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Energy 9 January, 2018 11:00 am   
Editorial staff

The capacity market will provide time for coal modernisation (INTERVIEW)

Aleksander Galos and Wojciech Wrochna of Kochański, Zięba and Partners Law Firm talk about the prospects of the capacity market in Poland, the energy strategy, and a nuclear power plant.

BiznesAlert.pl: There are the following reservations to the Capacity Market Act: that it is non-market-based, it will raise energy prices in Poland, and there are alternative solutions, such as through long-term contracts or modernization funds like those created in the past to invest in better units. What is your opinion on this?

Aleksander Galos: Today it is very difficult to finance modernization of existing generation sources or construction of new generation sources without support mechanisms. There are also problems with maintaining the existing sources that are unable to generate sufficient revenues from the market. The dilemma that Poland and every European country are facing in principle is what kind of support mechanism to choose. There is a whole range of them; one of them are so-called capacity mechanisms, including the so-called capacity market. It is not the most popular in Europe, but the government has decided to choose it. The assessment of whether this mechanism is cheaper or more or less effective than others seems premature today because it is only when it becomes operational that we can see what results it will bring. It should be recalled that several studies indicate that the introduction of a capacity market will lead to savings for consumers in the long term.

The legislator should be sure that the solutions they introduce will be beneficial.

The very name ‘capacity market’ suggests that it is the market that will decide what the final energy prices will be on the market. We will see at what price, first of all, large power generators will be willing to take part in the capacity market and what their financial expectations will be. Today we do not know that, but we rightly suppose, on the basis of the experience of other countries, that this will produce good results. The best point of reference for us today is the experience of Great Britain, where the capacity market has been introduced and it has proven itself in practice. The energy mix that appeared there is not what the originators had dreamt of, but the mechanism worked. Other countries have different mechanisms in place due to local specificities. In Poland, however, this is not the only mechanism, apart from it, there are other ones.

Each support mechanism means costs that will be reflected in the final recipient’s account sooner or later. Energy security, like the so-called clean energy, must cost money. If we want to be safe, if we want fewer emissions, then no matter what the source of energy, we always have to incur investment costs. Safety and clean air are costs.

Wojciech Wrochna: The capacity market is not just a model of support. It is also a systemic change in thinking about the energy market as such. Different support systems have different features – they can support a dedicated source of generation or a specific market segment. This aid mechanism, as the European Commission sees it, means the transition from a single-commodity market to a dual-commodity market, where two commodities operate: capacity and energy. This raises the question of whether energy prices will rise. To be precise, energy prices should not rise, but there will be another cost, that is, the capacity charge on the bill. On the single-commodity market, the peak capacity needs to be maintained exclusively from high energy prices. To make this pay off, the price of energy must be high. As a result, off-peak energy prices are low, but when there are problems with the power balance in the system, the price will rise sharply during peak times. Globally, however, in the dual-commodity market, i. e. with the capacity market, it should be cheaper – this is at least the assumption.

. In the dual-commodity market, a large part of the costs is included in the capacity charge and the energy market is thus more stable. Not all sources are able to generate on-demand power, which is the essence of the capacity market, which makes stable sources more reliable in the capacity market. This is also the objective of the capacity market: to ensure the medium- and long-term sustainability and security of energy supply.

The bidding will be won by the one who offers the cheapest energy supply. The point is that the best price will be offered by unstable sources, i. e. the RES (Renewable Energy Sources).

WW: It is true, because the marginal price of the RES is low, but the capacity market works in the following way: the generator who won the bidding and receives a fixed payment, is obliged to keep the given source ready to produce electricity. In case of power problems, which are announced by the operator when the balance reserve decreases, they announce the so-called ’emergency period.’ Then the source that won the bidding during the emergency period announced in advance must produce energy. If it does not do so, a gigantic penalty will be imposed.

So, will the RES not enter this arrangement in fear of a possible penalty?

WW: Theoretically, they can participate fully in this market, but they have significant risks associated with entering it. Of course, we are talking about unstable RES.

AG: Renewable energy sources based on wind or solar energy require stabilizing sources themselves. Where they are an important element of the market, stabilising sources are being built, such as gas recently. Then their cost would not be so attractive.

Coal can receive support from the capacity market only until 2021 due to Regulation 550. Does this mean that the capacity market was not created for coal, but for a new generation of gas?

AG: Firstly, the issue of the European Commission’s full acceptance of this Act is still pending. Secondly, the UK example shows that the creation of a capacity market has led to the development of emission sources. We will see what will appear in Poland, but the goal is to modernize coal sources and support coal sources under construction, such as Opole, Jaworzno, and Kozienice.

