Effect of Offshore Wind & Photovoltaic Solar Growth on European Energy Market

White Paper The effect of Offshore Wind and Photovoltaic solar growth on European Energy Market Trading and Operations - Barry Walsh – Lead Consultant Infosys

With European governments seemingly outdoing each other in the race to promote renewable energy and make the leap to carbon neutral economies, can a utility adapt quickly enough to the rise in volatility and overload of „big data‟ from the Smart Grid ?

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Abstract1 The discussions in this paper provides some focus to the current debate in the European energy markets by attempting to take a closer look at the key market challenges as well as a broader look at some “smart” solution methods. The most recent policy developments are brought together at the start of the paper and formulated in terms of the key EU energy policy directives, i.e. meeting 20-20-20 objectives, ensuring security of supply and promoting market competition. Germany and the UK were selected as case studies as a result of their having market models with features relevant to most countries across Europe, yet at the same time exhibiting very different regulatory frameworks and degree of market-driven mechanisms themselves. The discussion of challenges in these sections is positioned mainly from the perspective of upstream asset owners with a trading function, with the solutions presented at the end of the paper concerned with two key business functions within the same upstream utility: that of trading and risk management.

These solutions, while by no means exhaustive, do give a flavour of how European utilities should be adapting to solve the business issues via a combination of asset-backed and IT solutions, with a more detailed analysis of their dynamics in a future “smart market” reserved for a future paper. It is important also to note that the many current „concept‟ smart grid papers in circulation in Europe, and indeed pilot projects, are pitched at the level of the distribution networks and in some sense IT is many years ahead of the development of the energy market itself, particularly the upstream part of the value chain. Due attention is given here to the key domain issues, particularly at the level of the transmission networks, as herein lies at least some of the requirements for IT or smart-grid solutions. In summary, the market has to walk before it can run, and the likelihood is that some of the physical requirements in the age of renewables, such as ensuring transmission lines carry sufficient load from offshore, may dictate how best to structure the IT solutions and/or the smart grid/ smart market in the future2.

What„s happening in the European Energy Markets?

Despite the generally poor economic climate, investment in European energy infrastructures is widely seen by government across Europe as vital to ensure the continent remains competitive in the long term. Following on the heels of the European Electricity Grid Initiative, a nine year R&D programme to accelerate innovation and development of the European electricity networks and ENTSOE‟s3 Ten Year Network Development Plan, the European Commission unveiled a new regulation to ensure strategic European energy networks and storage facilities are completed by 20204. The rule, when in force, would replace the existing Trans-European Networks for Energy (TEN-E) policy and financing framework and direct EUR 9.1 billion of investment into the completion of priority energy infrastructures.

Of the 12 “priority corridors and areas” identified by the EC initiative in their proposal, three 5 are concerned with the key challenge facing the industry, that of integration of renewable energy sources to demand centres. One other, the adoption of smart grid technologies, is identified to ensure that all users have access to this renewable energy and are furthermore able to exert control over their own energy usage.

By means of the proposal, the EC aims to achieve its Treaty objectives of a functioning internal energy market, security of supply, promotion of energy efficiency, renewable energy development, and the promotion of interconnected energy networks. Specifically it enables the 20% reduction of greenhouse gas emissions, 20% increase in energy efficiency and 20% share of consumption from renewables by 2020 (the EU‟s 20-20-20 commitments).

Progress in grid upgrades and harmonization across Europe is fundamental to achieve these goals, but has historically lagged far behind the political will and technological advances. Regulation has been murky, cross-border planning and permitting has lacked coordination and the public is by no means sold yet on the necessary grid upgrades. However the recent unlikely alliance of TSOs and NGOs to ensure nature conservation goes hand-in-hand with sustainable modernisation of the grid supports the EC Oct 2011 draft law to make it easier to build and finance cross border power lines6.

1

It is assumed that on reading this paper, the reader already has some background on the operation and key drivers in today‟s energy markets.

2

BNetzA, the German Energy Agency have alluded at the start of this year to the still somewhat unstructured debate on how smart grids can add real value to the energy sector and propose a clearer separation of activities into those concerning a future “smart grid” and those concerned with a future “smart market”.

