Ireland’s electricity markets aren’t working, here’s how we can fix them.
Why we're in the crises we are.
Ireland is in a state of crisis. There is now a very real threat that we will not be able to keep the lights on over the winter months. If we can, the cost of doing so will be too much for many families and businesses to manage.
Our two problems – the lack of supply of electricity and the high costs –are at least partly a failure of our markets to deliver what was promised. The bedrock of electricity generation supply is the confidence of investors that the money they spend building a plant (either renewable or fossil fuel) will be repaid, while balancing this with the need for electricity prices to remain low.
Improving Supply
How much electricity we have the capacity to generate is determined by the capacity markets, known officially as the Capacity Remuneration Mechanism. This is run by the Single Electric Market Operator (SEMO), a joint venture set up by the grid management organisations in the Republic of Ireland and Northern Ireland. Companies bid for the chance to generate electricity over a particular year, and the cheapest generators that meet the demand are chosen for capacity payments for ensuring the stability of the grid. The Irish government’s Commission for the Regulation of Utilities commissioned a report on our Capacity Market that was published recently which makes for interesting reading on what can be improved. An essential passage on what has gone wrong is:
Since the introduction of the CRM (Capacity Remuneration Mechanism) [in 2018], 2,568MW of new capacity has won agreements in auctions, and 643MW of this capacity has subsequently been terminated. Most of the capacity terminated (i.e. 476MW) has been new gas generation.
Eirgrid, the state-owned organisation which ensures that the grid remains stable, is trying to procure 200MW of emergency generation for this winter, and 450MW for next winter – essentially, trying to procure the generation that we already planned to have before the projects were terminated.
An important passage from the report regarding the ESB is:
The most significant failure to deliver new build capacity …has been the failure of the ESB new build projects contracted … for delivery in 2022/23. These projects faced delays in commencing construction owing to long lead times for getting required consents, and hence faced a €10,000/MW termination charge. However, this charge was considerably outweighed by the gain in capacity value from re-contracting the failed projects into the subsequent auction at a capacity price of €100,000/MW.
As was put by Daniel Murray in the Business Post when news of this broke in January:
The dropping of the three additional gas power plants means that all five of the low-price ten-year gas power contracts for 2022 that ESB secured from Eirgrid have now been abandoned, with Barry Cowen, the Fianna Fáil TD, alleging market abuse by the energy company and calling for an inquiry. To win the contracts, ESB is likely to have significantly undercut its rivals on cost…..ESB bid all five of its new gas power plants at or below the awarded contract price of €46,150/MW, which is half the price of the benchmark for new entrants, and a third of the price cap ESB had argued may not be high enough to attract new generation.
The ESB blamed delays in getting environmental licences for the delay in construction, meaning they could not build the plants in the contracted time. Perhaps this could be solved by requiring planning permission before bidding in the capacity auctions. It is imperative, it is critical, that we have a far quicker licensing and planning system for essential infrastructure like energy generation.
Regardless of the reason, the root of our current capacity shortfall problem is clearly seen here. We knew how much electricity generation we needed, the ESB bid successfully for it, and then either couldn’t or didn’t build it on time. Then, after paying a fine, they rebid the same projects for later years and recent reporting from the Business Post shows they earned three times the price for the rebid projects. This is not the sign of a capacity auction system doing what it is supposed to do, it’s also not the sign of a semi-state company working in the best interests of the citizens of the state.
This is not a once-off, or limited just to the ESB, as was reported in this week’s Business Post:
…Data and Power Hub Services, which is an offshoot of Echelon Data centres, has also pulled out of another 100MW of gas generation due to be constructed next year. The company is also likely to be fined €2 million for reneging on its contract.
Clearly, we need a more streamlined planning system for projects that get accepted in the capacity auctions, or else stronger punishment for terminating a project. Changing the terms and conditions of the capacity auctions will do little to alleviate the crisis we are in at the moment, but it could help us from being back here again.. Eirgrid estimates our electricity demand will increase by 19-50% over the next decade, and ensuring we have the capacity to match that will be critical.
Electricity Prices
Even for the electricity generation capability we have built, the price of buying it may seem to be the result of a broken, or at least a highly faulty, system. The wholesale cost of electricity is set by the marginal price (the price of the most expensive unit used – these days normally generated by expensive natural gas). This means that the price of electricity, regardless of how much cheap renewable electricity we use, is normally set by the price of natural gas. We use this system as this is usually a very efficient model that incentivises generators to keep prices down (to capture more profit) and provides a strong price signal for generators and consumers. But as we have seen natural gas prices detach from what we have been used to, so too has the marginal price of electricity. This has resulted in huge increases in electricity bills, even as clean, cheap electricity is used at high levels. The average wholesale price of electricity for August 2022 was just over €387/MWh, back in February 2021 it was €58/MWh.
