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Auctions in the power sector

Analysis
Typography

Auctions in the power sector

The rise of auctions

Renewable energy auctions have become increasingly popular for expanding renewable power generation in developed and developing countries and are often implemented jointly with other measures to incentivise renewable energy deployment. Over the past decade, the number of countries that have employed auctions has increased eleven-fold from six in 2005 to at least 67 countries by November 2016 (adapted from REN21, 2010-2015; and IRENA, 2017a).

The growing interest in auctions is due largely to their ability to achieve deployment of renewable technologies in a well-planned, cost-efficient and transparent manner while also fulfilling a number of other objectives. Examples include job creation, local ownership and development (as in the South African Renewable Energy Independent Power Producer Procurement Programme).

The main strengths of auctions relate to flexibility, price and commitments. The flexibility of design allows policy makers to combine and tailor di¦erent elements to meet deployment and development objectives, while taking various factors into account, such as the country's economic situation, the structure of its energy sector, and the maturity of its power market. The certainty on price and quantity ensures stable revenue guarantees for project developers (similar to the feed-in tari¦) while at the same time ensuring that renewable generation targets are met more precisely (similar to quotas and tradable green certificates). In addition, auctions allow for real price discovery, which is particularly relevant in fast-changing markets with rapidly declining technology and other project-related costs (e.g., due to evolving local supply chains and local market maturity). Finally, auctions lead to contracts that clearly state the commitments and liabilities of each party, including remunerations and penalties for under building and delays to ensure the projects deliver in line with the bid (IRENA and CEM, 2015).

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 Auctions also have potential weaknesses. The risk of project delays or cancellations is attributed to the potential for over-aggressive bidding in the competitive environment of the auction, which has a variety of causes. These include excessive optimism about the rate of technology cost reductions and the underestimation of the financial consequences of a project delay. Another potential weakness is the associated transaction costs, which can be relatively high for both bidders and auctioneer. Small or new players are particularly a¦ected by this. The administrative procedures necessary for them to participate in the auction (e.g., feasibility studies and qualification arrangements, deposits or bonds) may constitute a barrier to participation.The extent to which these strengths and weaknesses a¦ect the ultimate result of an auction depends largely on policy design. This includes how well the process is adapted to the local context in terms of economic situation, energy sector structure, power market maturity and renewable energy deployment objectives.

Auction design

Auction design continues to evolve and to become more complex. To increase deployment in a cost-efficient way while meeting development objectives, auctioneers are adjusting and combining a variety of design elements. These design elements can be categorised under the auction demand, qualification requirements, the winner selection process and the sellers’ liabilities (see Box 2.1). In other words: what does the auctioneer want, who gets to bid, who wins the bid and how can the auctioneer ensure that winning bidders meet their commitments?

For an auction to be successful, its design should ensure that competition between bidders is optimal in order to drive prices down while it is limited to bidders with the capacity to implement projects at the contracted price within the given timeframe.

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Auctions in 2015 and 2016

In 2015 and 2016, prices resulting from solar and wind energy auctions fell sharply across the globe. For wind power, some of the lowest prices were recorded in North Africa, where Egypt announced a winning bid price of USD 41/MWh in 2015. Soon after (in 2016), Morocco announced the lowest winning bid price at USD 28/MWh (with USD 30/MWh being the average price across all wind farms).

Prices also declined in auctions calling for new solar PV capacity. In Dubai in the United Arab Emirates, a record-breaking bid of USD 29.9/MWh for an 800 megawatt (MW) solar park was received in early 2016. A few months later, Abu Dhabi announced that it had received a lower price of USD 24.2/MWh10 for its 350 MW auction (Bloomberg, 2016a). In Peru, prices fell as low as USD 48/MWh, and later in the year Chile announced record low prices of USD 29.1/MWh (IRENA, 2017a). Figure 2.2 illustrates the results of recent renewable energy auctions in different parts of the world. These projects are planned to be commissioned between 2018 and 2020, in most cases, with possible longer lead times for hydropower.By 2016, solar PV bids in the most competitive countries came in below USD 60/MWh, as seen in Figure 2.3. The figure illustrates the sharp decline in (average) winning bid prices for utility- scale solar PV between early 2010 and mid-2016. It also reveals that prices are converging  across a number of countries. However, a wide range between the highest and lowest prices persists, due to the resource potential, costs and enabling country-specific conditions.

