Electricity Markets and Renewable Generation

2015
Energy Risk Professional

ERP Exam Course Pack
REQUIRED ONLINE READINGS

In addition to the published readings listed, the Electricity Markets and Renewable Generation
section of the 2015 ERP Study Guide includes several additional readings from online sources that
are freely available on the GARP website. These readings include the following learning objectives
that will be tested on the 2015 ERP Exam:
1.
Market Evolution: Wholesale Electricity Market Design for 21st Century Power Systems.
(Alliance for Sustainable Energy, LLC.)
(Sections 1-4 only)
Identify challenges associated with modern electricity markets and explain actions that
can help resolve these challenges.
Understand the market mechanisms available that can improve the adequacy, generating
capacity, and ancillary services of markets that contain a large proportion of variable
renewable energy.
Compare the benets and weaknesses of energy-only markets and capacity markets;
identify global examples of their implementation.
Explain how negative electricity prices can arise and their practical impact on power
markets.
Identify challenges related to the implementation of demand response programs and the
market rules that can be adopted to incorporate demand response.
2.
The Impact of Global Coal Supply on Worldwide Electricity Systems: Overview of Europe, the
United States, Australia, Japan, China, and South Africa (IEA Coal Industry Advisory Board).
Compare and contrast global power market structures, and identify the relative proportion of coal-red generation in each of the following regions: Europe, the United States,
Australia, Japan, China, and South Africa.
Assess the relationship between coal prices and electricity prices in the following regions:
Europe, the United States, Australia, Japan, and China.
Understand and interpret the position of European coal-red generation plants in the
merit order curve.
Understand how emissions control programs, like the EU Emissions Trading Scheme and
carbon taxes, impact the operating economics of coal-red generators and local
electricity prices.
Understand the relationship between coal prices and natural gas prices in various global
markets.
2015 Global Association of Risk Professionals. All rights reserved.
2015


3.
Bo Shen, Girish Ghatikhar, Chun Chun Ni, and Junqiao Dudley. Addressing Energy Demand
Through Demand Response (Berkeley National Laboratory, June 2012).
(Sections 1 to 3 only, pp. 1-24)
Dene demand response (DR) and understand how DR works to curtail shortages on a
power grid.
Distinguish between DR and energy eciency programs.
Understand how government policy and market deregulation have been instrumental in
the creation of DR programs.
Compare and contrast the DR programs for various RTOs.
Understand how bilateral DR programs like cost recovery and demand-side management
(DSM) operate.
4.
Describe the various methods used to encourage end-user participation in DR programs.
Understand how technology facilitates the implementation of DR programs.
Jeery Altman, Ross Board, Felix ab Egg, Andreas Granata, and Hans Poser. Development and
Integration of Renewable Energy: Lessons Learned from Germany (FAA Financial Advisory AG).
Explain how the rapid build-out of renewable energy resources in Germany has impacted
the following areas:
Government spending
Retail and wholesale electricity prices
Baseload generators, including fossil-fuel and nuclear plants
Grid reliability, grid interventions (rebalancing events), and backup power generation
Transmission system development costs and grid usage fees
Compare and assess feed-in taris with quota-based renewable obligation programs.
Explain the response of German PV solar installers to modications in the German feed-in
tari program over time.
Identify the economic challenges associated with the use of feed-in tari programs.
Assess trends in German renewable capacity additions and penetration over a recent
20-year period.
Understand how observed domestic retail electricity prices are aected by the penetration of renewable energy capacity on a countrys power grid.
2015


5.
Chris Groobey, John Pierce, Michael Faber and Greg Broome. Project Finance Primer for
Renewable Energy and Clean Tech Projects.
Describe project nance, and explain the structure of a typical project nance agreement;
dierentiate between project nance and merchant nance.
Understand the importance of power purchase agreements (PPAs) in securing project nance.
Identify the primary stakeholders in a project nance agreement.
Dierentiate the characteristics of common loan structures used to nance renewable

energy projects.
Understand the project waterfall as it relates to the distribution of revenues to stakeholders in a project nance transaction.
Describe key U.S. government incentive structures for renewable energy projects, including
production tax credits (PTCs), investment tax credits (ITCs), and accelerated depreciation.
Market Evolution:
Wholesale Electricity
Market Design for 21st Century
Power Systems
Jaquelin Cochran, Mackay Miller, Michael Milligan, Erik Ela,
Douglas Arent, and Aaron Bloom
National Renewable Energy Laboratory
Matthew Futch
IBM
Juha Kiviluoma and Hannele Holtinnen
VTT Technical Research Centre of Finland
Antje Orths
Energinet.dk
Emilio Gmez-Lzaro and Sergio Martn-Martnez
Universidad de Castilla La Mancha
Steven Kukoda and Glycon Garcia
International Copper Association
Kim Mller Mikkelsen
Global Green Growth Institute (GGGI)
Zhao Yongqiang and Kaare Sandholt
China National Renewable Energy Center
21stCenturyPower.org
Technical Report
NREL/TP-6A20-57477
October 2013
Contract No. DE-AC36-08GO28308
Market Evolution:
Wholesale Electricity
Market Design for 21st Century
Power Systems
Jaquelin Cochran, Mackay Miller, Michael Milligan, Erik Ela,
Douglas Arent, and Aaron Bloom
Matthew Futch
IBM
Juha Kiviluoma and Hannele Holtinnen
VTT Technical Research Centre of Finland
Antje Orths
Energinet.dk
Emilio Gmez-Lzaro and Sergio Martn-Martnez
Universidad de Castilla La Mancha
Steven Kukoda and Glycon Garcia
International Copper Association
Kim Mller Mikkelsen
Global Green Growth Institute
Zhao Yongqiang and Kaare Sandholt
China National Renewable Energy Center
Produced under the guidance of the Department of Energy and
the Clean Energy Ministerial by the National Renewable Energy
Laboratory under Interagency Agreement S-OES-12-IA-0010
and Task Number WFH1.2010
NREL is a national laboratory of the U.S. Department of Energy, Office of Energy

Efficiency & Renewable Energy, operated by the Alliance for Sustainable Energy, LLC.
21stCenturyPower.org
Technical Report
NREL/TP-6A20-57477
October 2013
Contract No. DE-AC36-08GO28308
NOTICE
This manuscript has been authored by employees of the Alliance for Sustainable Energy, LLC (Alliance)
under Contract No. DE-AC36-08GO28308 with the U.S. Department of Energy (DOE).
This report was prepared as an account of work sponsored by an agency of the United States
government. Neither the United States government nor any agency thereof, nor any of their employees,
makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy,
completeness, or usefulness of any information, apparatus, product, or process disclosed, or represents
that its use would not infringe privately owned rights. Reference herein to any specific commercial
product, process, or service by trade name, trademark, manufacturer, or otherwise does not necessarily
constitute or imply its endorsement, recommendation, or favoring by the United States government or any
agency thereof. The views and opinions of authors expressed herein do not necessarily state or reflect
those of the United States government or any agency thereof.
Printed on paper containing at least 50% wastepaper, including 10% post consumer waste.
Abstract
Demand for affordable, reliable, domestically sourced, and low-carbon electricity is on the rise.
This growing demand is driven in part by evolving public policy priorities, especially reducing
the health and environmental impacts of electricity service and expanding energy access to
underserved customers. Consequently, variable renewable energy resources comprise an
increasing share of electricity generation globally. At the same time, new opportunities for
addressing the variability of renewables are being strengthened through advances in smart grids,
communications, and technologies that enable dispatchable demand response and distributed
generation to extend to the mass market. A key challenge of merging these opportunities is
market designdetermining how to create incentives and compensate providers justly for
attributes and performance that ensure a reliable and secure gridin a context that fully realizes
the potential of a broad array of sources of flexibility in both the wholesale power and retail
markets.
This report reviews the suite of wholesale power market designs in use and under consideration
to ensure adequacy, security, and flexibility in a landscape of significant variable renewable
energy. It also examines considerations needed to ensure that wholesale market designs are
inclusive of emerging technologies, such as demand response, distributed generation, and
distributed storage. The report concludes with a review of potential areas for future research on
wholesale power markets.
Well-designed markets encourage economically efficient solutions, promote innovation, and
minimize unintended consequences. Yet, many uncertainties remain about how to achieve these
aims in power markets, given the need to accommodate contextual constraints and effectively
invite and sustain capital investments. There is an acute need for international collaboration on
wholesale market design questions. The 21st Century Power Partnership aims to provide a
platform for collaborative analysis, and the authors of this report sincerely hope that it lays the
groundwork for future collaboration.
iii
This report is available at no cost from the National Renewable Energy Laboratory (NREL) at www.nrel.gov/publications.
Acknowledgments
The authors are greatly indebted to the many reviewers of this study, including Sam Baldwin and
Matthew Wittenstein (U.S. Department of Energy); Jos Mara Valenzuela (Secreteriat of
Energy in Mexico); Myung Kyoon Lee and Rene Karottki (Global Green Growth Institute);
Gordon Feller (Cisco); Morgan Bazilian (Joint Institute for Strategic Energy Analysis); and
Jeffrey Logan, Karlynn Cory, Tom Schneider, Robin Newmark, Lori Bird, David Kline, Trieu
Mai, Scott Gossett, and Mike Meshek (National Renewable Energy Laboratory).
The authors also wish to acknowledge the Ministerio de Economa y Competitividad ENE201234603 project, co-financed with European Union FEDER funds and the Spanish Wind Energy
Association (Mr. Alberto Cea).
List of Acronyms
CAISO
CFE
DSO
ELCC
ERCOT
EU
FERC
ISO
ISO-NE
LMP
LOLP
LSE
MISO
NERC
NREL
PJM
PV
RAP
RTO
TSO
California Independent System Operator

Comisin Federal de Electricidad
distribution system operator
effective load-carrying capability
Electric Reliability Council of Texas
European Union
Federal Energy Regulatory Commission
independent system operator
ISO New England
locational marginal price
loss of load probability
load-serving entity
Midcontinent Independent System Operator
North American Electric Reliability Corporation
PJM Interconnection
photovoltaic
Regulatory Assistance Project
regional transmission organization
transmission system operator
iv
Executive Summary
Wholesale electricity market designs represent both a challenge and an opportunity for realizing
21st century power systems, in which variable renewable energy and emerging technologies such
as smart grids, demand response, distributed generation, and distributed storage, are tightly
integrated into power system operations. Wholesale electricity markets in restructured,
competitive markets serve two roles: they define the security-constrained, merit-order dispatch
that ensures short-term reliability, and they define the financial incentives and rules of eligibility
for investment in resources that ensure long-term reliability. The continuing evolution of policy
objectives and emergence of new technologies is dramatically changing the nature of wholesale
market design. Fortunately, learning and expertise accumulated over recent history provides an
indication of how electricity market design might evolve. This report summarizes the key issues
and evolving approaches in the field, and looks ahead to the research areas and collaborations
that will support further advances.
Toward 21st Century Power Systems
Demand for affordable, reliable, domestically sourced, and low-carbon electricity is on the rise.
This growing demand is driven in part by evolving public policy priorities, especially of
reducing the health and environmental impacts of electricity service and expanding energy
access to underserved customers. Consequently, variable renewable energy resources comprise
an increasing share of electricity generation globally. Expanding the grid penetration of
resources with variable output requires more nimble power systems that can adjust quickly to
balance supply and demand. At the same time, new opportunities for addressing the variability of
renewables are being strengthened through advances in smart grids, communications, and
technologies that enable dispatchable demand and distributed generation to extend to the mass
market. Figure ES-1 illustrates the range of dynamic interactions that might characterize 21st
century power systems.
st
Figure ES-1. Illustrative view of 21 century power systems. NREL
v
Wholesale Market Design Principles for Integrating Variable

