Across the world, renewable energy auctions are seeing an upward trend, as nations seek to promote the development of greener energy sources. A renewable auction happens when the government issues a call for tender to power providers, to install a targeted capacity of renewable energy-based electricity. Interested energy players submit a bid price under the tender, which is the estimated price per unit of electricity that their project can realistically deliver.

competitive auctions are increasingly popular

Competitive auctions are an increasingly popular method of obtaining low-carbon electricity resources. The International Energy Agency (IEA) estimates that 32GW of renewable energy was awarded in competitive auctions globally between 2012-2017, a figure expected to double between 2018 and 2023.

“In the last round of auctions, we obtained a bid price of 32 sen per kilowatt hour, but when we closed the bidding on the second phase of Large-Scale Solar, we realised that the lowest of these bids was 17.77 sen (4.3 US cents) per kilowatt hour. That is 45% reduction in just a few years,” said Malaysia’s Minister of Energy, Science, Technology, Environment and Climate Change, Yeo Bee Yin, speaking at the Asian Utility Week conference in Kuala Lumpur.

Malaysia is set to become the latest country to introduce competitive capacity auctions as part of its recently announced electricity industry reforms. In theory, the inherent competitiveness of an auction scheme is meant to drive down bid prices, and translate into the most cost-effective price for consumers.

bid prices does not always capture costs related to grid connections or infrastructure upgrades

However, this form of auction does not come without its challenges. While bid prices may represent a projected production cost, it does not always reflect the generation cost itself – here, the bid price fails to directly compare to the levelised cost of energy (LCOE).

LCOE is defined as the expected cost of generating energy averaged over the lifetime of a power plant, and is an important business measure for power suppliers. LCOE itself does not always include all relevant costs for new energy sources.

Oftentimes, it fails to capture costs such as grid connections or required infrastructure upgrades. These costs can also be overlooked in auction bid definitions, creating the potential for a gap between bid prices and the true cost of generating and reliably supplying electricity. This ‘missing money’ problem is one which energy markets must work to address if expectations of affordable and reliable supply are to be met.

Feed in tariffs (FiT), a type of agreement that allows consumers to sell renewable energy back to the grid, is another scheme that could potentially distort financial evaluations. These long-term agreements, usually set by government regulators, offer guaranteed prices for renewably generated electricity. This mandated price can distort a power supplier’s pricing assessments, which have led to some countries like Spain moving away from such mechanisms in favour of more transparent auction processes. As the price of renewables continue to drop, the mechanism’s rigid structure further add to the complexity.

Another challenging area for renewable energy auctions is the basis of its model – the capacity market auction. Capacity auctions operate when regulators call for power generators to bid on a capacity obligation. A capacity obligation is a contracted promise by power generators to stand ready to provide power in cases of high electricity demand. In return, regulators agree to regular payments for the provision of this capacity. It’s a financially incentivised agreement, to ensure a nation’s electricity industry can handle high electricity demand at short notice. This is clear in theory, but can be murky in practice.

In the United States, mid-Atlantic grid operator PJM is currently embroiled in a dispute with the country’s Federal Energy Regulatory Commission (FERC) over the pricing structure of its own capacity market. With PJM covering a region that stretches across multiple US states, disagreements about the role of state subsidies that impact proposed capacity auction tariffs led to postponement of an auction due in August 2019. Complainants argued that zero-emissions credits that financially reward nuclear power plants were creating an unfair market for competitive bidding.

Capacity market structure must remain relevant as technology evolves

Supporters of clean energy argue that restructuring of the capacity auction, and particularly a minimum offer pricing regulating a minimum capacity price, will also result in undermining low-cost and subsidised renewable energy sources at a time when they are most needed. A clear understanding and definition of the rules around state subsidies and how they might factor into capacity auctions will be a key proposition for nations such as Malaysia in the formative period of designing its own capacity auction processes.

In the United Kingdom, a legal challenge of the nation’s Capacity Market (CM) scheme by clean technology company Tempus Energy in February 2019 resulted in the market closing for investigation by the European Union (EU).

The complainant in this case, Tempus Energy, argued that the market was fundamentally structured in a way that favoured fossil fuel technologies, and failed to adequately evaluate the benefits of often cheaper renewable electricity technologies.

A recent ruling by the EU passed the capacity market as fit for business once more, also citing movements by the UK to implement changes which will reduce the capacity threshold for participation in auctions, alongside the evolution of various other key auction rules that could potentially make it more accessible for renewable technologies.

Malaysia has the benefit of a blank canvas in designing its capacity market auction structure

This disagreement once again sets out the challenges of adapting legacy market structures to rapidly evolving renewable energy technologies. While this poses a challenge for existing markets such as the UK, it highlights the opportunity that nations like Malaysia face in designing a fresh capacity market auction structure with the benefit of a blank canvas.

Robust analysis of how renewable technologies can fit into such a market will be key to its success. The evolution of technologies such as battery storage reveal how flexibility will be equally important in ensuring that structure remains relevant as new technologies emerge.

It is clear from both local market insight and international market understanding that the bid prices for renewable electricity continue to fall. While competitive auctions are seen as an attractive option for purchasing electricity generated from these technologies, that decision will inevitably come with its own challenges. Ensuring the independence of the buyer, a fully costed economic analysis, and a suitably flexible market structure in which an auction can operate, will be essential in unlocking the benefits of falling renewable energy bid prices.