Cuando volví de Budapest decía que en próximas semanas resumiría lo comentado en la sesión en la que participé. Así que aquí van mis notas (largas, y en inglés, perdón por las dos cosas):
The New Electricity Market Design – The role of PPAs
When considering the role that PPAs may play in the new European electricity market design, the first question that should be asked is: why do we need PPAs?
The first answer is: because we need long-term markets, long-term contracts, to avoid both the impact of volatility in fossil fuels (as experienced during the recent crisis) and the cannibalization of renewable energy (something we have been aware of for a long time). And, unfortunately, we do not have enough long-term markets.
But this does not automatically imply that we need PPAs. First we must understand why we don’t have long-term markets, and then check whether the characteristics of PPAs will have a role solving some of these problems.
There are three major reasons that explain (at least partially) the small role of long-term markets in Europe:
- The long-term risk faced by demand (partly based on macro instability) makes it very difficult for them to engage in and guarantee long-term contracts
- Vertically-integrated utilities do not need long-term markets, since they hedge internally
- Moral hazard: governments have a history of bailing out agents when in trouble (retailers, consumers…). This clearly reduces incentives to hedge appropriately.
So, before thinking about PPAs, we should be thinking about creating the conditions that would allow these markets to exist, removing some of the barriers mentioned (some of these ideas have already been proposed by ACER):
- First, avoid bail-outs to incentive agents to hedge;
- Reduce the risk (if possible) for demand, or reduce the cost of guarantees;
- Make it easier for small agents to participate in the long-term market;
- If vertically-integrated utilities have market power, require them to become market makers;
- Create liquidity in these markets by requiring long-term contracts to be sold in forward markets; indeed, forward markets may be a good place to change long-term positions;
- Integrate long-term national markets and cross-border transmission rights; avoid copperplate assumptions;
How do PPAs fit into this? Not that well: PPAs are complex, non-transparent, expensive, and difficult to trade. This does not mean that they cannot play a certain role: we must allow the market to develop the products it needs. But PPAs have not been able, by themselves, to create relevant long-term markets. In fact, in some countries such as Italy or France they are almost non-existent.
However, it also means that we may need other, more standard products, traded in European-wide platforms, if we want to create a large, integrated market, accessible to all.
One option for these standardized products would be Contracts for Differences (CfDs), which do not need to be (and should definitely not be) only offered by governments. CfDs are just a simpler contractual structure that may facilitate long-term contracting of electricity for smaller agents, are easier to standardize, and hence to trade and access to. As said earlier, CfDs should not be monopolized by governments, in order not to crowd-out private contracts), but a certain amount of government supply may be useful as a market making instrument, and also to provide variation in the risk profile of these contracts. Centralized auctions for both government-backed and private CfDs may also facilitate market creation and transparency.
CfDs should also be correctly designed to minimize (or avoid completely) distortions in short-term markets and provide efficienty operation signals. Newbery or Schittekatte and Batlle have already provided options for this.
It should be noted, though, that CfDs will not solve all problems, in particular the risk problem faced by demand. A certain degree of risk will always be there, both individual and systemic. The question is whether this risk may be better managed.
In this regard, artificially reducing the cost of guarantees (as an incentive for engaging in long-term contracts) does not reduce the level of risk, only creates a subsidy (which may be socialized among energy consumers, or passed as public debt). Not all Member States in Europe will be able to pay for this subsidy.
So the point is to try to reduce the underlying risk in real terms.
A first option is to diversify: The larger the portfolio of consumers, the lower the risk. But this needs economies of scale, which raises the question of whether the utility model would be better suited. This would be true, but only if the utility is not vertically integrated: if integrated, the utility has no incentive to consider demand-side options (or at least much lower than for building new generation or networks), and hence it is not clear whether the outcome would be better.
Creating standardized products, traded in large platforms, may also help manage the risk. Trading allows to reduce risk by allowing for undoing positions. A question was raised of who would buy these positions if prices go down and the contract is overpriced: this same question could be asked about any other long-term market; and it is arbitrage in the market which solves the problem.
Systemic risk is more difficult to address: What would happen if electricity in Europe is expensive and energy-intensive firms leave? Who would take their PPAs or CfDs? Again, agents may bet against this and hence take these positions.
But even this reduced risk may still be too high for demand to enter into long-term contracts. In this case, it may be required to force retailers or large consumers to buy a certain share long-term, as done in South America, to improve the liquidity of the market, and again, reduce risk. Market making by incumbents may also be needed.
Another option that CfDs will not solve is the need for flexibility. Other products (such as Reliability Options) are needed to provide flexibility to the system.
A final comment: In all these developments, creating a truly European long-term market is essential. And the current European proposal runs the risk of giving more power to Member States and hence disintegrate this market. It is true that there is nothing new in the proposal about the competences of Member States…but if a larger long-term market is created, under the competence of Member States, with the corresponding reduction in relevance of the day-ahead market, that is in fact a transfer of power from the European Union to the Member States.