Renewable Energy
Broadly speaking, there are three paradigms in use around the world to organize electricity
delivery. In some regions utilities operate under the traditional vertically integrated utility
modelthe first paradigm. In these regions, most or all assets are owned and operated by a
single entity, and costs are recovered through a regulated rate of return. In other regions,
representing the focus of this paperthe second and third paradigmsthe main segments of
integrated utilities (generation, transmission, and distribution) are unbundled. The transmission
network typically remains regulated, while generation activities (and sometimes retail
distribution activities) are opened to competition. Energy is then transacted in a wholesale power
market. In the second paradigm, long-term adequacy is addressed through the energy market (socalled energy-only markets). In the third paradigm, there is an additional revenue mechanism
to reward generators for their availability, regardless of actual generation (so-called energy plus
capacity markets).
Policy debates in Europe currently focus on whether to transition to an energy plus capacity
paradigm, since significant thermal generation risks becoming uneconomical in the next 20
years. In many rapidly developing economies, policy debates center on whether and how to
move from a vertically-integrated paradigm to an energy-only or energy plus capacity paradigm
in order to better meet rapidly growing demand, improve reliability, achieve better economic
efficiency, and accelerate the integration of variable renewable energy.
This paper focuses on market designs that have emerged to meet these various challenges, and is
structured along the three main domains of power marketsadequacy, energy, and ancillary
services.
Adequacy: This function ensures adequate investment in capacity that is needed to meet future
demand occurs with sufficient lead-time to complete construction and interconnection of the
generating unit. High penetrations of variable renewable energy (with its inherently low marginal
costs) have led to lower average prices in energy markets. Conventional generatorswhich will
be displaced more often and sell energy at lower prices when they are selectedare likely to run
at lower (and less predictable) capacity factors and earn less revenue from the energy markets
(Milligan et al. 2012; Bauknecht et al. 2013), precipitating adequacy concerns. Also, the type of
capacity (e.g., ability to cycle on and off) that the system requires in the long-term to ensure a
reliable system becomes more important. Approaches to sustain adequate and appropriate
capacity may include some combination of scarcity pricing, capacity markets, and capacity
payments, and energy efficiency is increasingly considered an eligible resource in some markets.
Energy: This is the central transaction platform in power markets. To deliver energy when it is
needed, generators are dispatched on an economic basis, subject to reliability constraints and
congestion. In some markets, the economic dispatch of demand-side resources is growing
significantly, altering the economics for conventional generators. Increased penetrations of
variable renewable energy affect the energy markets in three primary ways: 1) the frequency and
vi
magnitude of changes to net load 1 increase, which in turn require that the system have
capabilities such as fast ramping and frequent on-off cycling; 2) the possibility of forecast errors
increases the difficulty in anticipating market outcomes, increasing the relevance of intraday
markets (where available); and 3) the proportion of fully dispatchable supply could decrease as
the low marginal costs of renewable energy displace them from the market. 2 Variable renewable
resources, such as wind, can in many markets bid in as a dispatchable resource, but their
performance improves significantly with good forecasts. Other energy market modifications
reviewed in this report include: dispatch resolution, more frequent markets, ramp products,
negative pricing, and forecast integration.
Ancillary services: This collection of services is necessary to maintain system balance between
supply and demand, and to ensure voltage and frequency support. Many markets include
secondary and tertiary reserves (e.g., regulation, spinning) in the ancillary services market; other
services, such as system inertia and voltage control, are not subject to markets. Variable
renewable energy can affect the design of ancillary services markets in the following ways. First,
the variability and uncertainty of wind and solar energy increases requirements for various
ancillary services, affecting the scheduling and pricing of those services. Second, their impacts
vary depending on system conditions, which makes the ancillary service demands difficult to
generalize across timescales and systems. Third, allowing variable renewable energy to
participate in ancillary service markets can offer more supply to the market, but could offer
challenges based on the unique characteristics of variable resources. The aggregate impact of
significant variable renewable energy on the grid suggests the need for modifications to current
ancillary service market designs and rules, and suggests the potential for new separate ancillary
service markets.
Table ES-1 summarizes the market design considerations reviewed in this report.
Market Design
Considerations Reviewed
Table ES-1. Market Design Considerations Reviewed for Adequacy, Energy, and Ancillary Services
Adequacy
Energy
Ancillary Services
Dynamic reserve requirements
(secondary and tertiary reserves)
Scarcity pricing
Dispatch resolution
Capacity markets
More frequent markets
Primary frequency response
Capabilities markets
Ramp products
System inertia
Capacity provision by
renewable resources
Negative pricing
Voltage control
Forecast integration
Co-optimization
Dispatchable variable
renewables
Ancillary service provision by

renewable resources
Net load refers to electricity demand minus electricity supplied by variable renewable energy and hence the
electricity that must be supplied by other resources.
2
Hybrid systems (e.g., wind + storage, solar + storage, solar + natural gas) enhance dispatchability and thus revenue
certainty to investors, but are not the focus of this markets report, which focuses market designs that accommodate
variability and uncertainty.
vii
Bridging Wholesale Markets and Emerging Technologies
Bridging opportunities between wholesale markets and emerging technologies, such as demand
response, distributed generation, and distributed solar, has the potential to reduce system costs,
including costs at the distribution level, where these resources in particular can address
congestion, losses, and inadequate infrastructure. But, the distinct characteristics of these
resources, particularly for distributed resources, present challenges to creating nondiscriminatory access in the wholesale market. Examples of persistent challenges include:
1. Increasing demand response participation.
Demand response holds significant promise to increase the elasticity and economic
efficiency of wholesale market operation. Nonetheless significant barriers remain before
these resources contribute in a significant way to system operation because traditional
markets follow 20th century demarcations between wholesale and retail sides.
Increasingly, market design might need to redraw these boundaries. Some markets,
especially in the United States, have established new specifications that have clarified the
role and trading parameters of demand response resources, resulting in significant
participation.
2. Integrating distributed generation.
Deployment of distributed generation, for example solar photovoltaic and combined heat
and power, impacts wholesale market operation in unique ways. For example, in
Denmark, combined heat and power plants are required to participate in wholesale power
markets, and a third of the plants also participate in real-time energy markets. Distributed
photovoltaic electricity, on the other hand, rarely participates in wholesale markets, but
has an indirect effect by reducing net demand levels during midday hours that used to
represent peak price hours. Given these unique characteristics, there will likely be no
single approach to integrating distributed generation into market design. Instead, local
contextual factors will figure prominently in market designs that result in coordinated
deployment of centralized and distributed energy resources, as well as in the treatment of
hybrid market actors such as microgrids.
3. Clarifying the role of storage.
Electricity storagemechanical, thermal, or chemicalpromises to ease concerns over
wind and solar market and system impacts and to decrease curtailment. Yet, significant
policy and regulatory barriers make it difficult for storage to participate in centralized
markets. For example, storage can provide generation, transmission, and distribution
benefits, but in many markets storage can only be classified (and valued) as one type.
Emerging solutions, such as allowing the owner of a storage resource to disaggregate
these various services and sell them each to a third party for transaction in markets, could
induce more optimal use of storage options.
Challenges to 21st Century Market Design
Wholesale market designs provide significant efficiency in real-time dispatch of system

resources, and offer great promise for integrating variable renewable energy and introducing new
resources on the demand side, because they help encourage innovation, minimize system costs,
and facilitate access to a broad range of options that increase system flexibility. Yet, there remain
viii
ongoing challenges involved with the design of markets for enabling higher penetrations of
variable renewable resources and emerging technologies. A few topics are listed below:
Minimizing Complexity: Around the world, most power markets have evolved into complex
designs that integrate efficient economic principles with the engineering and physics of the
electric power system. New designs, such as for flexibility, are being introduced, but at the cost
of amplifying existing market complexity. Too much complexity could necessitate market
revisions too frequently, fail to achieve extensive market participation, and create unintended
conflicts between markets, such as energy market rules that create a disincentive to provide
reliability services.
Encouraging Investment: In most wholesale markets, energy prices are based on the marginal
cost of providing energy, and therefore do not include any of the capital costs of the resources.
Investors calculate the risk adjusted returns of potential projects; and as energy prices decrease
with increasing penetration of zero dispatch generation sources, other revenue sources become
increasingly important, including scarcity pricing, capacity markets or payments, and bilateral,
long-term power purchase agreements. There is debate as to the merit of each.
Harmonizing across timescales: A reliable and secure electricity supply requires sensitivity to
multiple timescales. Electricity markets provide short-term price signals (seconds to days),
which are effective at allocating available capacity. In contrast, few power markets provide any
long term price visibility and are ineffective at incentivizing the optimal amount of long-term
installed capacity to meet reliability (Cramton and Stoft 2006). A challenge in market design is
how to provide long-term market signals to encourage investments in new merchant generation
(renewable or otherwise).
Ensuring Market Depth: In many power markets, a significant amount of energy is sold
through bilateral contracts, which addresses the absence of long-term market signals, but which
reduces market participation. The implications for systems with high variable renewables but
significant bilateral contracts are threefold. First, most energy delivery is purchased months to
years in advance, locking in generation that could be inflexible, and leaving a small day-ahead
and real-time market for new, innovative, and flexible supply. Second, spot-market prices might
be inconsistent with marginal costs due to the limited supply of flexibility. Third, limited
participation in the day-ahead and real-time markets can decrease market efficiency by reducing
the potential for market software to optimize supply resources based on their bid costs.
Conclusions
Experience in many countries illustrates the value in using markets to access flexibility. Welldesigned markets encourage economically efficient and stable solutions, promote desired
behavior, and minimize unintended consequences. Yet, many uncertainties remain about how to
evaluate system requirements and effectively induce and sustain investments in appropriate
resources. This report reviews market designs that help access flexibility, and it suggests that
sources of revenue could shift away from energy toward tailored services.
It is apparent that market design is a difficult task. Many competing objectives must be met,
including using short-term price signals to incentivize long-term investments, minimizing market
power, and providing incentives for suppliers for the many non-energy services that are needed
to balance the grid. Wholesale markets in many locations are markedly uncorrelated with pricing
mechanisms in the retail market. This means that participants in the wholesale markets have
ix
minimal ability to predict, plan, or account for consumer actions. Further, in some markets with
scarcity pricing, spikes in wholesale prices serve only to increase total costs, and do not provide
any incentives for consumers to change their behaviors to promote economic efficiency.
The challenge of appropriate market design becomes more apparent in emerging 21st century
power systems. Assets such as variable renewable energy, demand response, storage, and
distributed generation offer benefits that can be realized throughout the power system
generation, transmission, and distributionand therefore are difficult to capture in current
markets and regulatory structures, which deliberately segregated generation from transmission to
support utility unbundling. The power system may require a transformation from a system
premised on a strict separation between wholesale and retail, or generation and distribution, to
one that can integrate these markets, such that assets from across the system can contribute to
flexibility and reliability.
Moreover, market solutions are not the only option. Various hybrid designscombinations of
regulations and competitive marketsmight serve as alternatives. A key driver in any market or
hybrid design is to start with the characteristics that maximize the value of the power system and
ensure that the type and quantity of services that deliver economically efficient operation and
design of the power system are understood.
The power system is just that, a system, relegating various design and operational issues to
entities that are uncoordinated, possess imperfect information, and possess varying degrees of
market power. Moreover, these entities operate in a complex market with many economic
externalities; thus economies of scope (e.g., coordination of transmission and generation
planning) are difficult to achieve. On balance, however, markets can enable efficiency gains that
emerge from competitive (or nearly competitive) markets in electricity. Nevertheless, market
approaches remain just one option in a broader range of possible approaches, such as vertically
integrated utilities.
There is an acute need for international collaboration on wholesale market design questions. A
platform for collaborative analysis and modeling will help to evaluate pathways to 21st century
power systems. Proposed market or hybrid market-regulation paradigms should be rigorously
tested to understand both technical and financial outcomes, but also the alignment with the
public policy objectives that drive market design. The 21st Century Power Partnership aims to
provide this platform, and the authors of this report sincerely hope that it lays the groundwork for
future collaboration.
x
Table of Contents
1
Introduction ........................................................................................................................................... 1
Toward 21 Century Power Systems ................................................................................................. 3
Wholesale Market Design Principles for Integrating Variable Renewable Energy ........................ 7
Bridging Opportunities Between Wholesale Markets and Emerging Technologies ................... 26
Challenges to 21 Century Market Design ....................................................................................... 33
Market-Design Research As a Platform for International Collaboration ...................................... 36
Conclusion .......................................................................................................................................... 40
References .......................................................................................................................................... 42
st
3.1 Adequacy ......................................................................................................................................... 7

