The Small RES Auction: Where will the Competition Come from?

The draft RES law in Poland provides for an auction for electricity support for green energy beginning sometime in 2017. There is a faint hope that this will be 2016 if the Government is successful in bypassing the EU notification process (an unlikely contingency). When the auction day does arrive, if at all, the small auction for under one MW projects will have a result completely at odds with the announced objectives of the Government.

If and when the day comes, the Government will reserve 25% of the auction for small producers, i.e. under 1 MW. While I have objected to the 1 MW and to the requirement that an auction be used, it is interesting to speculate on the effects of this proposal if it is realized.

Pre-qualification of bids will be required, which will include the need to have planning permission, environmental approval, gird connection conditions and a building permit for your project. A deposit with the bid and penalties for failure to build the project if your bid is successful will be included. A developer will not know the actual reference price (the maximum bid) until 60 days before the auction.

Auctions will be conducted at least annually and there will be a window after a successful bid to actually construct the project adding a substantial downstream delay.

Poland has roughly speaking 5000 MW of RES capacity installed at the end of 2013 and will need over 10,000 MW of capacity installed and in use by 2020 to meet the Directive target (for electricity it is 19%). This means that support for about 1700 MW of electricity capacity will have to be auctioned for each year in 2018, 2018 and 2019. Arguably there is a need to front-end load the auctions to provide for the downstream delay in construction caused by using this procedure, so all of the 5000 MW will have to be auctioned at least two years before 2020 to meet the target.

This means that 1700 to 2500 MW of RES capacity will be annually auctioned to meet the 2020 target (theoretically). The small auction 25% share will be  425 MW to  625 MW. At 1 MW per project, this is 400 to 625 projects. Assuming a mix of smaller sizes as well as 999 kW projects, the system will need to generate over one thousand projects with building permits, planning permission and funding. To create any competition in bidding, there will have to be two to three times that number.

How likely is Poland to successfully implement this goal, i.e. to have enough bidders to meet the 25% target and have competition among bids?

Experience in small project RES auctions has clearly shown that the procedure tends to not produce bidders. The Instituto de Investigación Tecnológica in Spain just published a detailed review of renewable energy auction experience in every country where it has been attempted. See del Rio and Linares, “Back to the future? Rethinking Auctions for Renewable Electricity Support,” 2013. One of their major points from looking at dozens of different auction systems was as follows:

Unfortunately, these theoretical advantages of auctions come at a cost. Due to the

complexity of the bureaucratic procedures, and also to the planning required ahead,

auctions have higher transaction costs (Finon and Menanteau 2008) which, together

with uncertainties on the final price and the tendering schedule, deter participation by

smaller firms, resulting in a low degree of competition (Butler and Neuhoff, 2008), and

creating opportunities for market power. In turn, this may eliminate the higher

theoretical efficiency of this instrument. Id. at p. 3.

     Later in their paper after reviewing every country’s auction experiences, they conclude:

Unfriendly for small projects and actors. A major empirical lesson of tenders is that they are unsuitable for small installations and smaller actors. Competition may thus be affected. It has been argued that some of the aforementioned factors and, namely, information failure and difficult access to finance, have a disproportionately negative impact on small actors and, thus, that the instrument is not suitable for small actors, suggesting that smaller projects should be promoted with a different instrument (Morthorst et al 2005, Mitchell 1995). It is difficult to tell a priori if encouraging large installation or actors instead of small ones is a negative aspect. Although it is explicitly assumed to be so in the specialised literature, size is a double-edged sword. Larger installations facilitate economies of scale in production but a model of distributed generation calls for smaller plants scattered around the territory.^[1] Furthermore, some RE projects are inherently large (offshore wind and concentrated solar power) and tenders may be particularly suitable for these technologies. In contrast, smaller projects may need to be promoted with another instrument.[emphasis added].

We can assume that fewer small projects will be proposed than would occur with a stable, guaranteed support mechanism such as Green Certificates or Feed-in tariffs. Small investors or project owners (such as farmers) will face having to advance all of the development costs of the project will no assurance of what the level of revenue will be or whether they even will get support at all. For many biogas and PV projects (assumed to be the lion's share of the small market here) the reference price itself is likely to preclude bidding. The Institute for Renewable Energy report from last year gave us a road map on the actual costs of production by technology. If the reference prices are set at that only 80% of the industry can "make a profit,"  then presumably the level will be below the 12% IRR assumed by IEO and lower than their figures.  Higher marginal cost projects will likely be stopped in the planning stage due to this risk.

This result is consistent with every country's auction experiences.  Without technology "bands," all small projects will compete solely based on costs. [There is some discussion of a bonus for "stable electricity" production but it is unclear how this will work in practice].[2] Most small and medium size businesses will be relying on external financing for project completion and this will somewhat difficult to obtain in the climate of uncertainty over the reference prices.