3

European Network of Transmission System Operators for Electricity

4

“Guidelines for trans-European Energy infrastructure” European Commission 19/10/11

5

Northern Seas offshore grid (“NSOG”) and North-South electricity interconnection in Western Europe and building of EU-wide electricity “highways”

6

Sources Elia, PWC

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Both Germany and the UK are currently undergoing great changes in their respective energy industries as they rush to meet EU 20-20-20 commitments while attempting to ensure security of supply and more competitive markets. Meeting renewables targets of 19.6% and 15% respectively is falling heavily on an electricity sector which, with a future increase in electrification of transport and space heating, will share the greatest burden. Building this much additional green energy is hard enough, without the additional factor that the countries transmission networks are not geared up to handle the new connections.

Case Studies

Germany and the UK

On top of the renewables targets, Germany is faced with a mammoth task of replacing its nuclear fleet, earmarked for seemingly immediate retirement in the aftermath of the Fukushima disaster. A total of 8.3 GW of nuclear plant has already retired in Germany 7 and the rest of Europe has seen the result of its strained capacity deficit already this winter, with French peak imports on occasion being sourced from the UK. While Germany itself might be expected to rely more on imports in the near term, its previously aggressive build of wind farms now needs an even faster growth rate, not least to maintain mid-term supply margins but also to meet 2020 carbon reduction targets. The industry intends to focus on both efficiency increases from repowering the existing (saturated) onshore capacity8 and the explosion of Germany‟s nascent offshore wind industry. This development is likely to be supplemented by an equally ambitious target for solar photovoltaic (PV), supported by a generous feed-in-tariff (FIT) scheme. Germany recorded a world record installation of 7.5 GW photovoltaic panels in 2011 and is now approaching a total of 25 GW. According to the government‟s own energy agency9, potentially a whopping 50 GW will be online by 2020.

As Germany grapples with the logistics of replacing an objectionable but predictable technology with a popular but unreliable one, the UK faces its own problems in looking to 2020. Suffering from modest growth generated from an economy lacking heavy-industry and partly sceptical at least to onshore wind, the coalition government is instead looking to offshore wind to be the flag-bearing industry of the future. The world largest offshore wind farm, Walney, has now opened and the expectation is that the industry can generate new jobs and inject life back into a workforce grown wary of the boom and bust of the financial sector. This is currently not so for PV, despite the introduction of a German-inspired FIT scheme, the government has recently pulled back on incentives and only modest growth of 3.5 GW is projected to 2020.

Like Germany, the UK too is looking anxiously at its supply margins, albeit with some more breathing space before the crunch - a clifftop scenario post 2015 which sees no more production from the coal plant opted out of the Large Combustion Plant Directive (LCPD)10 followed by the ramp down of 7.1 GW of retiring nuclear capacity in the run up to 2020.

Germany

Values in GW

2011

GDP Growth

UK 2020

3.0%

2011

2020

0.7%

Peak Demand11

75

74

55

57

Total Wind

29

51

6

27

Offshore

0.2

14

2.1

18

Photovoltaic12

24.8

50

0.3

3.5

Table 1: Comparison of Actual and Forecasted German and UK Peak Demand and Renewables Capacity

EU 20-20-20: Ushering in the age of Renewables The German government in September 2010 introduced a new Energy Concept to 2050 and a proliferation of new measures to meet their goals. In this, the country has committed by 2020 to a reduction of 40% in greenhouse gas emissions and a target to produce 39% of electricity from renewables. Following Fukushima, the government adhered to the targets despite the added challenge of replacing nuclear faster and adopted the “Netzausbaubeschleunigungsgesetz” to speed up planning and licenses procedures for much-needed grid expansion. Further

7

National Grid Winter Outlook 2011/12

8

Initiatives include e.g. consultancy from Repowering-InfoBörse to develop and implement local repowering strategies

9

Deutsche Energie/Agentur GmbH (DENA)

10

Around 12 GW of inefficient coal and oil plant will be phased out in line with LCPD by the end of 2015 and further closures can be expected by 2023 as a result of IED directives. Source: DECC

11

German 2011 figure based on ENTSOE data from Jan-Nov 2011 only

12

In 2011 7.5 GW (Reuters) was added to 2010 total of 17.3 GW (www.erneuerbare-energien.de)

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commitment to Germany‟s ambitious targets is evidenced by the Federal Network Agency guaranteeing a generous return on equity, despite Europe‟s current economic woes, for investment in the electricity network 13.