3.2 Energy ............................................................................................................................................ 15
3.3 Ancillary Services .......................................................................................................................... 20
4.1 Demand Response.......................................................................................................................... 26

4.2 Distributed Generation ................................................................................................................... 30
4.3 Storage ........................................................................................................................................... 31
st
5.1
5.2
5.3
5.4
Minimizing Complexity ................................................................................................................. 33

Encouraging Investment ................................................................................................................ 33
Harmonizing Across Timescales ................................................................................................... 35
Ensuring Market Depth .................................................................................................................. 35
6.1 Short-term Operational Timescale ................................................................................................. 36

6.2 Long-term Planning Timescale ...................................................................................................... 37
List of Figures
Figure 1. Projected electricity demand by sector, 20102035. World Energy Outlook 2011
OECD/IEA 2011 (Fig. 5.1, p. 177) ......................................................................................................... 3
st
Figure 2. Illustrative view of 21 century power systems. NREL ........................................................... 4

Figure 3. Mean diary [daily] market prices based on wind penetration levels (Spanish hourly data,
20072012, provided by Red Elctrica de Espaa) ......................................................................... 13
List of Tables
Table 1. Market Design Considerations Reviewed for Adequacy, Energy, and Ancillary Services ... 7
xi
1 Introduction
Around the world, wholesale electricity market designs are being reconsidered in an effort to
meet a broader range of objectivesincluding accelerating private investment, promoting
competition and efficiency, encouraging the development and deployment of nonfossil fuel
sources of energy, and increasing flexibility in system operation. In light of this growing interest
in establishing or reforming wholesale electricity markets, there is a clear need for an
international discussion of the market design principles and paradigms that can guide the
transition to 21st century power systema system which integrates variable renewable energy
and emerging technologies such as smart grids, demand response, distributed generation, and
distributed storage.
This report aims to identify and briefly discuss the landscape of key issues in wholesale market
design for achieving power systems that are cleaner and more efficient, resilient, and reliable
(see Text Box 1 for explanation of wholesale market terminology). It is the first in an ongoing
series of issue papers from the 21st Century Power Partnership, a multilateral initiative to
accelerate power system transformation. Contributors to this report include public- and privatesector experts from around the world, who provide a uniquely broad range of perspectives.
Subsequent papers will examine international perspectives on related topics, such as emerging
designs for the retail power market.
The report is structured as follows. Section 2 describes 21st century power systems. Section 3
examines specific market design features that have evolved to accommodate high penetration
levels of variable renewable energy. Section 4 examines the need to bridge opportunities
between wholesale market designs and emerging technologies such as demand response. Section
5 examines the likely challenges to effective market design. Section 6 explores a research agenda
that might build international collaboration. Section 7 synthesizes conclusions.
Text Box 1. Wholesale Power MarketsDefinitions
Wholesale power markets refer to the exchange of energy, ancillary services, and capacity in the bulk
power system, which comprises the interconnected resources at the high-voltage levelgeneration,
transmission, and interties to neighboring systems. The retail power market refers to the exchange of
energy and services at the lower-voltage distribution level.
Bulk system (or grid) operators go by different names in different jurisdictions. In Europe they are
called transmission system operators (TSOs). In India they are called load dispatch centers. In the
United States they are called regional transmission organizations (RTOs) or independent system
operators (ISOs).
Approaches to system operation also vary widely. The United States, for example, uses two approaches
to wholesale electricity market designvertically integrated utilities and RTOs/ISOs. 3 The vertically
integrated utility paradigmcommon to many jurisdictions globallyrelies on the public utility
3
The U.S. RTOs/ISOs are California ISO (CAISO), Electric Reliability Council of Texas (ERCOT), ISO New
England (ISO-NE), Midcontinent ISO (MISO), NYISO, PJM Interconnection (PJM), and Southwest Power Pool.
1
transmission provider to procure the necessary resources to manage the uncertainty and variability of
the power system. 4 In the United States, the transmission providers are required to provide open access
transmission service. In areas with RTOs/ISOs (the focus of this report), transmission owners gave
operational control of transmission facilities to the RTO/ISO, which is an independent entity. The
RTOs/ISOs allocate transmission rights based on a system of bids and offers, and optimize unit
commitment and dispatch decisions to minimize system costs. In Europe, often the TSO both operates
and owns the transmission facilities.
Operators of the low-voltage level, who reduce the voltage from the transmission lines and deliver
power through distribution lines, also have different names, including distribution system operators
(DSOs) in Europe and utilities in the United States. The load-serving entities (LSEs), such as utilities,
competitive retailers, and the DSOs that sell electricity to retail consumers, purchase their power from
the wholesale energy market. Many European DSOs are considered entry gates to retail markets and
contribute to the effective functioning of energy wholesale markets (Council of European Energy
Regulators 2013b).
This report uses wholesale power markets to refer to the unbundled, competitive markets, such as the
RTOs/ISOs and electricity markets in Europe.
Variability refers to variations in demand and supply, for example, wind and solar generation can vary based on
changes in the intensity of their energy sources, and conventional generation and load can deviate from schedule.
Uncertainty refers to unexpected events, for example, forced plant outages or load or wind forecast errors.
2
2 Toward 21st Century Power Systems
Globally, investment in power systems is expected to exceed $15 trillion over the next 20 years
(IEA 2012), and electricity demand is expected to nearly double (see Figure 1). This growth will
give added urgency to the goals of achieving affordability, energy security, reliability, and
reduced health and environmental impact. In this context, energy-efficient devices, appliances,
and power systems will allow for more rapid expansion of energy access. Renewable energy
resources will support cleaner system operation, as wind and solar represent an increasing share
of electricity generation.
Figure 1. Projected electricity demand by sector, 20102035.

World Energy Outlook 2011 OECD/IEA 2011 (Fig. 5.1, p. 177)
Expanding the grid penetration of solar energy and wind energyand accommodating their
variable outputrequires more nimble power systems that can adjust quickly to balance supply
and demand. At the same time, options for addressing the variability of solar and wind energy
are being strengthened through advances in smart grids, communications, and technologies that
enable dispatchable demand and distributed generation to extend to the mass market. Figure 2
illustrates the range of dynamic interactions that might characterize 21st century power systems.
3
st
Figure 2. Illustrative view of 21 century power systems. NREL
Wholesale market design is crucial for realizing these opportunities, in two key distinct regards.
In the operational sense, electricity market design defines the protocols for dispatching electricity
in a reliable and economic fashion. At the same time, market design determines the long-term
landscape of financial incentives and rules of eligibility for investment in resources that ensure a
reliable and secure grid. The dual roles of electricity markets simultaneously operational and
financialare a defining characteristic of electricity market design. Ensuring harmonization
between the two roles is a persistent challenge. The need for harmonization is increasingly
evident in the pursuit of 21st century power systems. For example, as a general trend, flexible
performance (e.g., the ability to ramp quickly, as discussed in Section 3) and expanded resource
eligibility (e.g., demand- , delivery- , and supply-side resources, as discussed in Section 4) are
issues of growing importance, as new technologies and systems stand poised to enter both the
wholesale and retail power markets.
There is a wide range of starting points and motivations for market development; therefore, the
evolution of market design will follow myriad pathways. Some common objectives, however,
are present in all systems, including:
1. Promoting efficient operation of power systems,
2. Creating clear and effective incentives for investment, and
3. Improving reliability and cost-effectiveness of electricity service.
These objectives have driven power market design for decades. More recently, other objectives
have emerged that increasingly impact power market design, namely:
4
4. Reducing the health and environmental impacts of electricity service,

