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Viewpoint: Auctions -- The myth of market forces

WORLDWIDE: The renewable-energy industry's attitude towards auctions has gradually shifted from outright resistance to grudging acceptance.

But love them or loathe them, renewable-energy auctions are here to stay. Auction-based systems, also known as tenders, are the primary renewables support policy in a growing number of countries and will soon become the norm in Europe.

An economist's dream solution to the problem of keeping the cost of renewables deployment in check, auctions see the government or one of its agents playing auctioneer, with the crack of the gavel awarding a contract to the bidder willing and able to produce renewable power at the lowest cost. The theory is impeccable, the mathematics are sound. The policy promises to be elegant, simple and, above all, effective.

Yet, from the earliest experience, the outcome of auctions are best described as mixed. The UK's dalliance in the early 1990s saw well under half of contracted generation make it into operation because cut-throat competition and lack of penalties pushed prices below the true cost of building and running a project. Since then, fear of the so-called winner's curse has stalked auctions like Hamlet's ghost.

Too little competition can have equally disappointing results. The main pre-requisite for driving down cost is the participation of a number of bidders. So, when bidding opened for the contract to build Denmark's Anholt offshore wind farm in 2009, policymakers'

hearts sank when only one bid came forward. The fact that the obviously high-priced contract was let to a company majority owned by the Danish state served to underline the failure.

Of course, that is not to say that auctions for renewables cannot have good outcomes. Broadly successful programmes have been run in countries including Brazil, China, Morocco, Peru, South Africa and China. In Europe, too, auctions are rapidly becoming the norm for supporting renewables into the market. The UK this year revisited the policy and successfully signed up contracts for the construction of 2GW of renewable capacity. The European Commission would like to see something resembling auctions used as the first policy option for renewables support across the EU by 2017.

From a policymaker's perspective, the devil is in the detail. By carefully tweaking the fine details of auction design, policymakers can bring about their intended outcomes - generally a certain volume of renewable capacity at a low-ish price. The effectiveness of auctions, however, tells only part of the story, even when considering the long-term market impacts of auction rounds, where the inherently narrow focus of auctions risks missing the bigger picture.

Re-centralisation of renewables

Although the rhetoric about auctions place great emphasis on "market forces", the concept of auctions for renewable energy owes as much to the idea of a planned economy as it does to ones of economic liberalism. Decisions about which technology is built, where and by whom become matters for the state, not the market. Even in cases where technology neutrality or broad participation is stated as an aim for the policy, it is up to policymakers to define the qualification criteria.

An effective auction programme will, almost by definition, place far greater control over the future of the renewable-energy industries in the hands of a small number of policymakers than almost any other policy one could think of.

In subsectors where central government already has to play a significant role in bringing an industry into being, auctions are a sensible policy tool. Offshore wind needs policymakers to create an investable environment by selecting sites and getting grid connections built. Similarly, in pre-liberalised electricity markets, central procurement of renewable-power projects may be the only way to attract the expertise and capital needed to get renewables projects off the ground.

But in situations where there is a diverse and thriving renewables sector working day in, day out towards the transformation of the energy system, the re-centralisation of decision-making can only be seen as a backwards step, even if auctions do realise lower costs in the short run.

Like so many grand plans built on elegant theoretical foundations, the messiness that characterises the real world nibbles away at auctions' hallowed economic efficiency like so much acid. Compromises have to be made, and the theory of a perfect auction is replaced by a pragmatic patchwork of fixes, each of which takes more decisions away from the market and into the hands of policymakers.

The real question is what they will do with that power.

Oscar Fitch-Roy is a senior policy consultant for DNV GL - Energy and member of Exeter University's energy policy group

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