E3G

Risk management, credible options and the future of European renewables policy

By Jonathan Gaventa and Nick Mabey

A strategic approach to infrastructure

The majority of existing power grids were built in an era in which electricity systems were predominately national, power generation was sited relatively close to the points of consumption, and power flows were uni-directional and more predictable. If the proportion of renewable electricity is to increase significantly, these conditions are unlikely to hold. Most of Europe’s large-scale renewable energy resources are located at its periphery (including wind and wave power in the northern seas and solar power around the Mediterranean), away from centres of consumption. Making best use of this potential will require greater volumes of electricity crossing national borders.

It is availability rather than demand that largely determines the use of renewables: turbines only turn when the wind is blowing. When such technologies represent a higher proportion of generation, supply and demand must be balanced either across larger geographical areas (the ‘super grid’ approach) or through using new grid technologies to shift generation and consumption profiles (the ‘smart grid’). Both options may offer associated benefits beyond renewables integration. Smart grids increase reliability and efficiency, and allow consumers to have greater control over their energy use. A super-grid could drive European market integration and increase security of supply.

However, such new grids will only be built if the EU adopts a more forward looking approach to planning and investment. Traditionally, investments in grids have followed the building of power plants and other generation, even though power lines take significantly longer to build than, say, wind turbines. This sequencing creates a vicious circle: delays in grid connection can undermine investment in new renewable generation; yet without the investment in new generation, the required grids will not be built. In Scotland for example, over 9 gigawatts (GW) of renewables is currently waiting for grid connection and much of this has a connection date later than 2018. (See note 4 below) This circle can only be broken if grid planning becomes anticipatory rather than solely reacting to where generation is already under construction, and regulators and transmission operators accept the risk that some lines will be under-utilised until new generation is built.

Some degree of predictability is provided by the new ‘ten year network development plan’ of the European Network of Transmission System Operators (ENTSO-E). The plan is an important starting point for providing more certainty for grid development. However, the current plan is insufficiently aligned with European decarbonisation goals and remains a collection of predominantly national plans. For future iterations, ENTSO-E must be empowered to address longer time horizons (say, 20 years rather than ten) and to push forward long-term transformational projects that could unlock significant volumes of low-carbon investments such as a North Sea grid for offshore wind or a Mediterranean grid for linking large-scale solar generation.

Keeping the high renewables option open… will require a widening of the debate from subsidising the use of wind and solar to adjusting the entire energy system to the widespread use of renewables.

Public investment must support the construction of these strategically important networks where existing funding mechanisms are insufficient. The majority of new lines are expected to be funded on a regulated tariff basis, whereby the investment costs are repaid through tariff revenue over time. But public financing mechanisms will need to be employed to lower the cost of capital, to fund projects that are innovative or difficult (for example, offshore hubs for connecting wind farms) or where a project has strategic importance for energy security or decarbonisation.

Under the ‘energy infrastructure package’, the European Commission is currently developing proposals for infrastructure finance, including insuring project bonds via the European Investment Bank. However the European Council conclusions from February 4th 2011 appeared to prioritise infrastructure designed to meet security of supply and solidarity concerns. The package must be expanded to include the key investments that ensure Europe is able to meet its climate change trajectories.

Reoriented power markets

Current power market arrangements are designed to drive competition mainly among conventional power plants running on gas and coal. Wholesale electricity prices tend to be based on short-run operational costs and are largely driven by changes in fossil fuel prices. Most renewable power generation, by contrast, has high upfront capital costs but low ongoing operational costs. As the proportion of renewable generation within the electricity market increases, wholesale power prices tend to fall, and it becomes increasingly difficult for any investments to earn back their fixed cost.

In several EU member-states, these challenges have led to calls for electricity market reform, including the introduction of ‘capacity payments’ (mechanisms to remunerate the provision of back up capacity rather than electricity sold) to cover fixed costs as well as operational costs. Unless a co-ordinated approach is taken, however, these proposals may sit uneasily alongside the goal of European power market integration, as Georg Zachmann explains elsewhere in this report.

The underlying issue behind these dilemmas is the deep uncertainty about how future power markets will operate, and the barriers this uncertainty places on investments in both renewable and conventional generation. To answer both the investment and the integration challenge, European governments will need to develop power market arrangements capable of limiting costs to consumers, managing risks during the low-carbon transition and enabling the emergence of a single European market. An extension of the status quo would fail on each of these counts.

A believable story about the future

The final criteria needed to ensure the high renewables pathway remains a credible option is a more believable narrative about the future of European energy policies. As currently framed, European renewables policy effectively ends in 2020, a mere nine years away. Post-2020, there are no further renewables targets and no binding decarbonisation targets other than a general ambition to achieve 80-95 per cent carbon reductions by 2050 if other countries take similar action. However, the significant levels of investments in long-lived renewables manufacturing and installation capacity needed to deliver the 2020 targets (for example, the testing facilities, factories and ships needed for offshore wind) is unlikely to materialise without greater certainty over what will happen to renewables policy after the 2020 target date.

The European Commission is set to produce a ‘2050 roadmap’ for energy later in 2011, following on from the roadmap for a low- carbon economy published in March. The roadmap is an opportunity to limit this uncertainty and ensure that the high renewables option remains viable. This implies establishing a clear date by which the power sector must be decarbonised;  developing new renewables targets for the 2025 or 2030 time horizon; or pushing forward plant-based emissions performance standards to ensure that more polluting coal or gas-fired power plants cannot crowd out cleaner energy from renewable sources.

From subsidies to systemic change

Like all evolving technologies, those needed for the use of renewable energy sources entail risks and uncertainty. The financial support schemes that EU governments have put in place for renewables represent a strategic investment to expand available options by driving forward technological development and accumulating experience on risk and costs.

Keeping the high renewables option open, however, will require a widening of the debate from subsidising the use of wind and solar to adjusting the entire energy system to the widespread use of renewables. Investors in technologies and supply chains will require greater clarity on how big future demand for renewables will be. They need confidence that Europe’s energy infrastructure will be up to the task, that market arrangements will work efficiently and that policy frameworks will deliver the required decarbonisation trajectory. This requires the EU and its member-states to institute a more strategic approach to infrastructure planning, to reform electricity markets and to adopt longer-term carbon and renewables targets. Unless these decisions are taken quickly, the option of a high renewables pathway to a low-carbon energy system will be effectively foreclosed.


Notes
1. Fraunhofer ISI, EEG and ECOFYS, ‘Economic analysis of reaching a 20 per cent share of renewable energy sources in 2020’, August 2006.

2. European Climate Foundation, ‘Roadmap 2050: A practical guide to a prosperous, low-carbon Europe’, 2010.

3. European Commission, ‘Renewable energy: Progressing towards the 2020 target’, January 2011.

4. House of Commons energy and climate change committee, ‘The future of Britain’s electricity networks’, second report of session 2009-10.

5. The UK’s committee on climate change has proposed that power sector emissions should be no greater than 50g CO2/kWh by 2030.



This article was written for the latest Centre for European Reform report entitled: GREEN, SAFE, CHEAP: Where next for EU energy policy?