5. Rapidly expanding energy access to underserved or unserved customers, and
6. Encouraging power-system innovation.
The importance of the latter objectives depends heavily on context. Not all jurisdictions give
equal weight to each of these objectives, and it remains to be seen what, if any, market designs
optimize all of them. This report primarily focuses on the challenges and opportunities involved
in achieving objective 4a more energy-efficient and cleaner power systembut recognizes
that objective 5 is a primary public-policy objective in many settings, which in turn influences
the design of wholesale power markets and power system evolution generally. Policy makers and
regulators working to create 21st century power systems must balance disparate or competing
objectives, consult with broad networks of stakeholders, and attempt to render frameworks that
advance the public good, recognizing that there exists no single solution that maximizes all
objectives.
Wholesale power market design has evolved significantly since the first experiments in the early
1980s. Resolving fundamental issues of adequate investment, transparency, and competition,
however, has proven to be a complex task. Further expanding the scope of market design to
include objectives of health, environmental, energy access, and innovation presents new
challenges and opportunities. For example,
Promoting the entry of new sources of distributed generation could be perceived as a

challenge to existing market participants (Lopes et al. 2007; Kind 2013);
Rapidly expanding energy access might increase costs for other customers (Ranjit and
Sullivan 2002; Brew-Hammond 2010); and
Reducing health and environmental impacts by encouraging energy efficiency and greater
deployment of variable renewable energy sources could challenge existing investment
frameworks.
Although an examination of many of these interactions and tensions is beyond the scope of this
reportwhich addresses specific market design concepts on the bulk power system, namely
greater integration of variable renewable resources, energy efficiency, and smarter gridsthe
broader market design context is vital for understanding the drivers for policy and investments in
energy at both the wholesale and retail levels (see Text Box 2).
This report focuses primarily on wholesale market designs and complementary operational
practices administered at the system operator level. Retail market evolution also is important,
however, and many forces in evidence today will prompt a reconsideration of the role of
traditional utilities. Future research and analysis performed by the 21st Century Power
Partnership will examine the parallel questions concerning the transformation of the power sector
on the retail side, including how utilities can earn a return on services in a context of increasing
energy efficiency, significant demand response, and distributed generation.
5
Text Box 2. Electricity Markets in the Context of Power System Reform
Power system reform processes have been revealed to be sensitive to contextual factorstechnical,
financial, political, and institutionalthat constrain options and pathways for the design of electricity
markets. Broadly speaking, power system reform efforts globally fall into three categories. The first
consists of mature, restructured markets in which significant generation capacity already exists, and
where economic, social, and technological forces are precipitating a reassessment of market design.
Most markets in the European Union (EU), Australia, and the United States fall into this category, with
a reassessment driven by slow demand growth, rapid growth in energy efficiency and variable
renewable energy, and increased interest in deploying smart-grid technologies.
The second category consists of hybrid markets (Gratwick and Eberhard 2008), in which earlier
restructuring efforts have stalled out, leaving a mix of competitive and state-owned actors. Many
emerging economies fall into this category, including Tanzania, Argentina, Bolivia, Jamaica, and
various states within China and India. In many of these settings, the impetus for continued market
reform stems from rapid demand growth, lagging investment in new capacity by independent power
producers, and poor financial conditions of state-owned entities. In contrast with earlier rounds of
restructuring, many of these countries also show growing interest in adding variable renewable energy
to the generation portfolio and investing in smarter distribution gridsnew objectives that significantly
change the market reform conversation.
The third category consists of monopoly power sectors, in which little or no restructuring has occurred.
Mexico and South Africa fall into this camp, for example. Similar to the second category, in these
settings the impetus for power system reform typically is driven by a need for accelerated private
investment to meet rapidly growing demand or the need to change the current inefficient set-up of
pricing and dispatching.
The set of electricity market design principles that has been developed and refined largely in developed
economies faces translational challenges in emerging-economy settings. These challenges stem both
from the different objectives of emerging economiesespecially meeting rapidly growing demand and
improving energy accessbut also due to unique institutional challenges that commonly occur in
developing countries. Four unique institutional challenges have been identified that are relevant to the
translation of market-design principles: Limited regulatory capacity, limited accountability, limited
commitment, and limited fiscal efficiency (Estache and Wren-Lewis 2009).
Limited regulatory capacity pertains to the ability of regulators to implement and enforce policy.
Limited accountability refers to the level of accountability to which regulatory institutions are held.
Limited commitment refers to the diminished ability to rely upon contracts (Guasch et al. 2003). 5
Limited fiscal efficiency refers to the difficulties in financing infrastructure investment. The prevalence
of four challenges varies significantly by jurisdiction, but all are important considerations in the
development of electricity markets.
Although addressing the full diversity of institutional challenges and power system contexts is beyond
the scope of this report, it does attempt to provide general insights into the unique challenges that
emerging economies could face in the transition to market frameworks.
5
See, e.g., Guasch et al. (2003). The authors discuss the common occurrence of renegotiated government
concessions, and estimate that in Latin America between 1985 and 2000, more than 40% of concessions (excluding
the telecoms sector) were renegotiatedthe majority at the request of governments.
6
3 Wholesale Market Design Principles for Integrating

Variable Renewable Energy
This section reviews wholesale market designs in use and under consideration to ensure
adequacy and security in a landscape of significant amount of variable renewable energy. The
concepts are organized along three categories of markets commonly found in mature contexts:
Capacity adequacy, energy, and ancillary services. 6 These three categories represent the
foundational market domains of the bulk power system that will enable 21st century power
systems. Table 1 provides an overview of the design considerations reviewed in this section.
Market Design
Considerations Reviewed
Table 1. Market Design Considerations Reviewed for Adequacy, Energy, and Ancillary Services
Adequacy
Energy
Ancillary Services
Dynamic reserve requirements
(secondary and tertiary reserves)
Scarcity pricing
Dispatch resolution
Capacity markets
More frequent markets
Primary frequency response
Capabilities markets
Ramp products
System inertia
Capacity provision by
renewable resources
Negative pricing
Voltage control
Forecast integration
Co-optimization
Dispatchable variable
renewables
Ancillary service provision by

renewable resources
3.1 Adequacy
Ensuring resource adequacy is a critical function of power system policy and market design. In
jurisdictions with wholesale energy markets, the central challenge of this issue is balancing the
power generators desire to minimize investment risk with the public-policy priority to maintain
cost-efficient and dynamic functioning of wholesale power markets.
Broadly speaking, ensuring minimal investment risk for generators (for example through longterm contracts) shifts risk to consumers. Conversely, ensuring cost-efficient market function (for
example, forcing all generators to compete in economic dispatch with no guaranteed production)
shifts the risk to generators. Well-functioning wholesale markets do not guarantee long-term
6
Another important component of electricity market design, the financial transmission rights market, is not
extensively covered herein. Although these auctions could change based on the changing flows and changing
locational marginal prices from high penetrations of variable renewable resources, the fundamental design of the
market remains relatively unchanged from greater adoption of renewables in the electricity market, and therefore
these markets were omitted from this report.
Also not considered in this report are costs and benefits of renewable energy systems on the grid, such as energy loss
savings or costs, increases or offsets of transmission equipment, and environmental benefits, and policy and market
designs that would create incentives specific to new renewable energy generation. This report instead focuses on
market designs to accommodate existing variable renewable energy and emerging technologies, and market
modifications needed to ensure adequacy of supply from all sources. For more on international best practices to
achieve new renewable energy generation, see Miller et al. (2013).
7
revenue certainty, therefore price and volume risk over the long term imply that less-efficient
generators mightand perhaps shouldgo out of business.
The policy and regulatory challenge in designing markets, therefore, is to fairly apportion risk
while meeting social, economic, and environmental objectives. In pursuit of economic operation
of power systems with large proportions of variable renewable energy, market design
increasingly aims to avoid rewarding inefficient generators, and instead encourages efficient,
flexible units. Even in well-developed and integrated markets, such as in the European Union
and in one of the most integrated marketsthe Nordic Nord Pool regionthis design challenge
has proven to be significant.
Additional challenges include the lead-time needed to develop new generation resources and the
often even longer lead-times needed if new transmission services are required. Although this
period can be relatively short for renewable resources such as wind or solar energy, it can take up
to several years for natural gas combined-cycle power plantsand even longer for coal-fired or
nuclear plantsand take as much as a decade or more for new green-field transmission services.
Some additional mechanism therefore might be needed to ensure investment in the long-term
security of supply in a timely manner, so that enough generation with the desired attributes is
available when needed.
To evaluate whether a current or projected power system meets adequacy requirements,
wholesale markets and regulators primarily use one of two metrics. Either a fixed percentage of
peak load (e.g., 15% planning reserve margin above peak load), or a probabilistic measurethe
loss of load probability (LOLP)is used. As new generation is added to the resource mix the
LOLP generally declines. The effective load-carrying capability (ELCC) metric then is
calculated to determine the contribution that any given resource makes to the reliability target.
This often is an LOLP of 1 day/10 years (Keane et al. 2011a). The North American Electric
Reliability Corporation (NERC) makes a similar recommendation (NERC 2011).
How markets then achieve adequacy reflects an ongoing debate about whether a reserve
requirement is necessary and who should bear the risk. Some markets and regulators, such as
Nord Pool, rely on energy-only markets through scarcity pricing, to ensure sufficient cost
recovery for generators and thus maintain sufficient planning reserve margins. Generators bear
the market risk of meeting annual income targets through the power market. An alternative
approach is to require the RTO/ISO/TSO or load-serving entity to maintain a target planning
reserve margin, which could be satisfied through a centralized market mechanism (e.g., RTObased capacity market or payment), or decentralized requirements (e.g., require an LSE to
demonstrate sufficient reserve margins for its specific distribution system, such as through longterm, bilateral contracts). In this context, the ratepayer bears the market risk of paying for too
much capacity. Bilateral power purchase agreementsa predominant mechanism used by
CAISO)make it possible that these requirements could limit participation in energy-balancing
markets, and thus would limit flexibility. Following an overview of these two
mechanismsscarcity pricing and capacity marketsthe impact of variable renewable energy
on these market options is discussed.
8
3.1.1 Energy-only Markets with Scarcity Pricing

