Will renewable energy sources soon be profitable?

Michel Cruciani / Program Manager, Centre of Geopolitics of Energy and Raw Materials (CGEMP, University Paris-Dauphine) / 2015-05-06

Wind turbine and solar power sources now represent a significant fraction in the electricity generation mix of industrialized countries. How did they achieve such a breakthrough successfully? European countries use differing models, which all show their limits, for transition from a subsidy-intensive economy to a market-driven logic is complex. The question remains: will renewable energy sources soon be proven profitable?

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ParisTech Review – Research on profitability factors of renewable energy sources requires we possess reliable data. Are these available today?

Michel Cruciani – Data available are not always formatted to academic standards. The knowledge base remains limited and is far less developed than for, for instance, oil, coal or uranium. Moreover, in the field of renewables energies, everything is changing very fast. Generally speaking, we leave out heat pumps and thermal solar panel arrays (for domestic hot water), since these two applications have scarcely any impact on the collectivities and, likewise biofuels and heating uses for biomass sources; the latter depend on local resources that compete often with other uses. For example, not only can biomass be used to valorize wood used in industry, in furniture and to produce paper pulp but it can also serve as a source of heating or as a source of electricity. However, the amount of biomass a country can produce cannot be increased indefinitely.

We have the same phenomenon for hydro-electric installations, viz., the oldest renewable source of electricity. Hydro-power depends in fact on a limited potential and, in fact, in most industrialized countries, all possible hydro-electric sites have been exploited. So, at a time when there is a new show of interest in favor of renewable energy sources, hydro-power really hasn’t much to offer, other than in the form of pump storage stations.

Consequently, research has been focused mainly on resources that are not necessarily very new but where, nonetheless, technological progress offers levels of profitability that are almost commercially viable, i.e., new wind driven turbine generators and photovoltaic panel arrays. Other sources exist but are confined to specific geographic zones, par example, seismic zone for exploration of deep-lying geothermal sources, which are still experimental, as indeed are marine energy sources (tide, wave …).

How have photovoltaic panels and wind-turbines moved closer to becoming commercially profitable?

In an earlier period, photovoltaic panels were very expensive and subsequently reserved for special applications such as satellite solar arrays. Technical progress, in particular in the field of semi-conductors, has gradually led to increasing quantities of IC devices at more and more affordable prices. The next step was to explore and exploit resources other than silicon, viz., certain metal alloys optimized in respect to their photo-electric properties. The photovoltaic boom began around 1995, with Germany leading the field, the reason being that after the Chernobyl catastrophe (April 1986) a strong political anti-nuclear opposition was voiced. Simultaneously, the awareness of global warming and climate change was increasing and the IPCC was established. Towards the end of the 1980s, if you wanted to reduce the fraction of both nuclear power electricity and thermal combustion sourced power stations (coal, oil, gas …), renewable energies offered the only alternative. Germany and Denmark assumed the role of leaders here, installing wind farms and solar photovoltaic arrays in significantly large numbers; the technical know-how their operators acquired plus the component mass production possibilities lad to a lower price for equipment, especially when Chinese manufacturers joined in. Profitability now depends on the price a consumer is willing to pay for these new energy sources, compared with the cost of the equivalent kWh from classic sources (gas, coal, oil, nuclear).

How can we convince the markets to accept renewable energies?

As was the case for nuclear power in the 1950s, new energy sources (wind turbine and photovoltaic panels were not economically competitive compared with other existing power sources, the infrastructures of which has already been largely amortized. It was therefore necessary to establish support, aid and incentive measures. All the countries involved tried various formulae. Germany, for example, tested an aid to investments but this did not prove successful. It then changed policy to adopt what had proven successful in Denmark as of the 1990s: aids to production, in the form of financial support for the producers by a buy-back process with a price higher than the prevailing electricity market price.

You have quoted some European examples. But hasn’t Europe, in fact, enough electricity to hand and therefore does not need any more?