While German was releasing its Energy Concept, DECC‟s “2050 Pathways” engaged the public in determining suitable pathways the UK could potentially follow to reduce emissions by 80% by 2050, relative to 1990 levels 14. This was supported in 2011 by the UK Renewable Energy Roadmap in which the government recommits to a 30% renewables to power target. To support the offshore wind development, Ofgem is tendering the process to grant Offshore Transmission Owner (OFTO) licences and as owner of the seabed around the UK waters, the Crown Estate has auctioned off an equivalent of 40 GW of capacity.

Ensuring security of supply: how are they going to implement this?

Security of supply concerns in Europe are not only restricted to fossil fuels and problems with importing from relatively few, often political instable source countries. Delivery of renewable energy, too, must be secure and the German Agency for Energy and Water (BDEW), perceiving a barrier to progress, has called for action to decouple transmission connection from the project plans of individual wind farms. The relatively low capacity of the North-South transmission line is a major issue and although flows have been looped through neighbouring Netherlands to some extent, wind curtailment has been occurring for some time, and indeed the associated negative prices on the EEX power exchange that go with it. Further transmission challenges are the environmental impact of the grid upgrade and the cable length required: offshore wind in Germany is currently connected to shore relatively far inland while the wind farms sites are most suitably located far offshore15. Possible solutions may be the use of HVDC16 cables, increasingly suited for bulk transmission over long distances, and at least some partial undergrounding of cables.

In the UK, Ofgem via Project Discovery, has identified a £200bn investment requirement to protect security of supply and £7bn has already been earmarked for Scotland‟s high voltage network by 2021. To accommodate its aggressive offshore wind targets, the UK will need to employ similar strategies to Germany and despite the action of Ofgem and new projects in the pipeline 17, the ageing onshore transmission network is not currently suited to receive the load. Already the UK has experienced wind-cut out events where wind speeds exceeded levels safe to run wind turbines18. With current levels of wind production expected to increase at least four-fold, the problem will only be exacerbated further and operating reserve will be put under severe strain.

Making markets more competitive: what happens to the power price ?

By virtue of the opening of new interconnected routes for power to flow, the EC hopes to push towards their goal of an integrated power market.

Indeed, integration of large volumes of wind farms into a hub-based European wide offshore grid19 could naturally lend itself to both increased security of supply as well increased market coupling. Fossil fuel-backed incumbents may look worryingly at this scenario and see huge potential to drive down their power margins, particularly in Germany where traditionally the Big Four have enjoyed the benefits of more regulated market, with comparatively more state protection than the more open UK energy markets. The perceived loss of dependable revenue is as a direct result of the implied growth in renewables generation; initially a high cost technology to invest in, but ultimately cheap to run in the long term. As all markets rely on the principle of merit order economics, this means an ever-falling cost of plant at margin and therefore a collapse in wholesale energy prices. With some figures for German PV and wind alone projecting a surplus capacity of 27 GW in 2020 and given the negligible running costs of both technologies, the question might arise, just how low could the wholesale electricity price theoretically drop?

In practice, the economics are not so straightforward; load factors of both wind and PV are not sufficient to meet demand in every hour20. The argument also goes on the generation-side that inherent volatility necessitates a need for back up generation; often expensive oil plant is the only viable alternative to ramp up/down quickly enough. In the UK, it is in fact an alarming drop off in capacity for LCPD combined with a perceived need for this additional flexible capacity which has pushed DECC toward the somewhat distorted market mechanism of Capacity Payments as the only means to guarantee reserves in future21.

