EU Energy Policy Blog

In May 2007, the Spanish government published a long-awaited decree that regulates renewable energy generation payments. It was expected since last Christmas, and actually a draft has been available since November 2006. Both draft and final decree have been widely discussed by involved stakeholders. Two issues have focused particular attention: the amount of, and caps to, renewable energy subsidies; the alleged retroactivity of the proposed regulation.

In order to provide some background on the discussion, a short review of the economics of the Spanish electricity system may be in order. Renewable energy sources, and particularly wind energy, enjoy subsidies that can complement electricity market price (“Traditional hydro” is not considered to be renewable for these purposes). These subsidies represent a significant part of the energy cost in Spain, as shown in the figure below, based on data from CNE, the Spanish National Energy Commission.

The figure shows a breakdown of final average electricity price in €/MW-h during the years 2006 and 2007 (as forecasted by the CNE). Energy generation costs, and renewable energy sources (mostly wind) and combined heat plant subsidies are shown in red and salmon, respectively. Permanent costs (orange) mainly include subsidies to the Spanish archipelagos (Canary and Balearic islands) as well as payments because of past years’ deficits. Transmission and distribution costs (mostly regulated) are shown in green. There are also a number of smaller costs.

Final electricity price is regulated by the government. In 2006 average final electricity price was 77.644 €/MW-h, slightly lower than average cost, 78.220 €/MW-h. The difference is the deficit: 0.576 €/MW-h that is shown in the graphic as a small pink rectangle below the horizontal axis. For 2007, the forecasted figures are 88.810 €/MW-h and 101.244 €/MW-h. The deficit is forecasted to be 12.439 €/MW-h that makes a sizeable pink rectangle. Main reason is, on the one hand, greater fuel prices that have lead to increased production costs; and, on the other hand, the government reluctance to significantly raise final electricity price.

The previously mentioned figures are quite relevant for wind energy remuneration under the former regime: that of Royal Decree 436/2004 issued in March 12th, 2004. Wind generators could choose between being paid a regulated tariff or the wholesale market price plus a subsidy. The figures were given as percentages of a reference final electricity price, namely 90% of it in the case of regulated tariff, or 50% in the case of subsidy. The final reference price is similar to the average final electricity price, and wholesale price is closely related to production cost. The percentages above were established when electricity wholesale price was about 36 €/MW-h. In this case, assuming no deficit, wind generators should be roughly indifferent between choosing one way or the other one to be remunerated. As fuel prices have escalated, so electricity market price has done (from 28.74 €/MW-h in 2004 to 55.75 €/MW-h in 2006). Wind generators have mostly chosen to be remunerated according the “market price plus subsidy” option. Actually, earnings can be quite attractive in this case. For instance, if we assume a reference price in 2004 equal to average final price (77,644 €/MW-h) and that wind generators sell at average 2004 market price (55.750 €/MW-h), they would be remunerated at 0.5*77.644 + 55.750 = 94.572 €/MW-h. Actual remuneration has been possibly lower, because reference price is not exactly average final price and periods of high wind generation are correlated with lower than usual electricity market prices. In any case, the figure is likely to have resulted in much higher incomes than those initially expected by investors.

The new decree (Royal Decree 661/2007 issued in May 25th, 2007), as the former one, establishes that wind generators may choose between a fixed payment or the market price plus a subsidy. The specific figures are, for the fixed payment, 73.228 €/MW-h during the first 20 years of existence of the facility, and 61.200 €/MW-h since then. Regarding the subsidy, it is established at 29.291 €/MW-h only during the first 20 years. The figures will be updated according inflation and productivity rates. Once a generator chooses one of the two options it must keep it for at least one year.

A key difference is that any wind generator that decides to go for the “market price plus subsidy” will have its income bounded. Specifically, a cap and floor of the income have been established at 84.944 and 71.275 €/MW-h respectively. Note that the floor is quite close to the regulated tariff and, perhaps more significantly, that the width between floor and cap is relatively narrow. In any case, tariffs, subsidies, floors and caps will be reviewed in 2010, although these changes will only impact on facilities operating after 2012. Besides, facilities operating prior to 2008 have the right to perpetually receive the more generous tariff of the previous decree, or the previous decree subsidies until 2012.

Another novelty is the provision of special subsidies for wind generators re-powering. The subsidies are capped to 7 €/MW-h, being granted by the government on a case-by-case basis. Only facilities operating prior to 2002 are eligible.

The above economic regime is intended to incentive wind power penetration. Therefore, new wind facilities will no longer be eligible once the national objectives are met. Specifically, the decree set this objective at 20,155 MW of installed capacity (presently, installed capacity is about 11,000 MW). When installed capacity will reaches 85% of the objective, the government is expected to announce a date after which no new facility will be eligible to receive subsidies.

The government initial draft significantly differs from the final decree. The subsidy was less generous, there were no provisions relating re-powering and, more controversially, it established that the new economic regime should be applied to existing as well as future plants. Generators argued that proposed changes in the regulation regarding existing plants were not only inconvenient, but possibly illegal under Spanish law. The government denied this last point, and argued for the benefits of the measure. In particular, the minister of Industry has vigorously argued for a less generous retribution to wind energy.

CNE was legally obliged to report on the proposed draft. Its report was dutifully released in February 2007, three months after the draft release. It included criticisms to the government proposal as well as a significant number of suggestions that have been incorporated in the final decree version.

As explained above, the final decree is somewhat closer to the position of generators and wind-generators makers that the initial proposal. Actually, the day following the decree disclosure, the two major wind generators and wind-plants makers shares – Gamesa, whose main shareholder is Iberdrola; and Acciona, that recently becomes the main Spanish shareholder of Endesa – raised by 2.7% and 2.5% respectively.

No doubt, there is a number of issues that the new regulation raises. I find two of them especially interesting:

• The remuneration based on market price plus subsidy has been justified on the basis of providing economic signals to efficiently operate wind generators. However, this scheme also remunerates wind investment according to market prices, whilst government objectives on renewable penetration are actually independent of whatever the market behaviour may be. The new decree provisions regarding caps and floors, and a maximum wind capacity to be subsidised possibly aim to balance these concerns. However, the relatively narrow difference between the cap and the floor, when compared with the long term price volatility of fuel (and therefore presumably electricity), suggests that actual remuneration price is going to be either the cap or the regulated tariff and, therefore, that market signals for efficient operation are going to be weak.
• In any case, wind generation is not competitive on a purely economic basis. Whatever subsidy is granted, it should be justified either by environmental externalities, security of supply reasons, or industrial policy considerations. In the Spanish case, the combined value of these justifications seems to hover around 30 €/MW-h (the difference between a desired wind price of about 80 €/MW-h that regulation suggests, and an expected long-term electricity price of around 50 €/MW-h). Comparisons with other technologies and European regulations could be a worthwhile exercise.

Julian Barquin

This entry was posted on Sunday, September 16th, 2007 at 8:12 pm and is filed under Electricity, Energy Policy, English. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.