Viewpoint: Does low cost equate to high value in tenders?

The European energy market is changing. This transition is characterised by a significant expansion of residential power production, increased complexity in balancing demand and supply, and the first developments of renewable-energy sources combined with storage systems at an industrial level.

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The expansion of renewables at either utility scale or for residential use clearly marks opportunities for developers. But it comes at a challenging time amid limited economic growth in the EU.

Following European Commission recommendations, member states have been developing competitive auctions to support renewables. The application criteria vary from country to country to cope with local requirements: some tenders assign capacity slots on the basis of lowest remuneration; others focus on lower market premium or capital costs.

However, all share the property of pushing down the cost of energy while allowing the state to maintain some control on overall costs. The results have been evident with onshore wind power becoming competitive against conventional energies in levelised playing fields. But looking at the auction process from a different perspective, there are other points worth further consideration.

Stretched margins

The pressure tenders put on costs might be reflected on the shape and form of the proposed projects. Wind projects are generally under challenge from a cost perspective, and using the latest turbines to achieve the highest capacity factors while complying with increased grid requirements is a must. But this often requires complex negotiations with OEMs to find the right solution for the particular market.

Balance-of-plant designs also need to be critically examined so that cost-effective solutions are used and design margins are stretched to the limit. But this cost-saving approach should not jeopardise safety or quality over the project's operational life with consequences that may only appear further down the line in projects assumed to be in efficient operations for at least 20 years.

Auctions are highly selective, and not only due to the increased risks provided by the uncertainty around the bid. The entire process and the financial securities requested to guarantee the final realisation can act as a big barrier to smaller entrepreneurs. For some systems, the requested bank security is not marginal, and leases are expensive to obtain. The small players have so far provided great results in exploiting local resources and proposing projects with high capacity factors. Given their flexibility and capability to deal with local aspects, small developers often make good local contacts, secure excellent land plots, address potential grievances and optimise design in close contact with local authorities.

However, when a financial barrier is too high, these small developers have to find an equity partner or leave the way to bigger players. This is not necessarily a negative issue. When players can rely on lower costs by limiting their use of external financial instruments or because of a precise corporate strategy, they can set their acceptance criteria at lower levels with the possibility that the outcome of the auction sees projects with lower capacity factors winning over projects that would have better exploited the wind resource.

Risk to targets

Another potential concern relates to the project variations that, once the bidder is assigned a certain slot, are allowed only to reduce the installed capacity. While this is dictated by the auction rules and is necessary for guaranteeing process transparency, at project level it may appear as a lost chance for optimising the cost of energy. Reducing the final installed capacity has consequences.

Governments also have targets for their energy programme, and when a wind farm is not built to its full capacity, or not built at all due to the limited return on investment, the unassigned subsidy cannot be considered a cost saving for the state's budget. From the government perspective, auction systems can reduce risks for the economic effort of supporting renewable energy, but the risks of not achieving their final targets could be increased.

Auction schemes provide effective solutions to foster and schedule the installation of renewable sources, lowering energy prices by improving competitiveness. But when considering who develops projects, their implementation and the level of sophistication characterising each system, some concerns arise. These schemes should be long-term plans and allow some flexibility in order to secure energy targets and achieve other objectives such as local industry development.

Mattia Boccolini is service line leader project engineering at DNV GL Energy

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