The large number of bids required to meet the 25% target as well as the disincentives to bid for small project developers will combine to make the auction for under 1 MW quite a different result than intended. It seems likely that every bid within the maximum reference price will likely be successful, simply because there will not be bids sufficient to fulfill the 25% share of all electricity support being auctioned. This is the empirical result that Del Rio et al. noted in their study of all such auctions: they do not result in more competition, but actually promote market concentration. Companies organized and funded to provide for all the project costs up to the building permit without external financing can do well in an auction, especially one with the "set aside" for small projects. 

Practically speaking, to meet the deadline of an auction in 2016 or 2017, work would have to be underway today to obtain all of the permits and approvals. Uncertainty in the law, including its auction mechanism and reference prices, as well as the Green Certificate over-supply problem have sharply reduced the number of small projects in the Polish pipeline. Before the Green Certificate crisis, there were about 300 biogas projects in development in Poland. Admittedly a large percent of these would have inevitably failed due to financing problems or local opposition.  In the EU, only about one in three biogas projects make it from planning to construction in any event. The number in development should also be divided by at least two, in that they will not all be available to bid (have building permits, etc.) in a given single year. 

Viewed from another angle, after nine years of plugging biogas, the Polish Government can see only 50 anaerobic digestion plants in Poland instead of the 2500 plants they sought for 2020. What are the chances than hundreds of projects will be ready for bidding in 2016 or 2017? Virtually zero.

Reference prices by law must reflect the various and different costs of production of the energy. The key variable in play is not that competitive bidding will reduce the number of accepted bids, but rather how many bids can successfully "game" the reference price. There is no doubt that the biogas reference price if the criteria are honored will be significantly higher than the "factor of one" used by IEO, i.e. the grid fee of 200 PLN/MWhr plus the full substitution fee of 300 PLN. This 500 PLN/MWhr or 12.5 Euro cents is substantially lower than the generic cost of producing electricity from biogas (or PV right now). So a project that can be profitable at that level or slighter above that level will be a very strong candidate for a successful bid. I just do not see small wind (one small turbine) doing much in the market,[3] so biogas and PV should be the major players in the small auction. In any event, it is impossible to see how over 400 MW of small projects can be ready to bid in each of three or four successive years.

The people hurt by the auction mechanism will be the "mega-prosumers"  trying to supply their own energy up to 1 MW. Farmers will be the biggest casualty, since they have struggled to accept biogas under a program that was historically more predictable than it is now or will be under the auction. PSL can talk about organizing cooperatives, but I cannot imagine having to attend a meeting of farmers with the goal of reaching a consensus on collectively investing their own money in one of these projects that has to go to the auction. The credibility of the Ministry of Agriculture in urging farmers to invest in biogas plants is pretty much zero or single digits at this point.  

The players in even the small auction will be the bigger firms with sizable budgets for project development. As long as the reference price meets the statutory criteria, the auction can be a route to profitable projects for this portion of the sector. Their success, however, will come at the price of lower participation by the very people the Government keeps making promises to. The end result will inevitably mean that Poland does not reach the 2020 target of 19% green electricity  and hundreds of potential developers will drop out of the process.

A better solution would be the use the fix of Green Certificates with adjusted values to reflect cost of production as the vehicle for support of small projects and let the auction do what auctions have done elsewhere, attempt to provide some competition for large projects.

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[1] Biogas is the perfect example of distributed energy, where local sources of agricultural waste and products provide a local source of energy that should also be allowed to be used locally. See Mott, “Biogazownie jako wzorcowy model rozproszonej energetyki: lokalne odpady lokalnym źródłem Energii,” www.reo.pl (2013).   Local, direct sale of the electricity is also imperative to achieve the best results to the economy (decentralizing electricity and lowering its price).

[2] The bonus for stable electricity production does not affect the reference price which is already set. The lower capex for wind, for example, with a lower number of available MWhrs is already considered in the reference price. So adding a bonus for biogas reliability will not affect the small auction results since there will generally not be enough bids for the competition to matter. In the big auction, it is difficult to see how the bonus can be large and significant enough to affect the disparity in the cost per MWhr between wind/co-firing and biogas. 
  
[3] I can be wrong and invite comments, but the European wind association successfully got a 5 MW exemption for small projects in the new EU state aid guidelines, also indicating that the project economics seem to tip for above 1 MW wind projects. The investment in a 1 MW wind tower seems to be 1.6-1.8 MM Euro with only 2000 or so MWhr output. Most project development costs are the same as a large wind farm, so the economics seems to be less favorable than some other technologies. Some vendors claim that they can produce cheaper small wind energy, but it is hard to imagine 50-100 MW of these small projects every year.

UPDATE: This is the reason for the latest amendment on January 15, 2015 to create a second round of the small auction for sources up to 2 MW.