While governments, regulators, grid and market operators grapple with these concerns, utilities are at the same time anxiously trying to understand what these changes mean for them and seeking ways to influence the future market direction. We focus in the remainder of this paper on two main challenges as utilities try to adapt to the new renewables-driven market fundamentals: 1. How will the implied volume of renewables affect trading and forecasting 2. How can a vertically integrated utility adjust its operations to mitigate renewables risk

13 14 15 16 17 18 19

http://www.bundesnetzagentur.de/cln_1911/SharedDocs/Pressemitteilungen/EN/2011/111102ReturnOnEquityElectricityGas.html?nn=48242 The carbon budget established under the Climate Change Act 2008 requires a 37% cut in emissions by 2020 See e.g. EWEA “Offshore Electricity Infrastructure in Europe” Oct 2011 High Voltage Direct Current Such as the 2 GW Western HVDC link connecting Scotland with England and Wales e.g. http://www.icis.com/heren/articles/2011/12/14/9516653/power/edem/uk-electricity-curve-shows-first-signs-of-exposure-to-wind-volatility.html See EWEA “OffshoreGrid: Offshore Electricity Infrastructure in Europe Oct 2011” e.g. Q311 UK wind output was below average at only 19% (onshore) and 31% load factor (offshore). Solar PV estimated production was 7.8% load factor. Source: National Statistics / DECC Dec 2011.

20

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How will the implied volume of renewables affect trading and forecasting

The Effect on trading and operational activity of a European utility

A summary of the infrastructure measures currently being discussed/ under consultation in Germany and the UK is shown in appendix I. These capture those expected developments which are either directly related to the build of offshore wind farms (e.g. North Sea Offshore Grid Initiative, feed-in tariffs) or which are separate issues in themselves but which would directly influence the place of wind and photovoltaic solar in the merit order and thereby the power price (increased external interconnection, carbon capture and storage, electric vehicles etc.)

Draining of dependable income The tendency with these renewables-led developments may appear to present a draining away of dependable sources of income in the context of a trading environment as the emphasis shifts from utility-backed asset economics to consumer led economics, but this needn‟t be the case.

Price volatility is generally seen as an opportunity to make a profit, while the complexity of analysis required to support proprietary trading is more of a challenge. With the implied volumes of renewables growth in Germany, a trading utility will increasingly need to rely on sophisticated options tools to understand extrinsic value and maximise profit on the uncertainty. But any algorithm is only as good as its input data and investment in industrial strength forecasting models (picked from the cloud), backed up with best-in-class meteorologists are also necessary to support trading activity.

Decentralised Generation With the decentralisation of power generation, increased volume of non-dispatchable plant and the corresponding enlightenment of the demand side, trading activity will need to look increasingly outside plain-vanilla commodity markets and seek income from provision of other products and services. As ENSTOE have pointed out, the provision of adequate and reliable ancillary services by parties connecting to the system is essential to ensure continued security of supply, particularly in the context of high levels of renewable generation. Balancing markets may too present better opportunities for generating returns as independent RES22 units enter the fray and seek services to manage their risk 23. At the same time and as long as these RES units continue to enjoy fixed FIT income, utilities may explore options around aggregated balancing services for exposed wind power producers compensating for a growing lack of merit-order economics.

Indeed, even after RES units mature and subsidies drop off, trading-backed utilities are still likely to maintain the best view of market fundamentals and as such would be best positioned to offer both ancillary and balancing services to less experienced independents looking to manage their exposure to the power price24. In short, utilities will need to exercise a degree of agility, not least to manage their supply and demand over multiple time frames but also due to shrinking gate closure times to allow maximum opportunity to balance wind forecasts.

How can a vertically integrated utility adjust its operations to mitigate renewables risk The intermittency of wind is independent of the amount installed, but it is clear that with accelerated growth the risk to utilities grows with it.

Along with new fossil fuel peaking generation, of the potential methods of mitigating the problem: direct customer load reduction, electric vehicles (EVs), storage batteries or other storage such as CAES, heat pumps, increase interconnector capacity or power to gas storage etc., all address those times when there is too much wind (over-generation), and none really address what happens when the wind doesn‟t blow. This is where Demand Side Management (DSM) and utilisation of virtual power plants (VPPs) can greatly help 25.