Factors contributing to low prices

What has driven the bid prices for wind and solar PV to such low levels? Two main reasons include falling technology prices and the competition created by auctions. However, the low  bid  prices are also attributed to access to finance and other country-specific economic conditions, investor confidence and a (perceived) low-risk environment, and additional renewable energy support policies. In addition, specific trade-o¦s in auction objectives can raise or reduce bid prices (IRENA, 2017a) as follows:

ACCESS TO FINANCE AND OTHER COUNTRY- SPECIFIC ECONOMIC CONDITIONS. 
A  country’s overall macroeconomic conditions a¦ect project costs and hence the prices submitted by bidders. Conditions include the ease of doing business and access to finance, and the country’s credit rating. General soft costs associated with building and operating a project also a¦ect bid levels. Examples include the costs of labour, land and input energy. One example is the third phase result of the Al Maktoum Solar Park (USD 29.9ƒMWh) in Dubai. This was influenced by low soft costs, favourable loan terms (including relatively low interest rates and long loan tenure), and generally very low taxes in the UAE (Morris, 2016). Another important factor is the Emirate’s long-term vision to deploy 5 GW of solar power capacity. The promise of a long-term market for renewables created investor confidence while also intensifying competition among bidders wishing to enter the market, which resulted in low bids.

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vhgcgxgINVESTOR CONFIDENCE. 

Auction bid prices are significantly a¦ected by investor confidence in the renewable energy sector of a specific country and the risk level faced by project developers there. Where potential risks are mitigated by additional policies to support renewable energy, as well as by other factors, the cost of financing can decrease substantially. This lowers bid prices.

Investor concerns about demand-side responsibilities can be reduced by assigning a reliable o¦-taker and providing certainty and regularity in the procedures and schedules for auction rounds. The Dubai solar PV  auction, for instance, succeeded in drawing low bids for a couple of reasons. The o¦-taker, the Dubai Electricity and Water Authority, was creditworthy, and both country and region had a long-term vision for solar deployment.

Public finance institutions can provide private developers with risk mitigation instruments such as guarantees, currency hedging instruments and liquidity reserves (see Chapter 3). In Chile, the contracts are denominated in USD and are adjusted periodically (according to the US Consumer Price Index) so that developers are shielded from interest rate risks and inflation risks.

ADDITIONAL  RENEWABLE  ENERGY  SUPPORT

POLICIES to support renewable energy deployment can contribute to low bid prices   in two ways. Deployment policies, such as tax breaks or import duties, implemented in tandem with auctions, can reduce project costs and thus bid prices. Also, policies to develop local capacity through education and training can help create a local workforce that can both increase technology reliability and reduce the need to import talent.

TRADE-OFFS   IN   AUCTION   OBJECTIVES. 

The various choices made when designing auctions present trade-o¦s between minimising bid prices and other objectives. Examples are described below.

Local content requirements: there can be a trade-o¦ between developing a local industry, developing a local industry and achieving lower prices. Auctions with minimal to no local content requirements can encourage foreign players to enter the market. This means renewables may grow more rapidly and in some instances at lower prices than might otherwise be the case. However, the country might forgo the benefits of domestic development which brings with it such benefits as employment, local value, skills and know-how.

Bidding requirements and compliance rules: there is a trade-o¦ between ensuring the successful and timely delivery of projects in line with the bid and achieving lower prices.

Limiting the volume awarded to individual bidders: some countries limit the volume that can be awarded to any single developer to minimise risk and encourage more than one company to enter the market, thereby advancing deployment. However, such restrictions can hinder economies of scale.Greater government role: governments can take on the responsibility for some required tasks such as conducting resource assessments, selecting a site for the project and ensuring grid connections. If so, project risks and costs for potential bidders are reduced, lowering bid prices.

Clearly, bid prices are influenced by general macroeconomic and political conditions, the existence of additional renewable energy support policies and other considerations. However, it is important to gain a better understanding of the factors that led to record-breaking bid prices for solar PV and wind power in 2016 across di¦erent regions of the world to guide future policy design. In this light, it is also important to verify that the projects come online successfully and on time, and to gain an understanding of why they might not succeed (IRENA, 2017a).

With the rise of auctions, alongside other renewable energy support policies, ongoing cost reductions and rising electricity demand, numerous renewable energy projects (particularly solar PV and wind power) are being planned and are under construction around the world. The increasing share of variable renewable generation is prompting policy makers and regulators to reconsider power market designs and system planning and operation.

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