Europe in 2015 possesses excellent classic power production equipment, with its power stations (including the nuclear plants), a moderate growth rate and even load demand stabilization. This induces a problem for new energy sources. If the classic sites are well-established and if you can extend the expected operational life-span by simply replacing some ageing components, then it becomes difficult to make room for new sources, especially when they appear in the market-place with an economic handicap. To force their entry, the operators must implement market-pull methods, i.e., you stimulate the market by helping the producers guaranteeing them a long range revenue. They then take the initiative and responsibility to invest, in exchange for a ‘comfortable’ feed-in-tariff rate for their excess kWh. This scheme was extended to photovoltaic panel installations. The conviction of the is that by aiding both the market and the producers, there will develop a learning process and a scaling effect that will combine to eventually lead to lower prices to a point where these new energy sources will become every bit as (or even more) competitive as already existing classic sources. At the same time, the policy will include some “technology push”. To illustrate, research is currently being financed with the objective to obtain more efficient photovoltaic panels and wind-turbines that can operate even in light winds.

Have other incentive systems proven successful?

Italy, Switzerland and the UK opted for marketing solutions that went by the name ‘green certification’ but the analyses demonstrated that these solutions were less efficient and indeed often more expensive than offering consumers contracts with guaranteed revenues. In short, the mechanism operates as follows: on one hand, the renewable energy producers sell back their excess MWh and, on the other, each of the MWh generated is rewarded by a ‘green certificate’ (or tag) that can be sold on a second market. Under these conditions, whoever wants to sell electricity to an end-consumer must hand in a certain number of green certificates to a public authority pro rata his sales. Either this person is the owner of the renewable power source, with its corresponding certificates, or these can be purchased on the second market. The renewable energy certificate (REC) market theoretically compensates the MWh market and is seen as incentive enough to convince potential producers to make the necessary infrastructure investments. But this only works if the end consumer suppliers are subject to penalties when they do not produce enough RECs. In reality, the fines are never high enough and it often turns out to be more profitable to pay the fines rather than purchase the needed certificates. Moreover, the certificate market is rather volatile. It depends a lot on prevailing weather conditions (sunlight cover and wind strength). Certificate validity is limited to one year so you cannot save them. Because of this, the renewable energy producers – to cover the risk of not finding a purchaser for their RECs – take considerable margins when they choose their level of investment and when prices rise steeply.

The Danish, French or German systems require statutorily that the national electricity suppliers buy back all renewable energy production for the coming 10 to 20 years at a kWh tariff set by the public authorities. Are they more efficient, in your view?

In certain instances, the answer has to be “Yes,” especially when it comes to offering secure revenues for the investors. Europe is divided, with countries adopting one or other possible system. Belgium, for example, has both – green certificates in the Dutch speaking zone and guaranteed revenues in the French speaking zone. Italy changed its policy, moving from the certificate system to that of guaranteed revenues.

But to be frank, the system of guaranteed pay-backs, via set feed-in tariffs, also presents drawbacks. If the market place prices drop rapidly, for example when it becomes possible to assemble simpler design wind turbines or when a country starts to implement a mass-programme of solar panel installations, the guaranteed price will be far in excess of the real production cost for a MWh of wind or solar photovoltaic power. If law-makers do not pay attention to the market position, they can continue to subsidize the power producers at a guaranteed buy-back price that bears no relation at all with real cost involved. The wind-fall effects will attract more producers which in turn lowers the installation costs and increases even further the gap between production cost and the guaranteed buy-back price, etc. It is evident that the guaranteed price is transferred, in fine, to the end consumer and leads to tariff rises and to debts. France has managed to pilot its system better than neighboring countries.

Is the ‘renewable’ option socially equitable with respect to consumers?

Not really. We can agree that rural areas, with plenty of sunshine and being well exposed to winds, have a major advantage compared with dense urban built-up areas. Moreover, you need own capital or a bank loan to cover initial investments costs. For well-heeled industrialists who benefit from bank support, it is much easier than for low-income families. Of course, they can sign up to join an investment co-operative but their revenue will be strictly proportional to their financial contribution. Another social consequence has already been mentioned: the excess cost paid back to the renewable source producer increases everyone’s electricity bill. For a well-off consumer, the fraction of his income spent on purchasing electricity is low. In contrast, for a low-income consumer, the electricity bill becomes a sizeable part of his budget. He is therefore penalized. What we can observe in Europe today is a growing, measurable phenomenon of energy precarious people, due partly to the tariffs applied by the utility and consequently to the rapid growth of subsidies to renewable energy producers.

