Capacity Fees May Be Disguised Utility Subsidies, Poyry Says

Energy policy in Europe has lost faith in markets to deliver sustainable, secure and affordable power and may be sending the industry “spiralling” into subsidy dependence, according to Poyry Oyj.

So-called capacity mechanisms, which allow utilities to fix electricity prices for guaranteeing backup supply in advance, are being developed in Germany, France, the U.K. and Belgium. While they may cut wholesale power prices, the payments may increase costs to consumers if they are designed as another form of subsidy, Stephen Woodhouse, a director at Poyry Management Consulting in Oxford, England, said yesterday in a phone interview.

“Many of the calls for capacity payments across Europe are thinly disguised requests for support for stranded combined cycle natural gas turbine assets, with their finances destroyed by subsidized renewable capacity,” Woodhouse said. “The sector is falling into a spiral of needing more and more certainty for individual projects, which adds to the cumulative policy risk and reduces the influence of markets further.”

European Union carbon permits have fallen 66 percent in the past four years, eroding the financial incentive to cut emissions blamed for climate change. The reduction has prompted EU governments to put in place renewable energy subsidies and, in the U.K., a carbon price floor in order to help meet emission reduction targets, Woodhouse said.

Hasty Move

The European Commission will say next month in a strategy paper on the internal energy market that a hasty move to a system that rewards utilities for running back-up plants when renewable power is insufficient risks being counterproductive, according to a copy of the draft obtained last month by Bloomberg. Systems that reward availability as well as generation are known as capacity markets.

The payments might be “based on local political concerns, and they undervalue and under-pay” for energy traded across borders, Woodhouse said.

“The result will probably be an oversupplied system across Europe,” he said. “Politics requires more security of supply than economics.”

The fees may change the pattern of prices and demand response at peak times, potentially causing distortion, Woodhouse said. A utility importing into a country making the payments may be disadvantaged, for instance, he said.

“France, for example, is designing a mechanism in which only generation which is located in France is able to sell capacity,” he said. “Imports to France are welcomed without payment and the treatment of exports is unclear.”

Growing Gap

Poyry has been hired by 10 utilities and lobby groups to study Europe’s energy future, the Helsinki consulting and engineering firm said. It today published a preliminary report subtitled “The shape of the beast.” The company advises clients such as Dong Energy A/S, RWE AG, Statoil ASA, EON AG, Bord Gais Eirann and Cuadrilla Resources Ltd.

There is a growing gap between national energy policies and the longer term market-led vision held by the European Commission and Eurelectric, the lobby group, Woodhouse said. This gap could prevent the industry from attracting investment. Across much of Europe, the majority of new generation investments over the next few years will fall under regulated regimes that come close to deciding the timing, the amount of each technology and its price, Woodhouse said.

“Market-led investment is becoming increasingly rare,” he said.

Safeguard Supply

In some markets, decisions to close plant will also be subject to regulatory scrutiny, he said. German Chancellor Angela Merkel’s government backed a plan this month to prevent utilities including EON AG and RWE AG from closing unprofitable power plants as the nation seeks to safeguard supply. Power-station operators will have to inform authorities 12 months before a shutdown under the proposal.

The contrasting vision is for no capacity payments and free trading of energy and market-balancing services across borders, he said.

“While policy makers and the industry pretend growing consensus for the market-based vision in the longer term, national policies with industry compliance are taking us to a more regulated and interventionist world to deal with more immediate problems,” he said.

The multi-year international framework for carbon pricing is not expected to be delivered soon and governments are pressed into greater intervention, Woodhouse said.

The commission’s vision of investment driven by a carbon price may be “idealistic” because emission allowances may need to rise to unacceptable levels to work properly, Woodhouse said. This vision needs to be “challenged,” he said.

Carbon prices may need to surge to around 250 euros ($323) a ton to allow offshore wind energy to compete with a new natural gas fired power station, under one scenario for 2020, Poyry said. The scenario assumes costs for the gas plant of 50 pounds ($81) a megawatt hour compared with 130 pounds for offshore wind.

EU carbon for December dropped 4 cents today to 7.65 euros a ton on the ICE Futures Europe exchange in London at 11:22 a.m. The December 2020 contract settled yesterday at 11.33 euros.

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