How Wind Power Subsidies Destroy Both Electricity Markets & Economies

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Around the globe, the wind industry behaves like an enormous, bloodsucking leech – latching onto power consumers and taxpayers; and ever ready to drain its hosts dry and leave nothing but empty shells behind.

In Australia, those soon to be empty shells will include what’s left of our manufacturing industries; mineral processors and the tens of thousands of families that cannot afford power now – and the thousands more who will soon join them sitting freezing (or boiling) in the dark (see our posts here and here).

Australian businesses and families are all set to be pounded by the entirely unsustainable Large-Scale Renewable Energy Target (LRET), which is designed to see more than $50 billion filched from power consumers (as a Federal Tax) and transferred to wind power generators (as a mandated subsidy) over the remaining life of the LRET (see our post here).

Under the LRET, from here on – as a simple arithmetical and legislated FACT – power retailers are meant to purchase and surrender 587 million RECs in order to avoid the shortfall charge: described recently by Environment Minister, Greg Hunt as a “massive penalty carbon tax of $93 per tonne which nobody wants to see.” (see our post here).

As the shortfall begins to bite (within the next few months) RECs will – due to the taxtreatment of RECs – soon exceed the cost of the shortfall charge ($65 per MWh) and end up trading around $94 – at that price the cost to power punters would top $55 billion.

The fact that Australian electricity retailers have jacked up and are refusing to enter Power Purchase Agreements with wind power generators (the method by which retailers purchase RECs) means that the LRET is all set to implode, but that’s another story (see our posts here and here).

One of the topics before the Senate Inquiry is whether the insane costs drawn in the form of the REC Tax/Subsidy can be justified on any level, the Inquiry’s terms of reference including:

(a) the effect on household power prices, particularly households which receive no benefit from rooftop solar panels, and the merits of consumer subsidies for operators;

(b) how effective the Clean Energy Regulator is in performing its legislative responsibilities and whether there is a need to broaden those responsibilities;

(h) the energy and emission input and output equations from whole-of-life operation of wind turbines; and

(i) any related matter.

STT thinks these little policy-posers simply highlight the fact that there has NEVER been any cost benefit analysis carried out in relation to Australia’s Renewable Energy Target, since it was thrown into the energy policy arena, over 15 years ago.

That a scheme, which has already added $9 billion to power bills (in the form of RECs) and which would see the transfer of a further $50 billion from the poorest to the richest, has never seen the slightest scrutiny from independent economists is, let’s just say, more than a little surprising.

But this outlandish policy predicament is not unique to Australia. Oh no, the Brits are well and truly in the same boat. The UK has seen power prices rocket out of control with its rush to plant thousands of giant fans all over Ol’ Blighty – its broad sunlit uplands, and as far as the eye can see, out to sea.

The fact that the UK’s political betters haven’t bothered themselves with the usual type of economic inquiry (ie is there any energy, or environmental, bang for the massive subsidy $bucks?) is one of the key points raised in a very recent, and truly brilliant, study by Rupert Darwall.

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Rupert has already shone the spotlight on the insane hidden costs of wind power (see our post here). But, now he has excelled himself, with a very detailed analysis of what is nothing short of an energy market debacle.

His study, “Central Planning with Market Features: How renewables subsidies destroyed the UK electricity market”, should be mandatory reading for any Australian politician purporting to support the unsustainable LRET. The full paper can be accessed here as a PDF. We’ve picked out the parts most relevant to Australia’s wind power debacle below.

Central Planning with Market Features: How renewable subsidies destroyed the UK electricity market
Rupert Darwall
March 2015

The story so far

Energy policy represents the biggest expansion of state power since the nationalisations of the 1940s and 1950s. It is on course to be the most expensive domestic policy disaster in modern British history. By committing the nation to high-cost, unreliable renewable energy, its consequences will be felt for decades.

