Efficient regime for the expansion of renewable energies, further development of the energy-only market and preservation of EU-ETS ABASTRACT OF A STUDY FOR RWE AG June 2013 Frontier Economics Ltd/r2b.
Convenience translation May 2013 Frontier Economics/r2b 1 In 2008, the European Union passed the third energy and climate package, which comprised common long-term targets for CO 2 reduction, energy efficiency and the expansion of renewable energies. The climate targets are very ambitious, both in the mid-term and in the long-term: By 2020, CO 2 production shall be reduced by 20% compared to 1990, the contribution of renewable energies in the energy mix shall amount to 20%, and energy efficiency shall also be increased by 20% (compared to the increase expected before the 2020 climate policy ). By 2050, CO 2 emissions shall be reduced by 60%-80%. Achieving these targets will require an overhaul of the energy system, and the electricity supply system, in particular. Instructions for the study Against this background, RWE has instructed Frontier Economics and r2b energy consulting to complete a study to assess: 1. what role the EU ETS can play in the expansion of renewable energies, and if or how the system should be improved to ensure it continues to play a leading role; 2. how the future expansion of renewable energies in Europe can be organised efficiently while still achieving the political goals; 3. what changes are required to the design of electricity markets to ensure security of supply given the expansion of renewable energies; and 4. what political and regulatory conditions have to be fulfilled to achieve 1-3 (e.g. expansion of network), both on the EU level and the national level. Our approach conceptual analysis and quantitative modelling Our analysis consists of analytical considerations and quantitative modelling with view out to 2050.
2 Frontier Economics/r2b May 2013 Convenience translation The conceptual considerations focus on the linkages between the EU ETS, renewable energy support mechanisms, electricity market design, and network issues. Our model-based quantitative analysis supplements the qualitative considerations by providing a long-term forecast of electricity and CO 2 markets. Calculations have been made interlinking a European investment and power plant operation model with a European renewable energy model. This methodical approach is used to simulate the following scenarios: Efficiency scenario Targets for climate protection are solely met through the EU ETS. Additional support for renewable energies is not applied between 2020 and 2050. The expansion of renewable energies is therefore facilitated by the market (i.e. via electricity and CO 2 prices). The model deploys renewable energies (in terms of technology choice, location and investment timing) in a cost minimised way. Business As Usual In this scenario, the expansion of renewable energies is supported by Government incentives and subsidies in addition to the EU ETS. This in effect leads to a higher and differently structured renewable expansion than in the efficiency scenario. We assume that the current renewable support mechanisms, with national targets and technological discrimination between renewable energies (i.e. more expensive renewable energy technologies get more support), will be maintained. The forecast of renewable energy expansion is based on literature studies of planned national renewable energy policies. Positively realistic scenario At the European level, climate action relies solely on the EU ETS (as in the Efficiency scenario). At the same time, additional national targets for the expansion of renewable energies are pursued in Germany. This helps prevent the possibly politically undesired effect of the interim reduction of output shares of renewable energies in Germany. As in the efficiency scenario the model optimises the European expansion of renewable energies is optimised collectively subject to economic feasibility, while for Germany renewable energies still receive dedicated additional support (broadly without technological discrimination, although temporary Draft
Convenience translation May 2013 Frontier Economics/r2b 3 distinct support for new technologies is allowed for, e.g. for offshorewind). In addition, and to assess the consequences of alternative developments regarding CO 2 abatement, we calculate a sensitivity for each scenario in which we discard the option of carbon capture and storage (CCS). The following table shows the main results of the quantitative analysis for the three scenarios. For a detailed analysis (including results for the interim years 2025, 2035 and 2045, as well as the sensitivity without CCS), we refer to the full study. Table 1. Central results of the quantitative analysis Demand (TWh) RES Share Therm. Generation (TWh) CO 2 -Emissions Electricity Generation Efficiency