Moving towards market realities -- Spain's tariff options

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As the realities of Spain's amended market regulation for renewable energy filter down through the wind sector, the incentive to draw producers away from the apparent safety of fixed purchase prices and into the business of trading wind output on the wholesale power pool market is appearing more and more attractive. At least half the country's wind power generation will trade on the market within months, according to wind group Plataforma Eólica Empresarial (PEE).

The new regulation offers three options for selling wind power: a market option, a fixed tariff option and a transition option allowing producers to stay with the old regulation until 2007. A preliminary study by PEE puts earnings from the market option -- which includes a production incentive set at 50% of the average electricity sales price -- at 8.6% above earnings from the regulation's fixed-tariff alternative (table). The financial advantage can vary, depending on plant size and wind conditions, but the market option is more profitable "in practically all cases," maintains PEE's Alberto Ceña. The transition option represents the worst earnings of the three, says PEE.

So far, only two wind operators have applied to trade on the market, says Ceña. If most choose the market option, resistance to wind from national grid operator Red Eléctrica de España (REE) could wane. REE has complained about the difficulties caused by forcing it to buy all wind generation, regardless of consumer demand and grid restrictions. Wind's privileged access to the grid is the main argument used by REE for capping the volume of wind generation it can take onto the Spanish power system. If the bulk of wind suddenly obeys market laws of supply and demand, the rug is pulled out from under REE's argument, opening the way for growth beyond wind's 13,000 MW limit for 2011.

Supply and demand

On the market, wind must schedule its production alongside conventional power. Extra costs incurred for deviations from the schedule will be the same for excess delivery and shortfalls. As a generation technology reliant on an energy resource that cannot be controlled, wind producers are more likely to incur "imbalance costs" for deviations. For this reason, the initial response of many of Spain's wind power producers was to reject the market option, arguing that it was unrealistic and premature to apply the rules of supply and demand to an intermittent power source that had yet to fully develop its technology for forecasting output.

By this argument, the preferred option under the new regulation was the fixed tariff, which obliges distributors to buy up all wind power production at a price scheduled to diminish over the life span of the wind station.

"Those who say the market option is not viable are simply not seeing the figures," says PEE's Fernando Ferrando. From 2005, even operators choosing the fixed-tariff option must program wind generation a day ahead of production. Imbalances will be charged at EUR 7/MWh. He concedes this option allows a margin of error of 20% either side of a forecast -- and that producers may vary forecasts at intervals throughout the day. But the imbalance penalty under the market option is just EUR 3.1 /MWh. "That's a huge and decisive difference," says Ferrando. He says the difference pays off even if REE's tolerance of imbalances drops to close to zero.

Wind producers in the market have several options for reducing their exposure to imbalance costs. They may aggregate their production from wind plant across the country -- something they are not allowed to do under fixed-tariff rules. If scheduling is managed separately, each operator will incur costs for producing less than scheduled output, even if others are exceeding it and the correct amount of power is being delivered to the system. "But by aggregating scheduling, the imbalances will smooth out," says PEE's Ramón Fiestas.

By PEE calculations, the fixed-tariff requirement of lodging separate daily schedules for each plant raises imbalance costs by EUR 0.3/MWh, compared to the market option. Furthermore, extra earnings on the market are available to wind plant operators, who are offered an incentive worth EUR 4.8/MWh for guaranteeing their deliveries. The incentive is not available under the fixed tariff option.

Another key to PEE's favouring of the market route lies in its expectations of relatively accurate wind output forecasts. Based on modelling work, PEE assumes a maximum hourly error of 35% between forecast and actual production, which would result in overall market operation costs of EUR 2.5/MWh. The sum includes imbalance costs, plus the costs of forecasting and contracting market agents.

PEE's lobbying rival, the Asociación de Productores de Energías Renovables (APPA), is doubtful that the argument holds good. Experience in forecasting output in Spain is limited as yet and the 35% theory has yet to be proved in practice. APPA expresses serious doubts about whether forecasting can be accurate enough to avoid swingeing imbalance costs and it remains tentative about whether the market option is viable or not.

The market option's production incentive, set at 50% of the average electricity tariff, is currently running at EUR 7.21/MWh. Together with the "power guarantee" incentive on offer for producers prepared to guarantee output, PEE calculates a wind price averaging EUR 6.98/MWh over 2004, assuming an electricity market price of EUR 31 MWh.

The top rate for the fixed-tariff -- set at 90% of the average consumer sales price of electricity for the first five years of wind plant operation -- would bring in EUR 63.4/MWh. Wind plant in operation prior to rubberstamping of the new regulation on March 27 may carry on as before, at least until 2007, but even they are obliged to schedule their output by January 2005. With scheduling, PEE says earnings under the old regulation come out at 8.14% below the market option.

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