Yet it wasn’t so long ago that Britain led the world with electricity privatisation and liberalisation – the last big policy achievement of the Thatcher years – cutting bills and driving huge gains in capital and labour productivity, gains which are now being reversed.

• What went wrong?
• What are the costs?
• What can be done?

The re-imposition of state control is not because privatisation failed. As the Government concedes, ‘historically, our electricity market has delivered secure supplies, largely due to competitive markets underpinned by robust regulation.’ Instead, state control is the result of imposing an arbitrary form of decarbonisation involving an extremely costly European target for renewables generation (principally wind and solar energy) which Tony Blair negotiated at his farewell European Council in 2007. The result is that the privatised electricity sector is being transformed into a vast, ramshackle Public Private Partnership, an outcome that promises the worst of all worlds – state control of investment funded by high-cost private sector finance, with energy companies being set up as the fall guys to take the rap for higher electricity bills.

The Government justifies the return of state control on the presumption that the price of fossil fuels will rise continuously, a view now rapidly overtaken by falling coal prices and the halving of oil prices in the space of five months.

What went wrong: Key errors in the decision-making process

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Foundational Error. The turning point which led to the demise of the market was not proceeded by extensive policy appraisals or analysis of alternatives to the market, but from the adoption of the renewables target at a European Council meeting. Target-driven policy objectives are inflexible. They prevent exploration of trade-offs. The more compressed the deadline, the higher the costs. The overriding focus on meeting the target narrows the field of vision, so that emerging difficulties from other countries, notably Spain and Germany, were ignored as evidence for reappraising the target.

Policy Lesson #4

Setting a target before analysing the costs, operational implications and likely unintended consequences, without considering alternatives constitutes the foundational error in the entire process from which, in one way or another, subsequent errors flowed.

Target-driven policy-making. Cost, efficiency and affordability were subordinated to the goal of meeting an arbitrary target. Instead of seeing the market as a price discovery mechanism to reveal the lowest-cost producer, policy sought to disguise (socialise) the true costs and implications of renewables to minimise the apparent cost of the policy.

Policy Lesson #5

A policy framework to encourage renewables that systematically conceals their true costs will result in higher costs and higher electricity bills for the same quantum of renewable capacity.

Form over function. Having decided to adopt a renewables target, there has been no comprehensive analysis of its costs, benefits and implications for the market. In particular, decision-makers did not ask what exactly electricity consumers get in return for the use of high cost private sector capital and whether it represented value for money for them.

Policy Lesson #6

Before adopting EMR [Energy Market Reforms], policymakers should have evaluated it against a public sector comparator so that the net cost/benefit of using private sector capital is identified and quantified, rather than being implicitly assumed.

What are the costs: Renewables’ hidden costs

The costs of intermittent renewables are massively understated. In addition to their higher plant-level costs, renewables require massive amounts of extra generating capacity to provide cover for intermittent generation when the wind doesn’t blow and the sun doesn’t shine. Massively subsidised wind and solar capacity floods the market with near random amounts of zero marginal cost electricity. It is therefore impossible to integrate large amounts of intermittent renewables into a private sector system and still expect it to function as such.

To keep the lights on, everything ends up requiring subsidies, turning what was once a profitable sector into the energy equivalent of the Common Agricultural Policy. Worse still in a highly capital intensive sector, because prices and therefore revenues are dependent on government interventions, private investors end up having to price and manage political risk, imparting a further upwards twist to costs and prices.

Without renewables, the UK market would require 22GW of new capacity to replace old coal and nuclear. With renewables, 50GW is required, i.e. 28GW more to deal with the intermittency problem. Then there are extra grid costs to connect both remote onshore wind farms (£8 billion) and even more costly offshore capacity (£15 billion) – a near trebling of grid costs.

Including capacity to cover for intermittency and extra grid infrastructure, the annualised capital cost of renewables is approximately £9 billion. Against this needs to be set the saved fuel costs of generating electricity from conventional power stations. For gas, this would be around £3 billion a year at current wholesale prices, implying an annual net cost of renewables of around £6 billion a year. The cost of renewables is even higher compared to coal (which is being progressively outlawed).