BAU positive-realistic 2011 2020 2030 2040 2050 2020 2030 2040 2050 2020 2030 2040 2050 GER 558 558,4 558,4 558,4 558,4 558,4 558,4 558,4 558,4 558,4 558,4 558,4 558,4 EU29 3.328 3.727 4.186 4.311 4.443 3.727 4.186 4.311 4.443 3.727 4.186 4.311 4.443 GER 20% 37% 30% 27% 38% 37% 55% 61% 66% 37% 41% 45% 49% EU29 24% 34% 37% 43% 49% 34% 44% 54% 60% 34% 38% 45% 50% GER 446 382,8 328,0 349,6 290,2 382,4 281,6 227,4 180,5 383,4 317,5 258,3 220,1 EU29 2.464 2.348 2.508 2.310 2.078 2.346 2.175 1.792 1.546 2.352 2.446 2.214 2.025 GER 283,4 172,0 94,7 59,4 283,4 188,4 116,3 54,3 283,8 167,6 87,2 51,4 EU29 955,6 914,0 544,1 302,4 954,9 894,7 554,9 298,6 957,1 911,5 544,1 301,9 CO 2 -Price ( 2012 /t CO 2 ) EU29 12,9 10,9 25,7 55,6 110,0 9,8 24,0 54,3 85,8 10,8 25,9 55,1 104,7 Wholesale Electricity GER 51 59,3 83,4 88,6 100,6 58,7 68,7 76,3 71,7 59,4 80,0 87,4 95,4 Price Base ( 2012 /MWh) EU29 60,3 81,5 85,3 82,5 59,8 72,7 80,4 78,2 60,3 80,7 85,5 84,7 Additional Costs compared to Efficiency (bio. 2012 ) EU29-1,0 22,3 40,6 26,5 0,0 2,0 2,1-3,4 Source: Calculations r2b energy consulting GmbH The quantitative results support the following central conclusions of the study: EU ETS is effective as a long-term control instrument the expansion of renewable energies can be achieved in the long-term without additional renewable support The EU s emissions reduction targets in 2050 require a considerable transformation of the energy system towards low emission technologies, especially after 2030. Our analysis assumes that CO 2 emissions in the EU will be reduced by 60-80% by 2050, and that the electricity sector will contribute towards this aggregate CO 2 reduction by reducing its emissions by 80%. This implies on the one hand that conventional power production with efficient gas power plants (CCGT), power plants with CCS and/or nuclear have to play a considerable role in the European energy mix. On the other hand, the share of renewable energies needs to rise in Europe in order to meet the targets in a cost efficient manner.
4 Frontier Economics/r2b May 2013 Convenience translation This substantial change in the energy mix can be incentivised and encouraged with different approaches: Business as usual Governments retain both renewable energy support mechanisms, and the EU ETS. However, given the design of these systems at present, this approach as our modelling shows - is associated with significantly higher costs ( Business as Usual scenario); or EU ETS as lead mechanism for climate policy Reliance on the EU ETS as the sole market signal for the expansion of renewable energies ( Efficiency scenario). Under this approach, climate change would be achieved more efficiently compared to the first approach. Up to 40 bn per year could be saved across Europe (of which up to 7 bn p.a. can be saved in Germany). Our analysis also shows that renewable energies (as well as nuclear power and CCS) will reach competitiveness with an effective EU ETS. In 2050 and even without additional Government support for renewables or other technologies - about 50% of electricity production in Europe could be provided by renewable energies. 1 The EU ETS can therefore provide a suitable long-term framework and investment climate in favour of renewable energies. CO 2 prices would rise significantly reflecting a reduction in emissions permits over time. A separate support mechanism for renewable energies would no longer be needed to achieve the climate targets. The expansion of renewable energies, however, would be distributed unevenly across EU countries. While production in countries with advantageous wind and photovoltaic locations (and relatively low start values) would increase steadily from 2020, the quantity of renewable energies in Germany would initially decline in Germany: more renewable capacity has already been installed than would be required to meet the intermediate climate targets (resulting in higher cost than necessary) for the climate targets to be met efficiently. In these simulations, the optimised share of renewables output for Germany falls from 37% in gross electricity consumption expected for 2020, to 30% (2030) and 27% (2040) respectively, before increasing to 38% again in 2050. In all modelled scenarios, we assumed that nuclear energy is phased out in the German energy mix. Despite this, our analysis indicates at the European level 1 For this study, we assume for Germany constant and for Europe increasing electricity consumption until 2050. Draft