Managing Customer Load To compensate for a sudden drop in wind at any given time, a properly implemented Advanced Metering Infrastructure (AMI) would be a key enabler to ensure rapid reduction of demand. The corresponding market signal arising from under-production would be a higher price26, giving

21 22 23 24 25

Electricity Market Reform (EMR) White Paper 2011 “Planning our electric future: a White Paper for secure, affordable and low-carbon electricity‟ Renewable Energy Source 50Hz and Tennet are now marketing energy for intraday trading on EPEX at 15 minute granularity giving the market more scope for intra-hour profit taking A similar line of reasoning is Ofgem‟s consultation on an expanded role for the market operator Elexon given its position as a first mover.

Source: EDF. Also new peaking generation can help here but would tend to run against the tide in terms of an ultimate goal of zero carbon emissions The reverse situation for overproduction would be a lower price triggering an increase in demand or a decrease in supply

26

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the utility two choices: increase supply from other sources or lower the target demand level by interrupting on a large scale Virtual Power Plants such as non-critical industrial processes, customer fridges, freezers and dishwashers programs. A German utility though knows that Demand Side Management is theoretically more manageable with the energy mixture we have today, but complexity grows with the rise of alternative energies and its replacement of the old reliable lignite and nuclear technologies. As described above, any optimal IT solution really needs to properly address real-time variability.

Big Data Big Data is a new smart tool for traders are also vital; simply having web services provide live price feeds, wind and solar data and traditional plant type aggregated data will not be sufficient to keep track of the markets pulse. Massive cloud-based data warehouses with a Business Intelligence front end where a user can have instant access to live and historic pattern wind /solar smart grid data and access to more detailed consumption at solar/wind farm level will become a necessity as part of the day to day operations of a front office trader-analyst. It is conceivable that the operational control centres of the grid operators of today (Amprion, EnBW, Tennet and 50Hertz in Germany and NGT in the UK) may become the operational desks of tomorrow‟s prompt traders, with each market fundamental and grid congestion bottleneck displayed in dashboard format from country down to individual wind farm or even turbine level. Indeed the reeling in by European utilities of fully-integrated Business Intelligence (BI) systems used more typically in the domain of TSOs and plant operators may be critical to their survival, with supervisory control and data acquisition (SCADA) systems increasingly repositioned for use at energy trading level.

Grid bottlenecks

On demand exibility

RES over-generation

Micro-management of Supply & Demand

Challenge s

Extracting values from existing assets

Consumer enlightenment Non-dispatchable generation

Volatility

“Big” data

Managing customers load Complex analysis

Extrinsic value

Optionality Complex ramp up/ down operations

Volatility Decentralised generation

Forecasting RES Insu cient live data

Shrinking gate closure times

System balancing

AGILITY

PROPRIETARY TRADING Business and IT Solutions

OPERATIONAL RISK OPTIMIZATION

Provision of ancillary services

Peaking plant dispatch

Aggregated balancing services Cloud services for COTS Sophisticated options tools

SCADA systems DER interruption

DER-integrated BI

Industrial-strength forecasting models

AMI Demand Side Management Sophisticated algorithmic tools

Conclusion The latest developments in the European Energy Markets are on a critical path to meet the EC„s key objectives and ultimately 20-20-20 commitments. Despite the slow progress, transmission networks need to undergo rapid overhaul and will in the near future be replaced by smart-enabled „supergrids‟. Whether it is on the trade floor or in the back office, arbitraging across markets or managing risk, a European utility has its work cut out to adapt to the speed of the changes taking place. Agility is crucial, but cannot guarantee success on its own and must be supported by a deep understanding and management of the complexity. The energy trading environment of the next decade requires optimization on a hitherto unseen scale to ensure new revenue streams are created, to cope with the decentralisation of power generation, to manage customer load and to deal with the huge data requirements. To evolve and survive, optimization will need to be embedded in the very fabric of the business; across multiple timeframes, markets and commodities, across all resources and above all across all data-points.