Scarcity pricing 7 implies that when demand is very high, the supply may be insufficient and/or
costly to deploy to meet the load (Stoft 2002, p. 70). These price spikes reflect the relative
inelasticity of supply (and demand) at high load levels or due to other sources of capacity
constraints. Scarcity pricing can be designed to encourage investments in flexible response, such
as storage and price-responsive load, because these resources can respond quickly to brief
periods of scarcity. Scarcity pricing is favored in some markets on the basis that policy
interference in pricing mechanisms, such as through a capacity market, would jeopardize market
participants trust in the market and discourage investors from investing in new capacity.
In practice, regulators in many energy-only markets impose bid caps in an effort to protect
consumers from too high and volatile prices and to mitigate market power. Also, some energy
regulators are tasked to procure strategic reserves to ensure long-term adequacy. Strategic
reserves are withheld from the market entirely or included only when prices are highthey
create a de facto price cap for the market (European Commission 2012b). In Finland, for
example, where the power system is part of energy-only Nord Pool Spot, capacity adequacy is
the responsibility of the Energy Market Authority. Capacity can be acquired from new peak load
plants, demand response, or old units (based on bids), which would otherwise be dismantled and
instead receive power reserve payments. In the latest auction, demand response was able to
participate to deliver part of this reserve. The need for the reserve was calculated with ELCC
calculations considering wind power and stochastic imports from neighboring countries. Without
neighbors, Finland would have a capacity deficiency.
Scarcity pricing predominantly is found in the European Union, where the policy goal in several
states has been to combine scarcity pricing with carbon prices to increase the competitiveness of
low-carbon flexible units and use extensive interconnections to balance integrated regions.
Nevertheless, the European Union reflects different policy approaches to adequacy, and member
state policy actions have yet to create a coordinated market-based approach. The differing
approaches to adequacy have complicated cross-border trades, such as those between countries
with and without capacity payments (European Commission 2012b).
Examples of energy-only markets with scarcity pricing: Australias NEM, Nord Pool, ERCOT
3.1.2 Reserve Requirements: Capacity Markets or Payments
Alternatively, or even to supplement scarcity pricing, a capacity market or some form of capacity
payment could help ensure revenue adequacy. Although the specific characteristics among
existing capacity markets differ, their common objective is to procure capacity for a future time
periodoften 1 to 3 years. A qualifying resource that participates in the capacity market receives
a payment in return for providing capacity in the day-ahead market, or some other requirement.
Capacity markets also have their own challenges, including the potential abuse of market power
and providing sufficient incentives to induce the desired level of capacity in forward markets.
The ISO-NE Capacity Market, for example, conducted five years worth of auctions that did not
7
Scarcity rent is revenue minus variable operating cost, which is needed to cover startup and fixed costs (Stoft
2002). Scarcity pricing reflects the situation in which generators are supplying at full output, and load would be
willing to pay a generator more than its variable cost of production to produce more.
9
clear at a competitively set auction price, and instead cleared at an administratively set floor
price (Coutu 2011).
In the United States, where capacity markets are more common, the markets offer 1-year
contracts, auctioned 3 years in advance of delivery (ISO-NE and PJM) and 6-month contracts, 1
month in advance (NYISO). 8 Yet, these markets have not been critical to initiating new
investments (Caplan 2012), and they have been challenging to design due to difficulty in
anticipating required levels and types of capacity (Milligan et al. 2012). Also, the timescale of
current markets (6 months to 1 year) does not match the timescale needed to secure financing
and attract new investments (e.g., 15 years minimum). In comparison, most power purchase
agreements range in duration from 20 to 25 years. Furthermore, existing capacity markets do not
differentiate between resources that have different flexibility attributes. This likely will become
more important as the shares of variable renewables and demand response in the electricity
supply increase.
A new variant on reserve requirements that is gaining support in the European Union is the use
of a reliability option contract (Keay et al. 2013), which is the financial version of capacity
markets (Bauknecht et al. 2013). This mechanism imposes a reserve obligation on the buyer of
electricity (e.g., retail company, system operator). Capacity is sold via an auction, which
establishes a strike price in the day-ahead market. Sellers then must provide capacity at the strike
price when called upon (i.e., when market prices are high). Generators must pay the difference
between the spot price and the strike price. This addresses concerns of market power during
scarcity, because generators are encouraged to make capacity available at high prices. Because
they must pay the difference between the spot market price and the strike price, generators do not
gain from price manipulation (Bauknecht et al. 2013).
In Europe, the question of capacity remuneration mechanisms is discussed very differently
among the member states. Conventional power plants (even new flexible gas plants) are being
closed or are threatening to close not only because some are at the end of their lifetimes, but in
some cases because of changes in fuel prices. As a result, generation adequacy regionally is
becoming a matter of concern (European Commission 2012b; Council of European Energy
Regulators 2013a; Miller et al. 2013). Also, limited interconnection capacity, for example in
countries such as Spain, has increased interest in capacity payments (see Text Box 3).
In Europe, security of supply is a national question, but over-capacities would occur if solved
strictly nationally. Thus, European organizations and associations strongly recommend
international coordination (European Commission 2012a; European Wind Energy Association
2012; ACER 2013; ENSO-E 2013).
Examples of energy markets with capacity mechanisms: Ireland, Spain, Ontario, PJM, NYISO,
and ISO-NE
8
Other design differences include auction style (descending clock vs. sealed bid), participation (for example, the
PJM capacity market is open to transmission upgrades; ISO-NE and PJMs timeframe allows new resources to
participate), and measurements of availability (such as whether a generator is penalized for a forced outage during
tight capacity periods) (Coutu 2011).
10
Text Box 3. Revisions to Spains Capacity Mechanisms
In 2012, capacity payments represented 10.2% of the total Spanish market price (Red Elctrica de
Espaa 2012). Recently, a new competitive capacity mechanism has been proposed (Ministerio de
Industria Energa y Turismo 2013), which includes an investment incentive for a 10-year period and is
conducted through an auction configuration. The incentive amount is calculated as the product of the
capacity value of the technology (for example, 0.95 for nuclear and 0.09 for onshore wind power) and
the result of the auction. The incentive includes a hibernation mechanism, which would allow the
possibility of temporarily closing generation units when capacity is exceeded, especially during
minimal load periods. The plants scheduled for hibernation also are determined through an auction.
Additionally, availability service is applied for 1-year periods and combined cycle and coal thermal
plants are able to participate. Hourly payments for this service are calculated as a function of a monthly
payment, hourly total thermal generation, and hourly total dispatchable thermal generation.
There is no widespread agreement on the need for a capacity mechanism to supplement energyonly marketsand, if the need exists, how best to do it. There also is little, if any, evidence
regarding whether scarcity pricing would result in revenue sufficiency for capacity, as illustrated
by the current review of options in ERCOT (Newell et al. 2012). Because most retail consumers
do not see real-time prices that reflect cost, the demand curve for electricity is muted (Stoft 2002;
Kirschen and Strbac 2004). Proponents for capacity mechanisms argue that this malfunction of
the market for electricity, coupled with the lack of ability to differentiate reliability among
customers on a widespread basis, renders an energy-only market incapable of providing
sufficient forward capacity (Cramton and Stoft 2006). This debate is not new, and began long
before variable renewable energy sources were significant in the electricity supply.
Text Box 4 describes Brazils approachusing capacity auctions to achieve adequacy through
long-term contracts. Text Box 5 discusses how capacity markets can be designed to invite
participation by demand-side resources (demand response).
Text Box 4. Brazil: Market-based Mechanisms to Meet Reserve Requirements
In Brazil, the power system is dominated by hydro generation. Capacity adequacy assumed urgent
importance in 2001, as years of successive droughts resulted in reservoir depletion and widespread
power rationing. Subsequent reforms implemented from 2004 onward have established long-term
contracting of power as the only form of electricity procurement (Pinguelli Rosa et al. 2013). This
principle has been driven by the urge to reduce investment risk for new capacity additions. By this
metric, the reforms largely have been successful, resulting in significant investment in new capacity.
The 2004 reforms established two separate energy-trading environments. In the first, the Regulated
Contracting Environment, energy is sold by electric utilities, independent power producers, selfgenerators, and power marketers; the only buyers are distribution companies that are required to
contract their entire forecast demand for captive consumers. Contracts are auctioned off over time with
delivery dates of 1, 3, and 5 years after the date of the auction. There are separate auctions for new
and existing electricity.
Within this environment, contracts for new electricity are longer (duration of more than 15 years) than
those for existing electricity (duration of 8 years). Distribution companies are required to contract
11
100% of their expected power needs, but there are annual adjustment auctions where they can buy
additional energy when their forecasts are inaccurate. In the regulated environment, marketers
entities that either may purchase and resell energy, or may only help broker deals between buyers and
sellersare only allowed to participate in these adjustment auctions.
The second trading environment is called the Free Contracting Environment, and brings together
electric utilities, independent power producers, self-generators, marketers, importers, exporters, and
free consumers (those that do not need to buy power from distribution companies, typically industrial
and commercial firms). Buyers and sellers are free to enter bilateral contracts and negotiate prices,
quantities, delivery dates, and conditions. The Free Contracting Environment, also known as the free
market in Brazilian electricity sector parlance, has been growing steadily in the past few years. It
consisted of about 1,650 free and special consumers in 2012, which accounted for approximately 27%
of total consumption in the Brazilian electricity system (ABRACEEL 2012).
Dispatch decisions essentially are made on a hydro-centric schedule of weekly increments, part of the
legacy of a hydro-dominated system. Slow dispatch periods significantly limit short-term system
flexibility. Similarly, the pure long-term contracting environment in Brazil could blunt economic
signalsfor example prices of natural gasthat could lead to generator fuel switching in the mediumterm. Taken together these characteristics of the Brazilian case illustrate that a focus on procuring
resource adequacy, and operational rules focused on large legacy generators, could conflict with other
market objectives such as short-term and medium-term flexibility.
Text Box 5. Bidding Demand Response into U.S. Capacity Markets
In some U.S. capacity markets, demand response can bid in alongside new generation resources. This
serves a dual role in power system evolution, on the one hand shaving peak load and mitigating the
need for new supply-side resources, and on the other hand providing a supplemental revenue stream for
load beyond the avoided energy costs. Such allowances of capacity markets appear to stimulate
investment. For example, in the PJM capacity market in the eastern United States (known as the
reliability pricing model), the megawatts of demand response resources that bid into the auction for
delivery in year 2015/16 grew more than 150% over the amount bid into the prior year auction (EMC
Development Company 2012), representing 9.6% of total cleared capacity (Bowring 2013). Currently,
some of the PJM products allow limitations on demand responses availability (e.g., number of events
per year). To make the quality of demand response participation equal to thermal generation, demand
response could be required to meet the same performance obligations, i.e., no limits on number of
events, for example by bundling multiple demand sites that can be aggregated to provide unlimited
interruptions (Bowring 2013).
It should be noted however that stringent measurement and validation of demand response is required
for market participation, and demand response does not resolve all issues related to flexibility, system
stability, or incentives for retaining some amount of thermal generation. Demand response is discussed
more extensively in Section 4.
3.1.3 Variable Renewable EnergyImpact on Adequacy

With high penetrations of variable renewable energy from wind and solar, the expectation is that
the inherently low marginal costs of these generators will lower average wholesale energy prices
12
(see Figure 3). Conventional generators, which will be displaced more often and sell energy at
lower prices when they are selected, are therefore likely to run at lower (and less predictable)
capacity factors and earn less revenue from the energy markets (Milligan et al. 2012; Bauknecht
et al. 2013). In these markets, energy prices might be zero for extended periods of time, and
generators risk receiving average energy revenues that fall short of their average costs (Stoft
2002). In markets with capacity payments, capacity prices will increase as net revenue from
energy markets decreases. In energy-only markets, if scarcity pricing is insufficient, then
generators might need supplementary sources of revenue for their continued provision of
services that enable the power system to maintain sufficient reliability (Bowring 2013).
Furthermore, the type of capacity that the system requires in the long-term to ensure a reliable
system becomes more important. Although generation planning has typically been about the
energy (e.g., peak MW) capacityand capacity alonethat new resources would add to the
system, future planning could require system participants to offer certain traits or capabilities,
such as flexibility. In doing so, incentives must be in place to ensure that new capacity brings
with it these traits. The following new market designs represent approaches to address these
topics.
Figure 3. Mean diary [daily] market prices based on wind penetration levels
(Spanish hourly data, 20072012, provided by Red Elctrica de Espaa)
3.1.4 Capabilities Markets