What can be done: The worst of both worlds

Intermittent renewables destroy markets. You can have renewables. Or you can have the market. You cannot have both. The hybrid of state control and private ownership is far from optimal and inherently unstable. At no stage has there been any published analysis demonstrating that the use of private capital delivers better value for money than a public sector comparator.

There are two options to align ownership and control:

• If renewables are a must-have – although no government has made a reasoned policy case for them – then nationalisation is the answer; or
• the state cedes control, ditches the renewables target and returns the sector to the market.

THE PROBLEM WITH INTERMITTENT RENEWABLES

It is hard to understate the implications of the UK’s growing exposure to wind for its electricity. According to the Royal Academy of Engineering, which is sympathetic to renewables, it requires ‘a fundamental shift in society’s attitude to and use of energy.’ Success, the Academy says, depends on the ability to manage demand to reflect the output from wind, going on to note that despite increasing efforts to research demand management techniques (to match consumption to the variability of the weather), ‘there is still much uncertainty on how effective it will be and at what cost.’ So called ‘smart grids’ will be vital, the Academy says, but their potential and effectiveness at scale ‘are yet to be proven.’

Electricity has a set of uniquely demanding characteristics:

• It cannot be stored, except to a limited extent, with batteries and pumped hydro, and that storage is limited and incurs a cost;
• Supply must respond almost instantaneously to demand;
• If too little is produced, there is a danger of degraded quality and, eventually, of power cuts, which are costly to users;
• Too much production can damage the transmission system, leading to wires becoming deformed or even melting;
• Failing to equalise demand and supply can also lead to changes in the frequency of the power supply – too high, and it can damage appliances; too low, equipment can underperform.

Wind and solar technologies pose huge integration challenges. They are difficult to predict, particularly wind, which is highly variable – on gusty days, wind speeds can vary enormously over a few minutes or even seconds. According to Malcolm Grimston of Imperial College, London, low wind speed tends to be weakly correlated with high power demand (cold, windless winter evenings and hot, windless summer days). Depending on how wind-generated electricity is connected to the grid, large amounts of wind power can reduce system inertia and make it less stable.

When renewables account for a significant proportion of generating capacity, the whole electricity system becomes exposed to weather risk as it has to cope with what an OECD/ Nuclear Energy Agency (NEA) report calls ‘random amounts of intermittent electricity.’ The uncertainty inherent in farming is one reason why governments end up heavily subsidising farmers.

The logic of exposing all electricity generators to weather risk implies that the Government subsidises all forms of electricity generation, something wholly unanticipated by policymakers. MIT professors John Deutsch and Ernest Moniz remarked in a 2011 report that policies to encourage renewables have been successful in promoting large-scale deployment, before observing:

‘It is becoming clear that the total costs and consequences of these policies were not fully understood.’

In other words, politicians adopted pro-renewables policies with their eyes wide shut. Britain’s target of deriving 15 per cent of its total energy consumption from renewables was agreed before the system-wide consequences had been analysed. Energy policy has been trying to play catch-up ever since. Renewables policy is truly a leap into the dark.

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According to Project Discovery, the capital cost of onshore wind is double that of CCGT. For offshore wind, the capital cost per kW is nearly five times higher – before accounting for the thermal (gas and coal) capacity needed to cover wind intermittency. For Project Discovery, Ofgem applied de-rating factors to adjust the nameplate capacity of different generation types to reflect better the probable contribution each is likely to make to meet peak demand. Therefore, wind assets have a significant de-rating to reflect the lower average availability and risks of correlated periods of low output.

Table 2 below applies these to illustrate the capital cost for onshore and offshore wind compared to CCGT to meeting peak demand on the basis that CCGT is used as dispatchable capacity (i.e. which can be turned on and off when required). To derive the overall capital cost for each plant type, it applies Ofgem’s de-rating factors, assuming the balance is met with additional CCGTs.

