On the threshold of further, intensive growth in the Polish wind energy sector
On 3 April 2015, after nearly three years of efforts, social consultations and two fundamentally different attempts to set up support for the renewable energy sector, the RES Act was finally published. Large part of it will enter into force 30 days following the publication date and chapter 4, the most important from the wind energy point of view, setting out the principles for the auction based model shall become effective as on 1 January of next year. The mode for adopting the Act is associated with doubts as to the abstention of its content from the European Commission notification procedure. The government assumed that the notification obligation did not arise, as neither extending the certificates of origin system nor introducing an auction based model constitutes a form of state aid requiring notification. In the end, the EC itself will verify this and we should expect its position on this matter in the near future.
Waiting for the first auction
Assuming that there will be no obstacles to the RES Act becoming part of the Polish legal order, the Council of Ministers should announce the budget for first auction for facilities exceeding 1 MW by no later than the end of May of this year. Its date is to be announced by the end of March 2016 and reference prices by the end of 2015. Auction winners will conclude contracts for difference (CfD) with Operator Rozliczeń Energii Odnawialnej S.A. (“OREO”), a state-owned company especially incorporated for this purpose, as a result of which they will receive the difference between the final auction price and the current average electricity price on the open market for each MWh of generated green energy. If the difference is negative the energy producer will refund it to the operator.
As the Act leaves key elements of future auctions in the hands of the Council of Ministers (auction budget and its split across energy sources with capacity utilization factor above and below 4000 MWh/MW/year) and the Minister of the Economy (reference prices), auction participants are trying to figure out the best auction strategy. First and foremost, the optimum energy quantity and price which a participant is going to submit in a bid has to be determined. The price has to be high enough to remain profitable but low enough not to lose the tender. There are so many variables to be taken into account that working out the optimum strategy constitutes a considerable challenge and is fraught with risks. It will be possible to win an auction by bidding the right price but also subject to a pre-determined electricity generation volume which will be settled in three-year periods. If, in any one three-year period, less than 85% of declared energy is delivered, a penalty in the amount of 50% of OREO contracted price shall be payable for every MWh of the shortfall. If more than the declared amount is generated it shall be sold subject to a “black” price, outside of the support mechanism. When it comes to wind, the source of green electricity, long-term production forecasts are limited by a number of factors. Starting with the climate itself and the processes which affect its volatility, wind speed and direction, through parameters and location of installed turbines all the way to errors and inaccuracies in measurement techniques used to formulate pre-auction forecasts. It is worth pointing out that at approximately 200%, production is very sensitive to changes in wind speed, which means that a 1% change in average wind speed results in a 2% change in generated energy.
As a result, the key challenge for any future producer is to determine, as accurately as possible, the MWh of energy which it will undertake to deliver in subsequent periods of the 15 year OREO contract. That quantity dictates the minimum, break-even price, above which a producer should be willing to sell that quantity of energy. A correctly constructed model for calculating the optimum price level and energy volume for the needs of the auction should take into account all costs (project development, investment outlays, costs of capital, operational expenses associated with maintaining the plant and special purpose vehicle), all risks associated with periodic energy production in quantities above or below the declared and a reliable estimation of their probabilities as well as a competitive level of profitability. And it is not only the expected return on the investment which should be competitive, meaning one which carries a good chance of winning the auction, but also all key cost items and in particular the cost of capital and employed technology. These parameters will be decisive - next to location and its wind potential - for tender results particularly for low-auction budgets.
Calculation models most commonly employed use P90, P75, P50 etc. to determine the values of given parameters subject to different probability coefficients of the occurrence of actual production deviations from the forecast. The higher the “P” index, the lower the expected quantity of produced energy, and subsequently higher minimum price required for the project to remain profitable. Thus the trick lies in defining, or rather predicting output at an acceptable probability level of it being performed throughout the entire OREO contract term, which, given project parameters, is then used to determine the optimum price and quantity of energy to guarantee an auction win and reasonable return on investment.
Significant reshuffle on the developers market
Regardless of model quality and the degree to which a producer is ready for the auction, the key tender elements will be of primary significance to its outcome (budget, reference price and capacity thresholds), some of which will only become apparent just before it is set to take place. Furthermore, the smaller the energy pool designated to wind farms in the initial auctions, the bigger the impact of the actions of other participants, not all of whom have to be rational, on their outcome. The history of the auction model in other countries (e.g. The Netherlands) demonstrated that a large number of auctioned projects fell victim to underbidding, or reducing the price below the break-even point which in the end meant that they did not come to pass. Surely, the primary decisive factor in terms of the chances of successful wind farm projects subject to an auction model is their expected capacity primarily stemming from location. It is expected that the auction model will raise project capacity threshold to more than 2700-2800 MWh/MW/year, whereas the current green certificate mechanism successfully financed projects well below 2500 MWh. This means a significant reshuffle on the developers market, where many businesses will be squeezed out and many advanced developments (e.g. with building permits) which are still available will not find buyers and as such will be abandoned. Thus, the Polish renewable energy market is entering a brand new phase. Despite numerous imperfections of the auction system, in the near future this market will belong to land-based wind farm investments. And even though we still do not know whether in subsequent budgets the Council of Ministers will afford sufficient room for sources with capacities below 4000 MWh, or those achievable by land-based wind farms, one may hope, that in light of no alternative RES technologies which offer the possibility of rapid production of equally cheap energy, just that will happen. After a prolonged stagnation, we are now on the threshold of further, intensive growth in the Polish wind energy sector.
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