Is it so difficult to fine-tune the subsidies?

Law-makers have now realized that electricity tariffs must decrease regularly. Even if this is not yet the case everywhere, in most European countries the guaranteed price system now is more akin to a ladder. Every year, or even every quarter, the kWh price moves down one rung. This forces the producers to constantly seek the most efficient technologies … or the least expensive. In certain countries, the difference of production costs between classic or renewable sources has been largely reduced, and in fact is tends to zero. In these countries the guaranteed buy-back price could be cancelled. Producers could sell directly to consumers or produce electricity to meet their own needs. Lower kWh costs for photovoltaic electricity is becoming attractive for large-scale shopping malls, where large areas of solar panel arrays could be installed on supermarket roofs. As a result, we now have new economic slots.

Is the fact that the regulatory texts can be either national or European an obstacle to striking an energy supply balance in the EU?

It is true to say that one country’s policies here can impinge on policies elsewhere. It is the German consumers (households and a fraction of the industrialists) who pay the bill for a large fraction of the wind generated or photovoltaic power produced in Germany,i.e., about 20% of the total German electricity production. This is a non-negligible fraction and moreover, applies to the entire year’s consumption. Obviously, sunshine is more available in summer than in winter and never at night. Also, you have similar intermittency factors for wind turbines. So, in order to have 20% wind and photovoltaic power, you need a very large number of sites and equipment. The excess ‘renewable’ kWh are injected into neighboring national grids, and are given a priority because of a European directive. They are paid for by the German consumers and France imports them at a low cost. However, for the moment, the phenomenon has not yet reached a scale such that it might generate political problems in Germany.

But how can we ascertain that the market globally is balanced?

The electric energy market is designed in such a way that there is always a client for every kWh produced. And since the producers of renewable sourced electricity are paid as a function of tariffs set independently from the market conditions, this electricity can be re-sold at a very low price, or for ‘free’, even a negative price. The producers will be assured to receive the price guaranteed in their contract with the national grid utility. Since 2011, several times a year, the price for renewable electricity goes negative on the bulk energy market, viz., where large industries procure their power requirements. They are paid to consume this electricity! This is not the case for private home consumers, who subscribe contracts for annual supplies. But in France, the influx of German renewable energy tends to force the market price down, widening the gap with the guaranteed price and destabilizing the French producers. The cause clearly lies in Germany, inasmuch as the fraction of heavily subsided renewable energy sources in France, wind turbines and photovoltaic panel arrays is still limited, around 5% total production. In France hydro-electric sites and biomass energy still represent the major part of the renewable energy produced.

How can Europe arbitrate its energy transition?

The classic power stations in Europe date back to the 1960s and they are now ageing. Building a new coal-burning power station today (or a new nuclear plant) is expensive, given the environment protection and safety-surety regulations that apply. The cost of a kWh from new installations will therefore be comparable with that from renewable energy sources – bearing in mind that the price/kWh is not the only factor in the equation and that a guaranteed kWh produced at a classic site does not have the same value as an intermittent sourced kWh, viz., from the renewable energy sources. We can therefore imagine that the energy transition will be implemented with this in mind. However, if market prices continue their downward trend too long, logically nobody will want to build new power stations, which, notwithstanding, are absolutely necessary when the wind drops or when the sun is hidden.

If this situation arises, we shall not be able to avoid subsidizing renewable energy sources. This corresponds to a so-called ‘cannibalization’ process: renewable energies tend to push the market price down and necessarily need subsidies since the prevailing market price no longer covers the operators’ remuneration, even if the technologies improve and become more efficient.

How can we exit the energy deflation cycle?