Convenience translation May 2013 Frontier Economics/r2b 5 that nuclear energy, as well as renewable energy, continues to contribute to European power supply if the CO 2 reduction targets are to be reached with moderate costs. A similar conclusion can be drawn for electricity production in conventional plants with Carbon Capture and Storage (CCS). In our model, CCS can be interpreted as a proxy for currently unknown low CO 2 abatement technologies with a similar cost structure as CCS. Our calculations show that a moratorium on CCS technology would significantly increase the costs of electricity production required to meet the CO 2 reduction goals, when also considering that the the use of nuclear energy remains restrained in various countries. The next best back stop would be a combination of additional renewable energy production in conjunction with energy storage solutions. As a consequence, the costs of electricity production in our sensitivity without CCS are up to 30 bn 2012 per year higher in the EU than in the same scenario with CCS. Even in the short term there is no structural need to reform of ETS The EU ETS as a market-based instrument for climate protection will reduce greenhouse gas emissions in the EU efficiently and effectively to the target level. The EU ETS ensures that CO 2 emissions within the trading scheme are reduced where it is most economical. The carbon price signals the costs associated with CO 2 reductions. In other words, if considerable efforts are required to reach the target level, the carbon price is high; but if the goal can be reached with more modest measures, the carbon price is relatively low. This implies that price movements leading to high or low prices are an indication of the effective functioning of the EU ETS. At present, the EU ETS is characterised by low prices for CO 2 certificates. At the European level, this low price has led to reform ambitions, which from our point of view are not reasonable: The current low CO 2 prices are mainly a result of the economic crisis Up to now, underlying structural effects like the rapid expansion of renewable energies, energy efficiency measures, or a high supply of CER/ERUs contribute comparably less to lowering the CO2 price. Furthermore, the current low CO 2 price has a stabilising effect on the economy. In a recessive economic environment (especially in Southern Europe) a price increase would further risk the international competitiveness of the affected industries.
6 Frontier Economics/r2b May 2013 Convenience translation Our modelling confirms that the present and temporary surplus of certificates will be reduced, provided CO 2 targets (and the supply of certificates) are tightening in line with the 2050 targets. Therefore discretionary interventions and reform measures at this point in time, are not necessary in the current environment. Only long-term targets can create planning security for investors The reforms discussed for the EU ETS bear the risk of being viewed as politically opportunistic short term fixes, thereby creating additional uncertainty for investors in renewable energies and conventional power plants over the longer term future. To create a stable environment and planning certainty for investors, commitment to clear targets and a longterm EU ETS framework is needed. Structural reforms based on short-term considerations have the potential to undermine the EU ETS in the longer run. The global competitiveness of energy prices and the effect of energy prices on the European economy also have to be recognised This holds especially if other world regions do not develop and apply similarly intense climate targets. It would therefore be advantageous for the EU to agree on long-term goals that lead to the desired reduction of greenhouse gases, in order to ensure the longterm integrity of EU ETS. However, the CO 2 permit reduction plan is currently fixed at -1.74% per year 2, which would not be sufficient to reach the 2050 CO2 targets. A more significant annual reduction in the cap by around -2.1% per year would be required. 3 Alternatively, if the EU waits until 2030 to adjust this reduction plan, the adjustment would need to be increased to -2.2% per year. In any case, the tightening of climate goals would result in the long-term increase of CO 2 prices to values of over 50/t ( real 2012). This increase in CO 2 prices translates into increasing electricity costs, and weighs on electricity consumers in Europe. Therefore, independently of any reform to EU ETS, Europe can only reach its climate goals when other important competing world regions, like the USA and China, undertake similar climate policy efforts. Without a more active participation of these other countries, Europe is likely to face considerable competitive disadvantages for industry. In this context, a lone pioneering role 2 Per cent of average allocation for years 2008-2012. 1.74% corresponds to a yearly reduction of the maximum of 37.44 Mio. tco 2. 3 With a reduction goal of THG emission of 80% in 2050 compared with 1990. Draft