Understanding that undifferentiated capacity markets, even over long time horizons, would be
insufficient to create investment incentives for the right types of resources, the Regulatory
Assistance Project (RAP) has proposed a capabilities market that addresses the quality of the
capacity (Hogan 2012). RAP suggests two approaches. For markets without capacity markets, it
proposes an enhanced services market mechanism, which would create periodic forward auctions
to procure the required mix of balancing capabilities from new and existing generators. For
markets with existing capacity markets, RAP suggests restructuring them to apportion the
13
requested capacity over tranches of varying quality. RAP cites PJMs early version of its 2006
market design as an example of possible tranche types: Dispatchable (rampable), flexible
cycling (fast and frequent stopping and starting), supplemental reserves, and all others. This
approach necessitates prioritizing the type of capacity needs and establishing appropriate metrics.
The value in having a differentiated capacity mechanism depends in part on whether energy and
ancillary services markets alone create sufficient incentives for flexibility (e.g., through ramping
products; discussed in Section 3.2).
3.1.5 Capacity Provision by Renewable Resources
Variable renewable energy resources such as wind and solar power can contribute to resource
adequacy, but typically do so at a lesser fraction of their installed capacity as compared to
conventional resources such as coal or gas. Biomass and geothermal can contribute to long-term
planning close to their rated capacity as long as there are no significant fuel-supply constraints
(long-term fuel adequacy for biomass, heat constraints for geothermal). The capacity
contribution of wind power ranges from about 5% to 40% of rated capacity (Holttinen et al.
2013). 9 The wide range is a result of differing levels of correlation between wind energy delivery
and load level. The capacity value of a variable resource starts to decline at greater penetrations,
when the events with low variable generation start to dominate the peaks in the net load. Work
on solar energy is emerging.
Other approaches are under development for differentiating the value among generation options.
For example, Text Box 6 describes the approach that Mexico is taking to include environmental
externalities in merit order dispatch as a way to stimulate new investment in renewable capacity.
Text Box 6. Mexico: Incorporating Environmental Externalities in Electricity Dispatch
10
Incorporating the value of environmental or social externalities into power generation is one of the key
challenges of a 21st century power systemreducing the health and environmental impacts of
electricity service while maintaining the traditional motivation of improving reliability and costeffectiveness of electricity service. The Mexican Power and Climate Change legal framework mandates
the federal government and the national utility, Comisin Federal de Electricidad (CFE), to incorporate
the value of environmental and social externalities into the pricing of electricity.
Until recently this mandate was performed by CFE, the Secretariat of Energy, and the Secretariat of
Public Finance as part of a cost-benefit analysis of selected renewable energy projects, and not included
in the initial stages of sector planning when technologies are evaluated against each other on a cost
basis. This limited the transformative impact on sector planning. Since 2012, the federal government
began revising the framework for a new externalities policy, with a protocol that includes not only the
cost-benefit analysis from CFE, but which also incorporates externalities into merit-order dispatch and
planning for new investments by CFE. The Transversal Strategy for Productivity 20132018, published
on August 30, 2013, mandates Establishing prices and tariffs of energy that incorporate environmental
externalities and promote its efficient use, which addresses the need to provide market-based
The low end of the range reflects situations where, for example, wind generation occurs primarily during non-peak
hours, but is also affected by other factors such as total installed wind capacity.
10
This text box was contributed to the report by Jos Mara Valenzuela of the Secreteriat of Energy in Mexico.
14
mechanisms for achieving such goals, and which includes private investors.
Some of the main challenges to implementing the protocol and other policies that value externalities
include the need for significant investment in research infrastructure and human resources, as well as
coordination among environment, health, and energy sectors. But even if externalities are properly
valued, there is the need to choose adequate implementation mechanisms to enable transformative
consequences.
Renewable energiesboth conventional and unconventionalare included in dispatch entirely due to
their low marginal generation costs. Hence, developing an externalities policy for dispatch only
modifies the merit order among fossil-fuel generation, providing a competitive edge for natural gas
versus heavy fuel oil, on the short term. Yet, the system capability to increase power generation from
gas is limited by gas supply infrastructure. Therefore, commitment to an externalities policy fosters
new, cleaner investments if public and private investors receive adequate pricing signals on future
developments. While CFE is mandated to include the value of externalities in the levelized generation
cost for its technologies, private actors are not required to make such a commitment.
Carbon pricing directly or indirectly through a tax on fossil fuels would provide such a price indication
for global pollutants. Nevertheless, schemes for pollutants of local and regional impact shall remain in
place to complement the externalities policy system, leaving the incorporation of externalities into the
dispatching merit tables as the more certain tool.
3.2 Energy
Wholesale energy markets comprise the central transaction platform in power markets. Although
some details in energy markets can vary, as discussed below, in all cases energy markets attempt
to arrive at an economic allocation of generator dispatch that meets demand and satisfies security
constraints.
In the United States, the energy markets run by RTOs/ISOs consist of two-settlement markets,
where electricity is procured in a day-ahead market, followed by a real-time market, which meets
any imbalances that occur. The locational marginal price (LMP) is the price paid to generators,
and is set by the marginal cost to serve load in a particular location. If congestion restricts
sending lowest-cost electricity to a particular location, higher-priced electricity is dispatched and
the higher price is reflected in the LMP. Generators have financial schedules in the day-ahead
market that are paid the day-ahead LMP, and any additional generation they are asked to provide
in real time is paid the real-time LMP. If they reduce output relative to schedule, generators pay
back that portion of the amount committed day-ahead at the real-time LMP. Most of todays U.S.
energy markets are co-optimized with ancillary services markets, and incorporate transmission
constraints into the price setting. Generators and loads have the option to settle outside the
market, through bilateral contracts. The congestion costs that occur between them, however,
must still be paid through contracts for differences. LMPs allow a close alignment between
market schedules and real-time dispatch.
Most European markets offer day-ahead and intraday markets. In Europe, the power systems and
energy markets are operated separately; the market clears a dispatch order, which then can be
adjusted to accommodate transmission constraints. Germany, for example, with its extensive
bilateral market contracts, requires longer gate closures to allow the TSO to conduct load-flow
15
calculations and coordinate with neighboring TSOs, which in turn requires significant redispatch to resolve transmission constraints (Miller et al. 2013). 11 Nord Pool offers zonal pricing.
Increased penetrations of variable renewable energy affect the energy markets in three primary
ways.
1. The frequency and magnitude of changes to net load increase, which in turn require that
the system have capabilities such as fast ramping and frequent on-off cycling.
2. The possibility of forecast errors increases the difficulty in anticipating market outcomes,
increasing the relevance of intraday markets (where available).
3. The proportion of fully dispatchable supply could decrease as the low marginal costs of
renewable energy displace them from the market.
Although wind turbines can serve as a fast ramping, flexible, dispatchable resource, wind energy
and other variable resources, such as solar photovoltaics, have less predictability and availability
than conventional energy supplies. 12 The following market mechanisms are examples that could
improve the ability of markets to accommodate these changes and better value flexibility.
3.2.1 Dispatch Resolution
Energy markets that consist of short-dispatch intervals (e.g., 5-minute dispatch intervals), which
already have been adopted in many restructured markets, improve system flexibility by more
closely matching the changes in variable generation and load (net load) economically. As net
load changes, the dispatch optimization responds as wellcost-effectively optimizing
generation. Short-dispatch interval markets also reduce the required levels of regulating reserves
needed, which are the automatic resources that can respond to minute-to-minute fluctuations and
are the most expensive ancillary service (Smith et al. 2010). High energy prices during the ramp
periods also could provide an incentive for flexible supply. All generation receives the energy
market clearing price in an energy market, as opposed to markets with ramp products, described
below.
3.2.2 More Frequent Markets
A two-step market with unit commitment in the day-ahead timescale will leave significant
forecast errors to be resolved during real-time balancing. The balancing resources acting on the
timescale of a few minutes can be relatively expensive (Kirby 2007). An alternative is to have
some form of intraday market that enables participation from power plants with intermediate
lead/start-up times (Kiviluoma et al. 2012).
For example, the Iberian market already has a considerable share of variable generation. The
market structure consists of a day-ahead market followed by six sessions in the intraday market.
11
Gate closure refers to the future time at which the market commits to deliver electricity. Typically, gate closures
that occur close to the actual delivery time (e.g., 5 or 15 minutes in advance) can help minimize the magnitude of
forecast errors and associated reserves and allow for trading at potentially lower costs than power that would
otherwise be required to balance day-ahead schedules (Cochran et al. 2012).
12
Wind generation can serve as a dispatchable resource by operating at reduced outputs, such as in response to a
dispatch to ramp down, or in anticipation of a dispatch to ramp up. For example, MISO offers a Dispatchable
Intermittent Resource Program, which allows wind to bid into energy markets.
16
The gate closure in the intraday market is 3 hours and 15 minutes. The intraday market is at
times followed by a deviation management market, which is used when a deviation of more than
300 MWh is expected to last several hours. A tertiary regulation market is used to recover
secondary regulation reserves in the intra-hour timescale.
In the Nord Pool Spot, there is a day-ahead market followed by an intraday market, which
matches bids continuously until one hour before the hour of delivery. This decreases liquidity in
comparison to the Iberian intraday market, which has sessions that concentrate the trades. The
Iberian intraday market, however, has a longer delay between the trade and delivery.
Consequently, in Nord Pool there is no need for a market between the intraday and tertiary
regulation market, which is called the regulating power market in Nord Pool (and the real-time
market in the two-step markets). Nord Pools regulating power market requires activation in 15
minutes and also is used to meet operating reserves.
3.2.3 Ramp Products
Ramp products, akin to proposals for flexible ramping and ramp capability products in the
CAISO and MISO markets, respectively, are designed to periodically complement the fast
energy market by providing for operational flexibility to meet load more reliably and efficiently,
as well as incentivizing the specific resources that provide the flexibility to do so. The ramp
product market price can have supplemental payments that are provided only to those resources
providing the ramping support. Ramp products therefore reward only the flexible generation and,
during these flexibility-scarce periods, do not reward inflexible resources. The ramp capability
price would be zero during most hours, when ramping capacity in the energy dispatch mix is
sufficient to follow load (Ela et al. 2012a). When ramping is neededwhether due to expected
variability, or uncertainty in meeting the net load in future intervalsand not provided by the
energy market, the price would reflect the marginal cost of providing that ramping capability,
incentivizing flexible resources.
To add ramp capability and ensure sufficiently fast response, the Spanish TSO in May 2012
implemented a new market for the management of additional upwards reserves (Ministerio de
Industria Energa y Turismo 2012). EirGrid, the TSO in Ireland, also has proposed a new
ramping product to respond to imbalances that occur over the minutes-to-hours timeframe, such
as from changes in demand, wind generation, and interconnector flows. The TSO anticipates a
broad range of resources to supply this service, including wind and photovoltaic (PV) plants that
have been dispatched down, conventional generators, storage, and demand (EirGrid and SONI
2012).
3.2.4 Negative Pricing
Negative pricing can occur when serving the next increment of demand would actually save the
system money; that is, the marginal cost to serve load is negative. For example, negative pricing
can occur due to a lack of flexibility within the system. This might be due to limited transmission
capacity creating location-specific negative pricing, minimum generation periods during which
resources (e.g., coal, nuclear, hydro) cannot be shut down, and other reasons. Negative prices
also can occur during periods of high variable renewable energy generation and low loads. In
general, this can happen either due to resources setting the price with negative cost offers (e.g.,
due to production credits), or because of reduced capability to reduce generation and increase
17
load (e.g., due to self-scheduled resources). Incorporating negative pricing into market design
facilitates balancing and provides a financial incentive to increase system flexibility for several
reasons.
Negative pricing can discourage generators, such as wind (unless tax incentives
encourage production), nuclear, and coal from providing too much power when demand
is low.
Negative pricing sends a strong signal to generators to be more flexible and reduce
constraints on flexibility. In Denmark, the minimum running capacity of some older coalfired power plants has been reduced from 30% to 10% of maximum capacity due to
dynamic and negative pricing (Blum 2013).
Negative pricing can encourage greater diversification in the location and types of
variable renewable energy, especially in transmission-constrained areas.
Negative pricing can encourage the use of storage to absorb excess production, and load
to increase demand.
Negative pricing can provide a transparent mechanism for curtailment of renewable

