showing the real added value of wind energy in monetary terms to electricity consumers.

18 Bibliography 1. Dahl: Dahl, A. Carol, International Energy Markets: Understanding Pricing, Policies and Profits, MITYC: Ministerio de industria, turismo y comercio, Consumo espanol de energia,, 2. REE: Red electrica espanola, 3. Thompson: Thompson, Fred, COMPETITION AND THE SEARCH FOR AN HONEST BUCK,, 4. Agosti: Agosti, L., Padilla, J., Requejo, A, El mercado de generacion electrica en Espana: Estructura, funcionamiento y resultados, 5. Flatworld:, Maximizing in the marketplace,, 6. ReDe: Ministerio de industria, turismo y comercio, Real Decreto 661/2007, 7. Fabra: Fabra, Natalia, El funcionamiento del mercado electrico espanol bajo la Ley del sector electrico, 8. OMEL: OMEL, Resultados del mercado,, 9. Krohn: Krohn, S., Morthorst, P.E., Awerbuch, S., The Economics of Wind Energy: A report by the European Wind Energy Association, AEE: Deloitte, Estudio Macroeconómico del Impacto del Sector Eólico en España, Mejia: Mejia, Pedro, La factura electrica, 2011