Convenience translation May 2013 Frontier Economics/r2b 7 for the EU will not be tenable in the long-term, and not effective in view of the global nature of the climate challenge. If climate change policy is reformed, then reforming support of renewable energies should have priority Renewable energies will contribute significantly to future power generation and to the achievement of the EU climate objectives, even if support only came through the EU ETS. However, it is likely that for political reasons additional and separate support to further develop and promote renewable energies will be maintained (outside the EU ETS). It is, for example, unlikely that a temporary decline in renewable capacity and output would be politically tolerated in Germany in case renewable support for any new generation units was abolished in the short term. In any case, renewable subsidies and support mechanisms should be reformed so that they deliver more efficient outcomes. In particular there should be: Stronger market integration The current promotion regime for renewables in Germany hardly requires renewable generators to respond to market price signals, be it in relation to investment or in relation to dispatch decisions. In this context, mandatory and full direct marketing of renewable energy should be considered, possibly paired with a bonus model (with renewable bonus payments set by public administration or through auctions), or a renewable quota model could be introduced. Technology neutrality Today s renewable support mechanisms provide distorted incentives to invest in certain technologies above others. This means that normal competitive dynamics, which would otherwise result in the selection of the most efficient outcome, are undermined: Technologies with inefficiently high costs are built before more cost-efficient technologies. A renewable support mechanism with a more technologically neutral design would encourage competition between the technologies, and deliver more efficient total cost outcomes. In some instances, a newer or more immature technology may merit a separate specific support mechanism that distorts investment towards it. For example, it would be possible to employ a (temporary) separate bidding procedure for the realisation of offshore wind projects, if a prompt roll-out of this technology were assessed as necessary for political or strategic reasons. However, the design of any temporary incentive scheme would
8 Frontier Economics/r2b May 2013 Convenience translation have to be carefully considered so that it avoids the failures of today s renewable energy act (EEG). European co-ordination A reform of the promotion mechanisms for renewables should have a medium- and long-term aim of achieving a stronger harmonisation between the member states, as well as an efficient co-ordination of the expansion of renewable energies across the EU. To achieve this, the EU has to reinforce its role as moderator. Incremental renewable support mechanisms can be compatible with EU ETS as an interim instrument, but should be designed with efficient outcomes in mind As explained above, if the EU decides to retain additional renewable support mechanisms on top of the EU ETS this will result in a less efficient outcome. However, any additional costs can be minimised if the support mechanism is designed such that it promotes efficient outcomes (that do not deviate too much from those achieved under the EU ETS alone). In this respect, our quantitative analysis shows that it is possible for single countries to pursue their own development objectives without unduly burdening energy consumers. For example, our analysis of the German market in a scenario where renewables reach a 50% share of gross power consumption by 2050 confirms that any additional costs will remain manageable (see Table 2). This is true as long as German support mechanisms do not discriminate between individual technologies (so that the most efficient technologies are built). A temporary additional renewable support mechanism would therefore be economically tolerable, if the mechanism is designed with efficiency in mind, and entails a market-based, technology-neutral solution. In the longer-term, renewables support would have to be phased out so that the EU ETS becomes the primary and only support mechanism. This will also reenforce the additional installation of renewable capacities as it will reduce downward pressure on wholesale prices for power caused by a separate renewable promotion, which in turn has complicated the commercial and market-based viability of the renewable technologies. This cycle could be breached in the long term by a stepwise phase-out of the renewable promotion. Draft