resources via market means rather than out-of-market procedures.
One concern about negative pricing in the United States is that with the production tax credit
which in 2013 offers wind generators a $0.023 subsidy for each kilowatt-hour of energy
producedwind energy can still generate revenue when prices have become negative. They then
can offer negative prices representing this effective cost of generating. This subsidized bidding
can distort the clearing price and impact the rest of the generation fleet. A second concern with
negative pricing is that it makes revenue streams more difficult to calculate, and therefore can
deter investors from participating in energy markets.
When implementing negative prices, it is important for markets to coordinate with neighbors
with respect to the use of administratively defined minimum price levels. At present these
minimum price levels differ, for example, between Germany and Denmark, where flows from
Germany to Denmark have been observed when Danish prices were negative and extra power
was not needed, but German prices were even more negative. For example, this occurred in
December 2012, when Danish bids were curtailed to achieve market equilibrium above the
minimum price level, but even cheaper German power was imported anyway. Currently,
measures are under consideration to avoid this occurrence in future. As already occurs in
Denmark, individually negotiated compensation for offshore plants could be designed to
eliminate fixed feed-in compensation during hours of negative prices to relieve stress on the
power system, and this could be extended to include compensation from all wind power
production.
3.2.5 Forecast Integration
All U.S. RTOs/ISOs, all European TSOs with significant wind (e.g., Germany, Denmark, Spain,
Portugal, Sweden), and most provincial dispatch centers in China forecast wind power
production. The use of these forecasts, however, varies considerably from region to region
(Porter and Rogers 2009). TSOs in Germany are mandated to trade wind power in day-ahead
(and intraday) markets (where feed-in tariff support mechanisms apply). In other countries (e.g.,
18
Finland, Sweden, Norway), market participants must make their own forecasts for the portfolio
they are bidding. In the United States, most RTOs/ISOs use a centralized day-ahead wind power
forecast in the reliability unit commitment model, but not in the day-ahead market unit
commitment model. This ensures that the RTO/ISO will have enough capacity to meet the
forecasted demand with consideration of the forecasted wind power, but might not necessarily
mean that it will be done in the most efficient manner. Power production forecasts are also used
to improve situational awareness.
Integrating advanced, centralized forecasts into market operations could increase market
efficiency and provide additional opportunities for wind and solar resources to participate in
electricity markets. A challenge in many countries is how to set up the most efficient forecasting
modela mechanism to dynamically improve forecasting using both central and project based
forecasting could be the way forward. Text Box 7 describes forecasting advancements in China.
Text Box 7. Forecasting Advancements in China
In China, the State Grids Jibei Electricity Power Company Limited has been using a new energy
forecasting tool from IBM in phase I of its 670 MW solar-wind energy facility. As a response to utility
requirements, IBM created the Hybrid Renewable Energy Forecasting (HYREF) solution that performs
advanced data analysis to improve predictions of wind turbine output. Using multiple data sources,
including wind turbine sensors, weather forecasts, and images of clouds, the software can forecast
power output for as brief a period as 15 minutes and as much as a month in advance. The combined
weather and demand forecasting system has increased wind integration by 10%, powering 14,000
additional homes.
As important as the technology solution demonstrated in China is for renewables, it was the change in
system operation rules and market design that provided the catalyst. Over the last decade, the massive
deployment of wind in China has stressed the transmission and distribution system at key areas,
increasing curtailment and other non-optimal outcomes. In 2011, Chinas energy ministry and regulator
issued a new forecasting requirement imposed on all renewable energy projects interconnecting to
Chinas grid. It is now law for every interconnecting wind, solar, and other utility-scale renewable
project to provide day-ahead weather and energy forecast to the operator. This critical operations and
policy change spurred the development of the 670-MW demonstration project by increasing market
demand for more accurate and higher resolution forecasting capabilities for renewable energy plants.
This issue of policy creating market demand for private-sector investment is not trivial. For example,
the misalignment between actual renewables output and system demand stretches from up to 4 hours
daily for wind and to up to 1.25 hours daily for solar. Matching renewable supply to demand could be
worth up to $733 million globally (Dehamna 2013).
3.2.6 Allowing Variable Renewable Energy to Participate as

Dispatchable Generation
Wholesale power markets historically have treated variable renewable energy generation
similarly to nonresponsive load in its dispatch optimizationa price taker with zero price
elasticity (Ela and Edelson 2012). This worked with low penetrations, when market operators
wanted to maximize the amount of this low, marginal cost generation. Increasing penetrations of
wind and greater instances of negative energy prices mean that a more efficient solution is to
allow wind generation to make schedule and price offers (usually zero, reflecting marginal
19
production costs) into the market akin to other generators, based on their most recent forecast.
Similarly, enabling the operator to order the wind plant to ramp down temporarily to relieve
congestion can allow plant dispatch to be optimized at the system level, can increase overall
reliability and efficiency, and can ensure that curtailments are not conducted manually (Ela and
Edelson 2012). In Europe, wind canand in some cases mustbid into day-ahead markets and
some intraday markets (closing one hour before delivery), but is not included in real-time
markets. Many of the U.S. RTOs/ISOs now allow wind plants to submit offers for energy in the
day-ahead markets. The New York ISO was the first to permit bids from wind plants, followed
by PJM and MISO. In 2010, MISO introduced its dispatchable intermittent resources program,
which allows wind plants to bid into the real-time market and update those bids based on subhourly forecasts.
The inclusion of renewable energy in markets affects revenue risks and project economics (e.g.,
from curtailments and imbalance charges) (Miller et al. 2013). In markets such as MISO, some
contracts between wind generators and off-takers have required revision to reflect changes to the
formal classifications of curtailments causes, which in some cases has shifted from reliability to
economic. Although evaluating such rules in terms of project economics is beyond the scope of
this report, markets can be designed to shift the responsibility for flexibility from specific plants
to the system, such as through measures described above (e.g., intraday markets, short gate
closure, better forecasting) (Bauknecht et al. 2013).
3.3 Ancillary Services
Grid reliability under conditions of significant instantaneous (e.g., 20% or greater 13) renewable
energy penetrations remains a particular concern of system operators. Although numerous
studies have shown the impacts of integrating these renewables at the levels realized to date to be
modest (GE Energy 2008; CAISO 2010a; EnerNex Corporation 2010; GE Energy 2010; Danish
Energy Agency 2013), there are still outstanding questions on the best ways to integrate them
reliably and efficiently, and also how to do so at greater levels of penetration.
Ancillary services, as defined by the Federal Energy Regulatory Commission (FERC) and
NERC, are those services necessary to support the transmission of capacity and energy from
resources to loads while maintaining reliable operation of the transmission service providers
transmission system in accordance with good utility practice. Ancillary service markets typically
include spinning, non-spinning, and regulation reserves (Hirst and Kirby 1997). Other ancillary
services, such as voltage control, reactive power, and black start are serviced through cost-based
mechanisms and do not have markets (Rebours et al. 2007). The ancillary service markets are
simultaneously cleared with the energy market in the two-settlement system. Prices are
uniformly cleared based on the marginal value of that service. The price could include an
availability cost as well as a lost opportunity cost. The lost opportunity cost is the revenue that a
resource can forego in a separate market in order to provide capacity for that ancillary service.
Ancillary services also have administratively set scarcity pricing, where the price reflects a
shortage of the particular service. Some ancillary services also have location constraints, but they
typically are not as strict as transmission constraints in the energy markets.
13
The threshold for significant is system-dependent, and can be much greater in some jurisdictions before
penetration levels become a concern.
20
Variable renewable energy can affect the design of ancillary services markets in three key ways.
1. The variability and uncertainty of wind and solar energy increases requirements for
various ancillary services, affecting the scheduling and pricing of those services. 14
2. Their impacts vary depending on system conditions, which makes the ancillary service
demands difficult to generalize across timescales and systems.
3. Allowing variable renewable energy to participate in ancillary service markets can offer
more supply to the market, but could offer challenges based on the unique characteristics
of the variable resources in question.
The aggregate impact of significant variable renewable energy on the grid suggests the need for
modifications to current ancillary service market designs and rules, and the potential for new
separate ancillary service markets. Some of these possibilities are reviewed below.
3.3.1 Dynamic Reserve Requirements (Secondary and Tertiary Reserves)15
Some of the recent renewable integration studies (EnerNex Corporation 2010) analyzed the
effect that variable renewable resources would have on operating reserve requirements (see also
Text Box 8). The most recent studies have all concluded that the requirements should not be
static, but in fact should change based on the actual and predicted conditions of the system (Ela
et al. 2012a). The quantity of required reserves is proposed to vary hourlywhich is not
typically found in current operating-reserve requirements. Allowing reserves to vary by time of
day and system conditions can better target the high-risk periods of significant change in the
wind resource and reduce integration costs (Smith et al. 2010). By having a requirement that
changes each hour based on predicted conditions, market participants would have to plan ahead
to understand what the ancillary services demand might be, similarly to how they anticipate the
load demand (Ela et al. 2012a), which again makes it more relevant to have a market for these
services.
One method of implementing a time-varying system reserve requirement is to have a reliable
forecast of every unit, in near real time and crossing both balancing authorities and multi-utility
system operating boundaries. Although RTOs/ISOs have some level of this capability now and
receive forecast data, real-time visibility and access to, for example, meter-level data for
aggregate demand-side forecasts, is extremely rare on a global basis. Generally speaking, the
distribution-level power system does not exhibit sufficient sensing, monitoring, and real-time
computational power to provide the level of reliability that operators expect from conventionally
powered units. As demonstrated in the forecasting example in the previous section, mandatory
rulessuch as a requirement that changes each hour based on predicted conditionscan be a
powerful change agent and accelerate development of the technological solution to the
14
Contingency reserves, based on the size of the largest generator, remain constant if the renewable generator is not
the largest plant.
15
Nomenclature for reserves varies widely (Rebours et al. 2007). In this report, primary reserves refer to the
automated droop response of governors. Secondary reserves refer to synchronized resources that can respond rapidly
to automatic control signals from the system operator to move up or down. Tertiary reserves refer to the resources
that respond to non-automated dispatch commands that respond to planned and unplanned events, such as
forecasting errors and outages.
21
operational problem. In other words, the technologies for smarter energy systems can meet the
challenges put forth by greater renewable energy integration. What is required is a balance
between three (sometimes competing) policy and regulatory objectives in the wholesale power
markets worldwide, namely: (1) a non-negotiable reliability requirement, (2) dynamic and
negotiable energy policies, and (3) a non-dynamic and deliberately paced regulatory rule-making
methodology.
Text Box 8. Impacts of Wind on Reserve Requirements: Experience of Spain
Balancing services in Spain are primary reserves, secondary reserves, tertiary reserves, and imbalances
management. Primary reserves are not influenced by wind-power penetration, and non-dispatchable
generation is planned to contribute to this reserve. The use of secondary reserves is affected slightly by
wind-power ramping, but the required level of reserves remains unchanged. Tertiary reserves are
influenced by wind power variability when wind power ramps are opposite to load ramps but, even so,
the required level of reserves has only marginally been increased due to wind. Conversely, the use of
and the required levels of imbalances management have experienced a significant increase due to wind
power uncertainty. These reserves are offered in day-ahead markets as a function of wind power
forecast error, guaranteeing balancing reserves from day-ahead to real time.
Text Box 9 describes the market-based approach used in India to maintain grid frequency.
Text Box 9. Indian Mechanisms for Grid Disciplinethe Unscheduled Interchange
Since 1994, frequency discipline in India has been managed through the unscheduled interchange
mechanism. The unscheduled interchange specifies a price curve linked to frequency, such that
participants in the power system (both generators and load-serving entities such as utilities) face
financial incentives to maintain grid frequency. Generators that deviate from their scheduled supply,
for example, could either benefit or be penalized depending on whether the deviation is in the direction
necessary to maintain grid frequency. So if the grid is operating above 50 Hz, and the generator undersupplies relative to its schedule, it incurs no penalty; rather it saves on fuel cost. If the grid is operating
below 50 Hz and the generator delivers less power than scheduled, it pays a penalty linked to the
deviation and the frequency rate at the time. Thus, there is a strong financial incentive to reduce
generation (or increase demand) during high-frequency times, and to increase generation (or decrease
demand) during low-frequency times (Bhusan 2005).
3.3.2 Primary Frequency Response