Will it also succeed with the expansion of the Ostrołęka Power Plant?

AG: As far as I know, no investment decision has been made yet. The challenge for Ostrołęka may be that the Act does not provide for baskets. This means that if Ostrołęka counts on financing from the capacity market, it will have to compete with the modernized sources and the existing ones. This means that a lower global price may be set for all bidders, which may result in the bidding price not being sufficient or attractive for Ostrołęka to close the financing. However, these are the speculations of a side observer and ultimately the market and business plan for this project will decide.

Will the European Commission’s consent to the capacity market give us additional time to modernise coal-fired power generation?

WW: Yes. Although the direction of the content of the regulation with the 550 limit is not clear, if it were to happen so that it would enter quickly into force and additionally with the commitment of the units that would receive support earlier, to exit from the system, it would be a big problem. The first bidding will take place in 2018, 15-year contracts with new units will be signed for 2021-2036, and if the regulation enters into force in 2020 with a three- or four-year exit period for units that have signed contracts and exceed the 550 emission standard, this will be a major problem. There is still a large place for Polish diplomacy in the European Commission and negotiating meaningful conditions for the entry into force of this regulation in relation to these units. The recent solutions achieved by the Polish Government seem to be moving in the right direction.

AG: What is important is that a solution has finally been chosen. The Act itself will not change everything. Its aim is to mobilise, among others, private funds unavailable to the energy sector. In order for this to happen, all the elements must have the credibility of the financial market. It must believe that the money invested in new or modernised capacities will pay off. It is a matter of regulations, agreements and many other legal and organisational measures.

Some media criticise the capacity market – they say that it will be a support for coal power generation, not for the modernisation of the sector.

AG: Modernized sources will be more efficient than the non-modernized ones. In addition, the capacity market will operate under market conditions and anyone may enter them. It is true that the capacity market does not prefer the RES, but the same can be said about coal. Without support mechanisms the RES are still not competitive in Poland.

WW: It should be remembered that the capacity market is technologically neutral, while the recent changes have introduced preferences for sources with less emission, for which the support period has been extended even up to 17 years.

AG: It will be interesting to see the capacity market’s impact on the extent to which large energy-intensive companies will be willing to take part in the market by reducing their energy consumption, receiving the funds in return. Everyone complains about high energy costs, without thinking about the legitimacy of energy consumption. Now a possibility has been created to earn money by using less energy. This is a certain change in logic, which also encourages us to take a specific course in technological development. This will teach a certain culture in the use of electricity through market-based tools.

Should we therefore expect a Polish energy strategy?

AG: The Capacity Market Act precedes the energy strategy, although it would seem that a policy outline should first be presented, and only then should legislation be implemented. This was due to the time pressure. The Government wanted this Act to be passed later this year and it determines the country’s energy policy over a longer period of time. It may result from this law that coal will continue to be supported, at least at some point in time.

The Government continues to maintain that the share of coal in the power mix will gradually decline.

AG: The Capacity Market Act provides mechanisms for the emergence of all kinds of attractive energy sources. The possibility of foreign companies to participate in the market is a safe gateway for other sources. We will not depart from coal overnight. There is much talk about nuclear energy, but the development of a nuclear power plant would have to be in a very advanced state to talk about its rapid incorporation into the national mix.

WW: Any stable source can theoretically work in the base, but the truth is that fewer and fewer sources work without any underestimation and a number of factors determine this.

What rationale is the capacity market in terms of nuclear energy?

WW: Looking at the energy sector today and what the government says, it seems that nuclear energy will not have any kind of support. While other sources will be supported in different ways, nuclear energy will have no support at all, and without that, it is unlikely to come into being. It will certainly not benefit directly from the capacity market either, because it is not a mechanism which corresponds to its specificity.

AG: Nowhere in Europe can such a project be carried out without support. In Poland, there were discussions about the introduction of differential contracts, as in Great Britain. This has been abandoned, and no other idea has emerged. On the other hand, it seems that there should be room for nuclear power in connection with the emission reduction obligations. If the RES do not develop as investors would like it to happen, nuclear power generation, which is a stable and low-emission source, seems to be a good option. That is why the Ministry of Energy and the Government still maintain this idea.

Are the discussions on this subject not going too long?

AG: It is not only a matter of determination of those working on the project, but also of the speed of work on legal acts, and there is also an important issue of regulatory requirements. There are legal deadlines concerning safety issues, such as the periods of environmental or location studies, which cannot be shortened.

WW: There are announcements that the tender will start after 2020, as the investor declares, and the plant would be ready by 2031. This is not feasible.

Interview conducted by Wojciech Jakóbik