Table 2: Capital Cost per kW adjusted for Ofgem 2009 De-rating Factors
Plant type	Cost per kW (£)	De-rating factor (%)	Cost per kW of additional (dispatchable) capacity (£)	Total cost per kW (£)	Capital cost per kW as multiple of CCGT
CCGT	600	95	32	632	n/a
Onshore wind	1,200	15	510	1,710	2.7
Offshore wind	2,800	15	510	3,310	5.2
Source: Ofgem (2009), Project Discovery Energy Market Scenarios, p.90.

 

Cost and capacity implications

Since 2009, the relative cost of CCGTs to wind has fallen. DECC’s 2013 estimate of the ‘overnight’ capital costs of onshore wind (i.e. excluding capitalised interest) at £1,600 per kW compares to £610 per kW for CCGT. Thus the capital cost of onshore wind has risen from being twice as expensive as CCGT to 2.6 times in just five years. The costs of offshore wind have also worsened. Based on analysis of actual build costs in the US and adjusting for higher UK offshore construction costs, Edinburgh University’s Professor Gordon Hughes estimates 2013 prices would be at least £3,300 per kW compared to Ofgem’s 2009 assumption of £2,800 per kW – a rise of 17.9 per cent.

The need for intermittent renewable capacity to be twinned with dispatchable capacity drives a colossal investment requirement.

For the same peak electricity demand of 60GW as today, which was met by 85GW of capacity in 2011, the Government estimates the UK will need 113GW of capacity in 2025 – an increase of 28GW. Because the Government did not seek a derogation from the EU Large Combustion Plant Directive, 12GW of coal-fired capacity will also need to be replaced plus 10GW of time-expired nuclear capacity, implying a total requirement of 50GW of new capacity, of which two thirds (33GW) is planned to be renewables.

Thus meeting the UK’s renewable target requires 28GW more capacity than if peak demand was met conventionally. Assuming a 50:50 split between onshore and offshore wind, on the basis of Project Discovery’s numbers, this implies an additional capital cost of £56 billion. The additional cost of deploying the extra 5GW of renewables (33GW less 28GW) instead of CCGTs is £7 billion, implying a £63 billion extra cost of renewables to provide the same peak capacity as from conventional power stations.

Wind and solar also require heavy extra investment in transmission infrastructure. For onshore wind, proposed reinforcements of the transmission grid are of the order of £8 billion, which represents a doubling of the Regulatory Asset Value of National Grid’s existing transmission network. This extra capital cost has a material impact on the underlying (and disguised) economics of wind, particularly in remote, windy locations. According to electricity industry expert Alex Henney, the implication is the cost of transmission of Scottish wind power is of the order of £500 per kW – making the capital cost of onshore wind 3.7 times higher than that of CCGT.

THE CHOICE

Appearing before the House of Lords Select Committee on Economic Affairs in November 2013, Lord Lawson asked Dieter Helm: ‘So if you were Secretary of State for Energy, what would you do now?’ Helm replied,

‘I would probably emigrate as quickly as possible; I would hate to perform such a task. The obvious answer is that when you are in a hole, the first thing you do is stop digging. Many things are currently being pursued that would make things significantly worse.’

This dead-end has come about because policymakers ignored the likely effects of subsidising high fixed cost/near-zero variable cost intermittent energy on the functioning of the energy market before adopting the policy. Attempting to mitigate the damage by subsidising the provision of capacity, the Government is taking control of electricity generation, but not taking ownership of it.

The bottom line is if the state wants renewables, it should do it properly and get out its cheque book.

In reality, there are two choices:

(1) If meeting the UK’s renewables target is the over-riding policy goal, then the most efficient solution is using the Government’s balance sheet to directly finance investment in generating assets and buy out existing assets, i.e. full or partial renationalisation; or

(2) Abandoning the renewables target, isolating the market from the price-destructive effects of embedded renewable capacity and setting a clear path to return the sector to the market.