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ELVs Heat pumps CAES Power 2 Gas

Managing aggregated RES risk

Best of breed meteorologists New market products

Storage options:

Data Warehouses

APPENDIX I

Renewables-enabling infrastructure measures currently under discussion and resultant effect on power price

Price Effect 2020 Development Focus

Peak

Increased external interconnection

ÅÆ

New nuclear

Carbon Capture and Storage Supply side measures Distributed/Small-scale generation, e.g. CHP

UK

NorGer link

additional 1 GW on UK-FR interconnector

North-South network

Western HVDC link

Not likely before 2020

North Sea Offshore Grid Initiative

È

Relative to current prices marginal cost is more than renewables due to use of uranium

N/A all retired by 2022

ÅÆ

Post 2020 - assuming online at a time when markets already dominated by renewables, little further effect on price

Emissions Adoption this April Performance of BMWi‟s27 CCSStandard (EPS) Actset at 450g CO2/ kWh28

e.g. EDF 6.4GW of EPR reactors at Hinkley Point and Sizewell

È

New peaking plant

Ç

Typically gas and oil plant priced at higher marginal cost than average clearing price

New Pumped Storage

È

Relative to current prices

Feed-in tariffs

È

Capacity Payments

È

Guarantee of fixed payments beyond normal trading revenue would tend to lessen the need for a scarcity premium on top of short run marginal cost

Carbon Price Floor

Ç

But only if fossil fuels still required to meet demand

Smart Grid / AMI

È

In so far as enables actions to reduce demand, and therefore power price

Electric Demand Side vehicles Measures

DE

Connecting renewables directly to load at lower voltages would reduce the residual load requirement and hence the clearing price

È

integrated offshore grid

28

Easing of transmission bottlenecks, would increase unconstrained power generation and market coupling, both driving down outturn power price

È

Distribution network

27

Offpeak

È

Grid Transmission network measures (internal)

Example development Note

È

Ç

Heat pumps

È

CAES

È

Power to Gas

È

Load shifting from peak to offpeak

Storage for over-generation would ease price pressure later during peak periods

E.On‟s Waldeck 2 300 MW extension approved Reduced 2012 EEG See footnote 20 tariffs See footnote 20 See footnote 20

National Platform for Electric Mobility (NPE), presented in May BMWi publication on “potential of the heat pump to manage load in the electricity market and integrate renewable energies”

Federal Ministry of Economics and Technology See UK Government‟s Electricity Market Reform (EMR) White Paper 2011 “Planning our electric future: a White Paper for secure, affordable and low-carbon electricity”

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APPENDIX II

Further References

• NGT “Operatingin2020_finalversion0806_final” June 2011

http://ec.europa.eu www.entsoe.eu www.susplan.eu

• Renewable UK “Offshore Wind Forecasts of future costs and benefits” June 2011 • EC “On security of energy supply and international cooperation - The EU Energy Policy:

http://www.addressfp7.org/ http://www.twenties-project.eu/

• Engaging with Partners beyond Our Borders” Sep 2011

www.eex.com

• Gartner “Smart Grid Survey: What Utilities Want and Where They Think They Can Get It” Sep 2010

www.bundesnetzagentur.de

• EWEA “OffshoreGrid: Offshore Electricity Infrastructure in Europe” Oct 2011

www.bmu.de

• ENTSOE “Scenario Outlook and System Adequacy Forecast 2011 – 2025 Main Findings” Feb 2011

www.bmwi.de

• EEG “Development of renewable energy sources in Germany 2010” July 2011

www.bmz.de

• Project_Fenix_2009-11-24_Constructing_the_Active_European_Power_Grid_Juan_Marti_v1

www.bdew.de

• EC “Guidelines for trans-European Energy infrastructure” European Commission” Oct 2011 • DENA “Positionspapier_dena-Verteilnetzstudie“ Nov 2011 • BNetzA “110831NuclearPowerExitSummaryReport” Aug 2011

www.dena.de www.decc.gov.uk/ http://www.nationalgrid.com/ www.ofgem.gov.uk

• ENTSOE “Offshore Transmission Technology” Nov 2011 • ENSTOE / Europacable “Joint_ENTSO-E_Europacable_FINAL_17_Dec__2010_signed” Jan 2011

www.elexon.co.uk www.tennet.org

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