Last week, European Commission President Ursula von der Leyen said that the EU is considering an “emergency intervention” and a “structural reform” of the electricity market. We should be careful what we do in haste, but most can acknowledge that something needs to be done.
There is a growing push for a price cap to help ease the burden on consumers. I think this is a bad idea, for a few reasons. The cap could take the form of setting a maximum price that suppliers can charge. This would certainly bankrupt the companies involved (like we have seen in the UK with their price cap), leaving us in a worse situation than we are already in. This would lead to insufficient supply, leading to rationing and blackouts. Another way would be to set a maximum rate for bills, and then let the government cover the difference. This is essentially just a bailout of electricity suppliers, and as we have learned through extremely difficult times, bailouts have to be paid back, at enormous economic and societal costs. The end result is that blunt price caps either lead to disastrous shortfalls in supply, or a massive corporate bailout.
Unfortunately, natural gas is very expensive right now, and there is nothing we can do about that, in the short term. But there are many cheaper electricity sources we are. already using. As I said above, the wholesale cost of electricity is set by the cost of the most expensive generator. For those below that, they get to make a good profit. This is what incentivises them to be cheap: be more efficient and you make more money. But now these inherently cheaper generators are making massive profits, just because of the rise in natural gas prices, after all, the cost of running a wind farm is not increasing. As this story from the Irish Times says:
The State’s Commission for the Regulation of Utilities (CRU) forecasts that wind farms could earn an average of €330.23 a mega watt hour (MW/h) for electricity they sell to the wholesale market over the 12 months from next October. … This is six times the €53.66 MW/h that the regulator predicted the industry would earn over the same period two years ago, before energy prices began rising rapidly in 2021.
A much more sensible idea than a straightforward cap on electricity prices is a cap on the maximum price earned by cheap renewables like wind farms (‘inframarginal generators’). As espoused in this excellent piece by Barry O’Halloran in the Irish Times, the government guarantees a minimum price for certain wind farms to incentivise investment in the sector, but not a maximum price. Remember, the average wholesale price of electricity for August 2022 was just under €387/MWh, while certain wind energy projects are guaranteed a minimum price of around €75/MWh. Implementing a maximum price on renewable energy, one that is still enough to incentivise investment in the sector, could dramatically cut the cost of an increasingly important part of our electricity supply system.
This diagram from Prof. Lion Hirth makes the idea clearer:
As can be seen, the overall wholesale price remains the same, keeping the price signal for consumers, but the government holds onto a lot of the profit, allowing it to be redistributed back to the consumer.
The current Renewable Electricity Support Scheme (RESS), a scheme which supports a fraction of the renewable projects in the country, already works in this way. It’s because of this price cap, and the revenue that has been collected, that Irish consumers will be getting a payment of €89 this year from renewable generators rather than having to pay anything to it, as we have been paying to through the PSO levy for years. This is only a fraction of the total renewable projects in the country, so expanding this system to other renewable generators could help, with the money then being integrated into the PSO fund that will be paid out.
Focusing on economic relief this winter will have to be our priority, and it will be necessary to shore up families and businesses struggling with bills, but we should keep in mind market reform for the future. As we reduce natural gas use in the future, we may see marginal prices rise as generators price in their investment costs to the subsequent lower usage. Ensuring return on investment for generators while still having an efficient market must be a top priority for market operators.
Other Fixes
There are things that need to be done to ensure our electricity costs can be brought down in the long run. Improving our electricity infrastructure (i.e building pylons) would make it easier to move electricity around the country. Currently, Dublin has a lack of supply and Donegal has an excess. The lack of infrastructure means cheap electricity being generated is currently going to waste, while we have a serious electricity generation shortfall in the Dublin area.
Building storage, either battery, hydrogen or pumped hydro will also help us take advantage of when we have a lot of wind energy that we can’t move (this is a big problem in the west of the country, which has a lot of wind farms but not a lot of demand), and help us power the country through the 2-hour demand peak in the evenings.
Clearly, streamlining the planning process and grid connection consent process (perhaps by doing more things at the same time, like is happening in Germany now) and reducing the fees required for getting connected to the grid will help bring generation on quicker, and lower subsequent wholesale costs of both renewable and fossil fuel generation by reducing the initial investment costs. This has to be an imperative action for this government.
Conclusion
While the long-term solution to high prices is to increase supply of cheap energy (particularly by fixing our broken planning system), structural reform of electricity markets is also important. There will be no quick fixes to any of our problems, short or long-term. Our electricity system is a mosaic of structures and systems, it is not something we can overhaul lightly, but thinking about how it can be changed to adapt to the situation we are in is a vital step to ensuring energy security and affordability in the future.