Auctions Lead to Prices That Do Not Allow RES Projects to be Feasible

The latest news from Chile emphasizes the key fault of auctions of renewable energy support- artificially low prices in project bids that later cannot be actually built. Banks in Chile are reluctant now to finance projects that have unrealistically low prices for electricity as they are so risky.

"Auction systems as a mechanism to support investment in photovoltaics, which implement other countries, leads - as intended - to lower energy prices, which offer investors in auctions. Prices for the bid winners, however, are sometimes so low that the implementation of the projects may seem questionable."
Gramwzielone. October 24, 2016.

Typically, speculative bids are made with the hope that project costs will decline over the schedule to actually commit and build the projects. The penalties for under-bidding in this fashion can never be large enough to require the developer to actually build a project at his bid price if it will lose money for years. The basic problem described above, i.e. “threading the needle” between lowering the burden of bidding to encourage competition in bids and more restrictive pre-qualifications so that winning projects are actually built, has seldom been done successfully.  In a report prepared for the European Commission, EcoFys et al noted in January 2014: “…finding a compromise between encouraging high implementation rates without reducing the number of market participants too much proved to be a difficult task.” Design features of support schemes for renewable electricity, January 2014, p. 5.

Auctions have also notoriously failed to assure that projects actually get built. Firms bid the project to later find it is not economically possible to proceed or that they have failed to secure necessary steps that make completion impossible. At one point, only 8 % of biogas projects in the Netherlands that won bids were actually built.[1] Brazil had an auction where none of the winning projects were later built.[2] 

While auctions aim for a specific amount of electricity to be produced or capacity to be installed, empirical experience has shown that a shortfall of the auctioned amount is a rather common phenomenon. This is mainly due to ‘underbidding,’ which results in economically non-feasible projects.” EcoFys, supra,  page 45.

“A tender scheme creates competition between bidders and, thus, inherently encourages them to bid as low as possible. However, the evidence in France, Portugal, Nova Scotia, U.K., India, China and Brazil shows that they may overestimate their capacity factors, underestimate their costs (because, for example material costs turn out to be higher than they were expected to be) and follow strategic behavior in bidding (i.e., win the bid, then adjust).” Del Rio,“Back to the Future,” Renewable and Sustainable Energy Reviews 35 (2014).   page 51.

“Empirical evidence indicates that low implementation rates caused, e.g. by underbidding or the
existence of non-cost barriers, are one of the main drawbacks of auctions used for RES-support… remains to be seen whether auction schemes can eventually achieve the desired effectiveness.” EcoFys, supra, page 72 (emphasis added).

     This problem completely undermines the assertion that auctions allow countries to specify the amount of renewable energy they want and to specify a maximum price. The process more typically resembles a “wish-list” than a real “shopping cart.”  The period between auctions, given the need to publish in advance the reference prices and other terms, may actually not provide any advantage in adjusting the compensation to fit the investor’s expectations and the public’s limits. Other systems may, in fact, have quicker response times to adjust for the right fit in support levels.

     The shift to this mechanism is a major reason why the total renewable energy investment on an annual basis in the European Union is falling now. The other major issue is the shift of the project ownership away from new market entrants to the major utility players (for whom the auctions are a major technique to preserve their market share of electricity). Auctions are fundamentally anti-competitive in this regard because they promote the concentration of market share in the largest utilities.[3] 

     The cheap prices may look attractive to governments, but the results are hardly consistent with an improved situation for energy customers.

[1] “The Dutch are having trouble simply getting stuff built. Only eight percent of the biogas projects awarded contracts since 2011 have been completed – and a whopping 98 percent of the PV projects that won auctions last year were apparently not built even though they had to be completed within a few weeks in compliance with auction rules.” Craig Morris, The Energie Wende Blog, June 25, 2014,

[2] Even in normal auctions in Brazil, “a large share of the selected projects are heavily delayed, thereby negatively affecting the effectiveness of the auctions” EcoFys, supra, page 53. In the Netherlands: “The realisation rate of projects so far amounts to roughly 40% of the projects that were committed in 2011…” EcoFys, supra¸page 57.

[3] “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 afore mentioned 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.” Del Rio, supra, page 52. Morris writes in The Energie Wende Blog, on June 23 2014: “In Germany, normal citizens and energy co-ops accounted for nearly half of the installed capacity in renewables and a third of the capital invested as of 2012. A switch to reverse auctions would therefore gradually revert ownership back to conventional utilities.” This may, in fact, be the real objective of the Commission’s new policy. 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 which, together with uncertainties on the final price and the tendering schedule, deter participation by smaller firms, resulting in a low degree of competition and creating opportunities for market power. In turn, this may eliminate the higher theoretical efficiency of this instrument.” Del Rio, supra.


rashmi said…

Very Informative..

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