Either would result in substantially lower electricity bills than where they are heading under EMR and 2) would enhance the UK’s economic performance.

A DESCENT INTO POLICY INCOHERENCE

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What of energy policy being ‘evidence-based, fair and just’? Assessed against the Government’s three objectives for energy policy, renewables policy is not remotely rational, fair of affordable:

• Keeping the lights on. Weather-dependent renewables are inherently poor at reliably generating electricity to meet demand. Indeed, the Government has acknowledged the ‘significant challenge’ represented by ‘operational security (i.e. enough responsiveness to ensure real-time balancing of supply and demand)’, though DECC couldn’t bring itself to name the culprit.

• Keeping energy bills affordable. Self-evidently, setting strike prices for renewables (and nuclear) that are double the current wholesale price of electricity puts upward pressure on energy bills – and that’s before taking account of the higher system grid level costs of renewables which the Government tends to ignore (Figure 3). If affordability really were a driver, nationalisation would provide a lower cost renewables route.

• Decarbonising energy generation. A 2014 Brookings analysis quantified the avoided carbon emissions per MW from wind displacing baseload coal generation at $106,697 a year and $69,502 a year for solar, based on a value of at $50 per tonne of carbon. By contrast, CCGT-generated electricity saves $416,534 of carbon per MW a year – nearly four times that for wind and six times that of solar in the US, where solar capacity factors are nearly double those in the UK.

Overall, the Brookings analysis, which does not explicitly incorporate the extra grid infrastructure costs of renewables, found that wind and solar generated respectively annual net disbenefits of $25,333 and $188,820 per MW at a carbon price of $50 a tonne whereas CCGTs generated an annual net benefit of $535,382 per MW. The conclusion is inescapable: ditching renewables and encouraging shale fracking is better economics and more effective at reducing carbon dioxide emissions.

Despite all the energy white papers, official analyses and the Government conceding that renewables are on course to cost £48.3 billion (before extra grid and dispatchable capacity costs), the Government has yet to produce a document analysing the costs and benefits of intermittent renewables to justify its leap into the dark. Delay in changing course merely adds to wasteful spending on renewables capacity for which the Government has no objective policy case. Deciding to opt out of the EU’s renewables target would take Britain off the escalator of higher energy bills and enable electricity supply and demand to be determined by the market, not central planners in Whitehall.

A LESSON FROM THOMAS EDISON

At 3pm on 3 September 1882, Thomas Edison switched on the first incandescent bulbs powered by his Pearl Street generator several blocks away. It was a huge technical accomplishment. In Edison’s words:

‘It was not only necessary that the lamps should give light and the dynamos generate current, but the lamps must be adapted to the current of the dynamos, and the dynamos must be constructed to give the character of the current required by the lamps, and likewise all parts of the system must be constructed with reference to all other parts, since, in one sense, all the parts form one machine, and the connections between the parts being electrical instead of mechanical.’

Edison’s brilliance was not solely that of an inventor. He was an entrepreneur who changed the world. According to the economic historian Thomas Hughes, from the start, Edison realised his system would have to be economically competitive. Thus he conceived of the problem to be solved by invention as inseparably technical and economic. Every technical step was informed by the need to beat the economics of gaslight. An example of Edison’s understanding of the integrated nature of electrical production, transmission and consumption is opting for high resistance filament light bulbs, otherwise the current required such large copper wires for mains distribution as to make it uncommercial.

When politicians decided to impose renewables on the electricity system, they took the opposite approach to Edison. Renewables didn’t have to be cost competitive. They didn’t have to be reliable. The extra costs they impose on the system were ignored. Politicians did not want to think about the wholly predictable destruction of the electricity market from their policies. The world would have to fit around their preferred generating technology.

Edison’s approach ushered in the age of electricity. If central planning worked, the Berlin Wall would still be standing.

Rupert Darwall
March 2015