IRENA report offers proposal for renewables’ price cannibalization headache

A long-term subsidy combined with a market for energy storage services may address one of the main barriers facing renewable energy developers around the world.

Regulators navigating the energy transition should change how power is paid for and priced, according to a 23 June report by the International Renewable Energy Agency (IRENA).

Renewable energy subsidies, for example 15-year contracts auctioned for renewables development across Europe, might be awarded over longer periods to solve the problem of low prices for power preventing higher investment in renewable energy.

The IRENA report shared the view that current power system structures, whether public or private, block investment in a future renewables-based generation system, causing misalignment with national net-zero and energy transition goals.

Today's wholesale power pricing structures based on the cost of fuels used for power generation, or marginal costs, don't work for renewables-based power systems, wrote IRENA in the report.

Electricity prices should no longer be based on "how well the system compresses fuel costs": They should be geared toward developing renewables and procuring sources of backup or demand reduction to handle their variability, found IRENA.

Other "misalignments" relate to how the current systems don't deliver "social and environmental imperatives."

For example, governments don't take into account the social risks of energy price changes currently exacerbated by the global energy price crunch.

One misalignment seen by IRENA, price cannibalization, is directly linked to the current pricing structure. "The cannibalization effect … with the depression of wholesale prices as we increase deploying renewables, which introduce a very serious barrier to [deployment] because renewables cannot recover their lifecycle costs with these very low prices," said IRENA consultant and report author Xavier Casals.

This effect continues to pose a threat to new renewable projects despite the current higher cost of European natural gas raising power prices.

"Nowadays, we are seeing a window of opportunity driven by the increase in natural gas prices. Now it's very high on the political agenda to address the misalignment of the market in the marginal pricing mechanism for renewables, but we are still [only addressing] very high natural gas prices without paying enough attention to the impact on the transition," Casals said.

An April report from the EU agency overseeing wholesale energy markets validated existing EU energy market practices.

But since the European energy price crisis escalated, European Commission (EC) President Ursula von der Leyen backtracked on the findings by saying the system "does not work anymore."

Von der Leyen's admission shows the political tension around the topic in Europe, Jakub Fijalkowski, a policy officer at EC policy advisory body DG Energy, said at the launch event for the IRENA report.

Suffering last year amid high electricity prices and industrial strikes, Spain has led a push for electricity market changes at the EU level.

Regional difficulties

During the IRENA report launch, speakers in a panel discussed the issues around renewable energy investment.

Renewables have high capital costs but low operating costs, while fossil fuel power sources have the reverse, wrote Harvard Professor William Hogan in a paper in February.

Global Wind Energy Council Head of Policy and Projects Joyce Lee said during the panel not enough land is auctioned for development to encourage further investment in supply chains, factories, and grid buildout. Renewable energy businesses are struggling with revenue instability.

Corporate power purchase agreements were taking off, for example in Europe, but corporate power demand was limited to high-income companies and there weren't enough of them to allow countries to reach net-zero targets, she said.

Developing countries wrestle with other issues. India needs $10.1 trillion in investment capital for the net-zero transition, and for international or national public institutions to guarantee the investments, according to Council on Energy, Environment and Water CEO Arunabha Ghosh. "We don't see de-risking at that scale, and without it, we don't get the system transition that we're discussing," he said.

Meanwhile, in Uruguay, where a public utility relies on hydropower generation, there are difficulties in maintaining sparse networks while opening the market to new service providers, according to Head of Department Electric Energy at Dirección Nacional de Energía in Uruguay Virginia Echinope.

Solution for price cannibalization?

IRENA's report argued pricing failures meant low renewable power prices—price cannibalization—make the costs of raising capital to build renewables higher, and projects increasingly less attractive to investors.

It offered a two-track solution that it said "provides a safe investment environment that minimizes finance costs for CAPEX-intensive technologies."

The two main policies the IRENA supports are long-term renewable energy procurement subsidies, and a separate mechanism for the short-term procurement of "flexibility services."

These are higher-priced technologies switching into gear to handle deviations between renewable power generated and demand.

Flexibility services subsidized could include demand-side management, battery energy storage, distributed solar panels, dispatchable renewables, hydrogen energy storage, or electric car batteries used as energy storage.

The long-term procurement policy mirrors existing subsidies encouraging development of renewables, but over a longer period. "For example, power purchase agreements, feed-in tariffs, and public direct investment schemes have proved suitable for supporting the deployment of CAPEX-intensive renewable power plants, minimizing the cost of procuring renewable power by keeping finance costs low," the report's authors wrote.

Price volatility means that the situation has become urgent. "So basically, this is something we need to address and the bottom line is here, it's time to procure two very different things under one structure," said Casals.

Posted 24 June 2022 by Cristina Brooks, Senior Journalist, Climate and Sustainability

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.