Proposed Auction Design Hampers Expansion of Wind Energy
ResearchAuctions for Renewable Energy Support in Europe
European countries regularly invite tenders to allocate its funds for the construction of new wind energy plants. Often enough, however, there is a lack of applicants interested in investing. Owing to the absence of competitors, companies that place high-priced bids emerge as the winners of these auctions, a fact which drives up costs unnecessarily. In order to prevent this, the European Commission is currently considering the implementation of a regulation which is already in use for certain auctions in Germany. Under this regulation, the number of plants to receive funding is capped ex post if the total number of bids is low. However, in the current low-supply environment, this would weaken competition even further. What is more, a decline in the number of bidders would delay the expansion of renewables.
This is the result of a ZEW expert brief by researchers of ZEW’s Research Group “Market Design” as well as of the Karlsruhe Institute for Technology (KIT) and the consultancy Takon.
The German government’s target is to increase the share of renewable energy in total electricity consumption to 65 per cent by 2030. To that end, it seeks to support the expansion of the renewable energies via auctions. In these auctions, the authorities first determine the amount of megawatt capacity the plants are to provide overall. Energy companies then place bids for the energy plants they plan to construct, along with information on their respective capacities. The bids correspond to the remuneration per kilowatt hour of electricity produced by the plant in question.
If the overall capacity of the individual investors’ bids surpasses the overall quantity put out to tender, only the plants with the lowest bids win the auction. Competition of this kind curbs the costs for the support of new plants because companies undercut each other in order to win the contracts. If, on the other hand, the overall capacity of the bids falls short of the overall amount of capacity put out to tender, all bids receive funding. Whenever companies expect there to be little competition, they will place high-priced bids close or equal to the auction’s maximum bid, even for actually low-cost projects. This, in turn, makes renewable energy expansion unnecessarily expensive.
Competition is already relatively low
In order to prevent this problem, the European Commission is currently discussing a change of the rules for auctions for on-shore wind energy support. This change would provide for a reduction of the amount of capacity that will receive funding if the auction receives only few or only high-priced bids. The technical term for this kind of ex post reduction of the quantities put out to tender is “endogenous rationing”. In Germany, endogenous rationing has already been adopted for innovation tenders, the goal of which is to support innovative power plant combinations. Here, only 80 per cent of the bids win in any auction in which the capacity offered is lower than the capacity put out to tender.
The authors of the ZEW expert brief warn against implementing such a measure, however. They fear that it will deter companies from participating and result in a downward spiralling of supply. “It is particular with regard to the expansion of on-shore wind energy that such auction rules would be harmful. There are very few plant locations available and approval procedures are lengthy and prone to all sorts of risk. This is why competition in the field is already relatively low,” says Dr. Marion Ott, a researcher in the ZEW “Market Design” Research Group and co-author of the ZEW expert brief.
In order to participate in auctions, the companies first need to cover qualification costs, e.g. for meeting participation requirements such as gaining a (partial) approval for building a plant on a specific site. Companies will therefore only decide to participate in an auction if they expect a support payment which exceeds their qualification costs. Companies with more expensive projects only have a chance of winning the auction if the overall plant capacity offered does not exceed the overall capacity put out to tender, in which case (almost) all bidders receive funding. Otherwise, companies with more expensive projects are likely to shy away from investing in the costly qualification for the auction. Thus, if in the future auctions were to be subject to endogenous rationing, this would deter such companies from bidding in the first place given their gloomy prospects of being awarded a contract. This would further reduce supply. In extreme cases, no company will participate in the auction.
Approval procedures must become simpler and less risky
Of course, these considerations may apply only to a limited extent to real-world auctions. Yet existing research shows that in the long run, bidders will identify the strategies which pay off for them. This is why endogenous rationing of the quantity put out to tender could suppress bids and cause lasting damage to the market. “Adjusting auction rules in this way does more harm than good to competition,” according to Marion Ott. “If the European Commission and the German government wish to see an increase in supply, they should find political solutions. Many companies shy away from participating in auctions because their qualification costs are too high. In order to incentivise participation, permit procedures need to become simpler and less risky. Moreover, with Germany’s new Climate Action Plan, the country has few locations available which could be used for the construction of wind energy plants.”
The researchers have found that tenders to support renewables pursue different objectives, not all of which are compatible. Adjusting auction rules can help to promote individual goals among them, but not all of them at the same time. For example, one goal is to hit the sweet spot between the added value of additional renewable energy plants and the costs to support them. To achieve this goal, the maximum bid should be set rather low, below the value of additional energy. At the same time, however, there is the goal of balancing this value against the cost on society. Achieving this goal would necessitate a higher maximum bid.
Then again, there is the goal of attracting a sufficient number of bids. On the other hand, there is the goal of keeping the support payments at a minimum. The latter two objectives are inherently contradictory: while the number of bids rises in proportion to an increase in the maximum bid, low funding costs require the maximum bid to be as low as possible – which ultimately leads to the complete suppression of any offer.
Tenders will never be able to equally satisfy each of the objectives, which is why prioritisation is needed. “Endogenous rationing, that is, the reduction of the quantity awarded, serves neither the objectives of the state as auctioneer, nor the economy as a whole. What is more, it hampers the number of bidders and thus competition in general. In that sense, endogenous rationing is diametrically opposed to all relevant objectives, it impedes the expansion of renewable energy and constitutes an additional obstacle to the construction of wind energy plants in particular,” says Marion Ott.