Is isolationism profitable?


Below you will find opinion on the article concerning the text entitled "Import of cheap energy – higher costs for consumers" by Prof. Władysław Mielczarski, Ph.D. Eng., Łódź University of Technology, BiznesAlert, published on the CIRE website (in Polish) on the September 7, 2015.

The Polish power system is struggling with many serious problems and is facing the necessary system reforms. The question about benefits from cross-border cooperation is one of the major issues to be discussed. For Poland and Polish end customers, changes may be profitable, not only financially, but also thanks to an increase of the operational safety of the national power system. This is even more the reason why one cannot agree with the theses contained in the publication of Prof. Mielczarski "Import of cheap energy – higher costs for consumers", which demonstrates that import of energy, also from renewable sources, increases costs for the Polish end customers. Especially that currently in Europe more than 70% of power markets is fully merged and this process continues.

The main point of the article consists in the statement that there are fixed costs to be borne by the power industry independently on whether our power plants are in operation or not, as we need available capacities to cover the highest demand. The author assumes that if we are importing power, we incur these costs in some other form, e.g. through quality fee, which is financing the Operating Capacity Reserve, Cold Contingency Reserve and other system balancing mechanisms. The above reasoning is not true. If the price of imported power is lower than the short-term marginal cost of the Polish power plants, then the import of power is beneficial for the Polish consumers and does not increase the total maintenance cost of the power system in Poland. In July and August 2015, spot prices on Noord Pool were at a very low level (even below 10 EUR/MWh, see Fig. 1) thanks to the high level of activity of the hydropower industry in Scandinavia (favorable hydrological conditions).

The competitive power market determines the balance on the power market according to the short-term marginal costs of the most expensive power plant included in the merit order. Operating power plants which are closer to the right side of the merit order (which are hard coal-fired power plants) make a very low return on investment (i.e. they cover fixed costs at a very low level), they only cover their variable costs, e.g. costs of coal, materials or CO2 emission allowances. The power plants which are at the beginning of the merit order (brown coal-fired power plants) are profitable. For instance, this was the case in 2013, and then we had very low energy prices on the wholesale market. This situation was significantly disrupted by the introduction of the Operating Capacity Reserve.

The Operating Capacity Reserve (OCR) is a financial mechanism using the funds from additional payments for the power transmission (PLN 560 million in 2014; PLN 400 million in 2015). Its implementation means in fact that power consumers made an additional payment to the hard and brown coal-fired power plants amounting to nearly PLN 1 billion. Despite these expenses, the OCR did not help in the time of power deficits, as when capacities were low in the system, the power producers did not have to make power available as part of the OCR and did not bear any financial costs for this reason. This is a proof of both a defective structure of the OCR and for the susceptibility of the Polish power system to climate factors (due to the fact that 94% of the power is generated in thermal sources). Prof. Mielczarski recommends to support the Polish power system with capacity payments of the OCR type, which means administrating a double dose of the drug which proved ineffective. In my opinion, the treatment must be changed.

One of the efficient methods to counteract power deficits in the summer season - contradicting the theses presented by Prof. Mielczarski - could be the use of photovoltaics. There is a very strong correlation between the increase of demand caused by heat waves and an increase in power production from solar panels. This technology is not susceptible to the weather risk which plagued the Polish power plants in July and August. The Polish power system needs a diversification of generation sources to be able to retain the stability of power supplies. Auctions to support the RES plants which will be launched later this year will be a perfect opportunity to prove this point. On one hand, we will meet our EU obligations, reduce the pressure of the power industry on the environment, and, on the other hand, we will increase the reliability of the power system. Poland will get an antidote for the summer power deficiencies without implementing a power market, without an additional cost for the consumers exceeding what is already our national contribution to the EU climate change policy.

Prof. Mielczarski perceives the power market as the best tool to ensure the reliability of the National Power System. However, the study performed by the Forum for Energy Analysis which concerns experiences in implementing the power market in the United Kingdom shows that this scenario is not easy to implement. The power market in the United Kingdom did not give an impulse for new investments, but it burdened the consumers with significant costs (nearly GBP 1 billion a year). It is very likely this scenario could also happen in Poland. We are dealing with a paradox - if we are considering the volume of capacity, Poland is dealing with overliquidity, and if we are considering the power quality, we have a deficit. As a result, owners of power plants which are decapitalized are ready to accept a very low remuneration for generated power. On one hand this prevents new power plants from entering the market, as they will not get a sufficiently high remuneration for power. On the other hand, this prolongs the market presence of worn, unreliable facilities which we would like to get rid of as soon as possible.

Coordination and improvement of power exchange with foreign countries allows to maintain the operational safety of the National Power System. Import of power from the Noord Pool (Sweden, 600 MW) was an incredibly important element which protected Poland against the full black-out in the first decade of August. We import power from this direction using a direct current connection, and this technology allows to determine the direction of current. The import is made according to the market coupling mechanism, which means that power exchanges cooperate with each other and the current is sent wherever the spot prices on a given day are higher. According to this mechanism, if Poland has a power deficit, the prices get higher and higher and determine the direction of current from Sweden to Poland. Which means that the foreign power producers automatically allow to cover the Polish power deficit.

One can hardly accept the thesis that the Polish market is flooded with subsidized power from Germany. Against the claims of Prof. Mielczarski, Poland does not import power from Germany at all! Recently, it even has been exporting small amounts of power to Germany (see Fig. 2). Perhaps the import will start once the second phase shifter at the section with Germany in mid-2018. A large amount of energy is transported through Poland from Germany and is transferred on to the Czech Republic and Slovakia (so-called loop flows), but they in no way affect the prices and market trade in Poland. In the context of the developments in August this year, we can only pity this situation. If we had a market coupling with Germany, if we had cross-border connections capacity available for commercial transactions, we would not have to limit power supply to 1.6 thousand commercial consumers in Poland, which resulted in significant financial losses in the economy. And the power in Poland would simply be cheaper, which would be beneficial for all consumers.

In the debate of experts on the Polish power system, its problems and future solutions, we need diligence and inclusion of various contexts: political, social, economic and technological. When proposing solutions, we are obligated to consider the European regulatory environment. The European Commission has been consistently pursuing the goal of strengthening regional cooperation on the power market, increase of the RES share, the fullest possible use of resources on the demand side. By mid-2018, according to the assumptions of the network code which only came in force, all the European power markets will have to be connected. I believe it is harmful to keep the Polish power system isolated, to protect Polish power producers against foreign competition, ignoring the benefits from diversification of power resources. Let us consider: how can we become an active player on the regional market, how can we become a power exporter, which generating resources guarantee high quality and reliability, what is beneficial to consumers? We have to plan the system reform realistically, pragmatically, so as to take into account the processes which will shape the European power market within the next few decades, and one of them is to strengthen the trade exchange on the power market.

Fig. 1
Fig. 2

Author: dr Jan Rączka
Date of publication: 16 September 2015