Convenience translation May 2013 Frontier Economics/r2b 9 Administrated capacity markets are currently not necessary in Germany With renewable capacity set to increase, we expect to observe a fall in the utilisation rates of conventional power plants. Together with the general question of whether energy-only markets can guarantee security of supply in Germany and the EU, this observation has led to a discussion about the merits of introducing capacity mechanisms in Europe. Currently, we do not see a fundamental need for the introduction of capacity mechanisms to support conventional power plants in Germany. This is because there are currently no fundamental capacity deficits in Germany in the generation sector. However, even today grid congestion can lead to a need for local reserve capacity. In the long term, grid expansion is required for this purpose: in particular, the changing generation mix and the increasing volatility of feed-in and dislocated generation, requires a grid expansion for the North-South transmission system. The academic literature suggest a number of reasons for introducing long-term capacity mechanisms: insufficient flexibility of electricity demand; externalities (i.e. investors do not consider the value of the overall security of supply when making investment decisions); imperfections in capital markets; or the threat of regulatory interventions to remove price peaks (which lower the income return expectation of investors) However, this does not directly imply the need for an introduction of a capacity mechanism: greater demand flexibility, risk hedging instruments, and explicit commitments to allow price peaks in the wholesale market would remove market imperfections, without the need for comprehensive capacity mechanisms. The introduction of capacity mechanisms would bring a set of new challenges: For partial capacity market concepts i.e. where strategic reserve is subject to a capacity mechanism while other generation capacity operates in the normal energy-only market there is the possibility of inefficiencies and market distortions depending on the market design, with some options being favoured selectively against others. Conversely, with comprehensive capacity markets, there is also the risk of design errors as a central institution (without any skin in the game or financial interest of its own) would have to define several parameters of the mechanism. In addition, any capacity mechanism could be
10 Frontier Economics/r2b May 2013 Convenience translation exploited for short-term political objectives, which would also reduce investors certainty. Furthermore, for any type of capacity mechanism the reform efforts would need to be co-ordinated at the EU level to avoid distorting competition in the EU single market. A capacity mechanism in any individual country would have implications for neighbouring electricity markets due to the integration of European electricity wholesale markets. For example, it is possible that a unilateral, uncoordinated introduction of a capacity mechanism in one country would reduce the incentives for investment in power plants in neighbouring countries. Such distortions lead to additional macroeconomic costs and therefore have to be minimised. Our quantitative analyses show a significant medium- to long-term increase in the electricity wholesale prices (see Table 2), even if renewable support mechanisms are designed with efficiency in mind. Therefore, even without capacity mechanisms, market prices (wholesale and balancing energy price) are generally able to deliver investment signals that promote higher renewable shares, both in relation to the capacity demand as well as to the type of required capacity (e.g. flexibility), provided renewable energies are properly integrated into the competitive market. Our quantitative analyses also confirm that the modelled shares of renewable energies can also recover costs in the electricity market. Despite these conclusions, it is still possible that political considerations result in the introduction of capacity mechanisms, for example to insure against the risk of blackouts. If politicians force the introduction of capacity mechanisms, the depth of intervention into the power market should be minimised in order to avoid market distortions. As with renewable support mechanisms, any new capacity mechanism should be technology-neutral, and should promote an integrated and harmonised EU-wide system. The approach of a strategic reserve, which is held in the background, but which does not engage in the market on a daily basis would meet this requirement as an example. Draft
Frontier Economics Limited in Europe is a member of the Frontier Economics network, which consists of separate companies based in Europe (Brussels, Cologne, London & Madrid) and Australia (Melbourne & Sydney). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Limited.
r2b energy consulting GmbH Zollstockgürtel 61 50969 Köln Tel.: +49 (0)221-78 95 98-60 Fax: +49 (0)221-78 95 98-70 E-Mail: info@r2b-energy.com FRONTIER ECONOMICS EUROPE BRUSSELS COLOGNE LONDON MADRID Frontier Economics Ltd 71 High Holborn London WC1V 6DA Tel. +44 (0)20 7031 7000 Fax. +44 (0)20 7031 7001 www.frontier-economics.com