In order for market prices to rise again, investment decisions in favor of modernized, classic power stations would be needed. However, there is not really any special need for extra generating capacity with, on one hand, the constant arrival of new qualities of renewable sourced energies and, on the other, stagnation in consumption. One possible answer to the situation would consist of postponing decommissioning of classic power stations. The final straw, so to say, is that the stations closed today are not the oldest constructions but the most recent, those that prove too expensive to run and are in the incapacity to keep in line with market prices. This is especially true for gas-burning stations. Since year 2011, the latter are no longer competitive because of the massive arrival of American coal, mined near the US Eastern seaboard ports and exported in large quantities to Europe; the reason for this is that the American operators now have access to cheaper shale gas. This in turn has pushed the price for coal down and, consequently, we now see European gas-burning stations closing, particularly in Germany – even though they are among the most efficient in the world – replaced today by far more polluting coal-burning stations!

Oil would have to drop significantly below the price level of 50 $ US/bbl. if gas were to recover its position in Europe compared with coal (the price of gas is generally indexed on oil prices). Classic power production sites are being closed to accommodate massively produced renewable energy imported from Spain, Germany, Portugal and Denmark. But this calls for some caution: if we wait too long to replace the power stations, we may face a wall, with huge investments needed in a short time to replace already amortized plants by a new set of stations.

Are all the industrialized countries in comparable situations?

Great Britain is isolated from continental Europe, and this may be beneficial, the country having some extra time ahead to adapt. But the country cannot profit from this luxury. The classic sites, notably the nuclear power stations and coal-burning stations, have far older equipment than those in operation either in France or Germany. Britain must therefore accelerate a rehabilitation programme, hence the government decision to purchase French nuclear power stations. As far as other major countries are concerned, none has an electric demand as stable as that found in Europe. The USA, Brazil, China, the emerging countries – all of whom who are introducing incentive measures in favor of renewable energy sources – benefit from a continuously rising domestic electricity demand. In this light, the new capacity coming on line will meet rising demand, without undue pressure or competition with existing production sources. Actors are not being forced out of the game, as is the case in Europe.

Will a future cohabitation of renewable and classic power sources be stabilized some day?

Each country is seeking solutions here. France has established capacity management systems. In order to compensate for the intermittent factor of renewable sources, you need to have classic generation stations as a back-up. These stations must be ‘paid for’. On a customer’s bill, it is the fixed fraction, or the service subscription fee that plays this role. The cost of the subscription contract could rise to remunerate those producers who decide to maintain their stations or even build new ones adapted to following the load curves, i.e., capable of starting instantly, rapid powering up to offset fluctuating winds or sunshine availability. Germany, in contradistinction, has preferred not to develop this compensatory mechanism, the simple reason being that the country has far more classic over-capacity than exists in France. Germany has built up strategic reserves. German power producers can only close down a station with an authorization issued by the federal minister of energy. They receive a compensation with the proviso that they maintain their stations in operation.

Is the relationship to electricity prices the same throughout Europe?

The answer has to be “No” given the large differences that exist. Countries such as Germany or Denmark, who have placed their bets on renewable energies, have all accepted to pay a high price. The relationship to prices occasionally depends on factors external to the energy procurement system. In Germany, for instance and because of a levelling demographic birthrate trend, housing has become far less expensive than it is in France – with no new construction plans for housing universities, schools … so the rapid increase in the price of electricity is socially acceptable. Moreover, the Germans do not use much electricity for domestic-heating purposes. Germany consequently could afford a very expensive electric supply, all the more so that in order to support industry, some of the enterprises concerned have been exempted from paying any overheads, the difference being borne by the domestic consumers. There is a comparable situation in Denmark. In Spain, in contrast, there was a plan to see the State authorities cover the overhead costs due to renewable energy sources. The Spanish energy debt grow rapidly to reach several billion euros. Suddenly, when the national debt figures exploded, the country declared itself incapable of paying the producers the compensation money promised. The Spanish who had indebted themselves to invest in solar panel arrays and wind farms are now in a very precarious situation.