Although secondary reserves (also called regulation and secondary frequency control) help
control frequency by maintaining balance, more immediate frequency control is accomplished by
governors in the immediate seconds following a disturbance. This autonomous response is what
stabilizes the frequency and helps avoid the triggering of under-frequency and over-frequency
relays or instability that could lead to machine damage, load-shedding, andin the extreme
caseblackouts. Because conventional generators provide this service as part of interconnection,
and because there was, at least in the large synchronous interconnections of the continental
United States, more than enough frequency response in supply, this service was not explicitly
compensated through cost-based measures or market designs (Ela et al. 2012a).
22
The move to organized energy markets might have made the provision of frequency response a
disincentive, however. This is because its provision could reduce plant revenue by requiring
plant operation at somewhat less than maximum output to provide capacity to support frequency
response, and because generators can be penalized for schedule deviations that might be needed
to provide frequency response (Ela et al. 2012b). Several modifications could provide positive
incentives for frequency response, including adding frequency response characteristics to other
ancillary services markets, adding this service as a requirement for interconnection, or adding a
new separate market product holding its own specific characteristics and schedules and prices
(Ela et al. 2012a). Once the need for frequency response is recognized and made an incentive,
emerging technologies which might not inherently have these capabilities will have the
motivation to create innovative ways of attaining them (Miller et al. 2011).
3.3.3 System Inertia
Variable renewable energy lacks inherent inertial response, which helps the system remain stable
in the initial moments after a disturbance, before the automatic response by governors.
Simulations by the Western Electricity Coordinating Council have shown that frequency
response degrades during periods of high wind and low load, when conventional generators
comprise a small share of the dispatch mix (Ela et al. 2012a). 16 The simulations also show that it
is technically possible for wind to sufficiently emulate this inertial response by connecting to a
power electronic converter; some load and storage also can supply similar capability. Inertia is
an inherent part of synchronous generation, therefore it has no added cost other than being
online, and so a market similar to the other ancillary service markets, with changing schedules
and prices, might not be the best approach. If some resources do provide the service, and others
do not, however, then some sort of compensation might be required.
3.3.4 Voltage Control
Reactive power, which supports voltage control, does not travel far due to high inductive
impedances. It therefore is very localized which, in turn, inhibits a broad competitive market.
Challenges for reactive power markets are further compounded by rules governing the
procurement and use of reactive power capabilities. In general, all generators except wind plants
are required to be capable of providing reactive power within a power factor range defined in
their interconnection agreement, although in Spain new operating procedures are being studied to
require wind turbines to provide voltage control (Ministerio de Industria Energa y Turismo
draft). Compensation for provision of this service varies by transmission provider. In the United
States, there is no requirement to compensate generators for reactive power within the power
factor range unless the transmission provider is compensating its own generators. Generators
typically are paid for fixed costs as well as opportunity costs; that is, any costs it foregoes in the
energy markets because of constraints on providing reactive power (Federal Energy Regulatory
Commission 2005). Yet, market simulations demonstrate potential for a competitive reactive
power market. For example, simulations assert that in an optimal market, nodal reactive power
prices would remain at zero, except during contingencies, when prices would be low (Thomas et
al. 2006). This pricing scenario still would meet long-term average costs due to the low cost of
investment in reactive power supply. The complexities of solving the market models with a
16
The Western Electricity Coordinating Council is a regional forum that promotes electric service reliability in
western Canada and the western United States.
23
reactive power provisionwhich would require solving the full alternating current power flow
problem at intervals of as little as 5 minutes 17remains impractical, even though there can be
significant benefits from a reactive power market (Hogan 1993; Cain et al. 2012).
3.3.5 Co-optimization
The co-optimization of energy and ancillary services has improved the market efficiency of
scheduling and dispatch (Hirst and Kirby 1997; Singh and Papalexopoulos 1999). Nevertheless,
exceptions to co-optimization might be necessary to ensure a broad base of supply for ancillary
services. Load is ill-suited to co-optimization, for example, because the opportunity cost for
participation includes factors beyond energy price, and participation particularly depends on the
duration of response (Ela et al. 2012a). Storage, with its limited energy, also is not suitable for
co-optimization. NYISO changed its market rules to exempt storage from co-optimization in the
energy market (Smith et al. 2010).
3.3.6 Ancillary Service Provision by Renewable Resources
Although much research has focused on how variable renewable resources could increase the
need for ancillary services, variable renewable resources also can be used to provide these
ancillary services (Miller and Clark 2010; Miller et al. 2011; Ruttledge and Flynn 2011).
Currently, rules do not allow this provision in most of the ancillary services markets. In
Germany, auctions for frequency control reserves occur six days in advance, which effectively
precludes wind energy from bidding due to forecasting uncertainties (Holttinen et al. 2012).
Variable generation, however, can provide great flexibility. Variable renewable generators can
have fast electronically controlled ramp rates, zero minimum generation levels, and no start-up
time needs. With increased penetrations, it might be more economical to utilize variable
renewable resources to provide these services for both consumers (in terms of reduced
production costs) and for variable renewable generators (in terms of increased profits) (Kirby et
al. 2010). Text Box 10 describes the provision of ancillary services in some markets by demand
response.
17
Todays real-time markets typically use a DC power flow, which ignores reactive power and variations in voltage.
24
Text Box 10. Provision of Ancillary Services by Demand-side Resources
Demand-side resources increasingly are providing ancillary services to the grid, in roles that require
faster and more verifiable performance than traditional uses of energy efficiency. Demand-side
resources long have been employed in ways that only require several hours of lead time, such as
interruptible load for emergency peak shaving (Pfeifenberger and Hajos 2011) or to increase
nighttime load during off-peak price periods. Yet, provision of ancillary services occurs on much
shorter timescales, typically seconds to minutes. Such fast-acting demand response is employed in
several U.S. wholesale markets including ERCOT, PJM, and MISO (Pfeifenberger and Hajos 2011).
System security requires that such systems ensure rigorous performance characteristics (response time
and minimum load size), special contractual and compensation mechanisms, robust measurement and
verification methodology, and high-speed communications interface to enable automatic control. As
such, industrial sources have predominated in providing ancillary services. Pilot and demonstration
projects are underway to aggregate residential and commercial resources to provide ancillary services
(Navigant 2012), but significant legal and technical barriers remain to ensure adequate performance
characteristics.
25
4 Bridging Opportunities Between Wholesale Markets

and Emerging Technologies
Bridging opportunities between wholesale markets and emerging technologiessuch as demand
response, distributed generation, and distributed storagehas the potential to reduce system
costs, including costs at the distribution level, where these resources can address congestion,
losses, and inadequate infrastructure (Sioshansi et al. 2012). The distinct characteristics of these
resources, however, particularly distributed resources, present challenges to creating nondiscriminatory access in the wholesale market. This section reviews wholesale market
considerations specific to each of these types of resources.
4.1 Demand Response
Increasing the price responsiveness of electricity demand, either through voluntary reaction to
price signals or through contractual commitments to change demand in response to system
events, holds promise for reducing system peaks and adding significant flexibility to the grid.
The technical potential for demand response is growing. Globally, some analysts estimate that
55% of all meters globally will be smart by 2020 (Navigant 2012). This widespread
deployment of smart meters enables residential and commercial demand response to be more
widely integrated in power markets, but various technical obstacles remain. For example, the
reliability with which demand response can directly cushion the variability of renewable energy
depends on its characteristics. From a flexibility perspective, prized qualities include: direct
dispatchability to either increase or decrease demand; little or no advance notification; fast
response; ability to be called upon frequently; and verifiable visibility to the operator (Cappers et
al. 2012; Cutter et al. 2012).
Beyond the technical obstacles, institutional barriers also inhibit demand responsein the
residential sector in particularfrom fully participating in wholesale markets. Two critical
institutional barriers are regulatory and customer-related barriers, but some market rules also
represent barriers in many locations.
4.1.1 Regulatory Barriers
Current regulatory structures are the greatest barriers to increasing the potential for demand
response (Kirby et al. 2011). These structures typically reflect the traditional demarcation
between wholesale power markets and retail rates and programs, and often are ill-suited to
demand response, which straddles the wholesale-retail divide. In the United States, for example,
RTOs and ISOs under the regulation of the Federal Energy Regulatory Commission operate
wholesale power markets and maintain reliability, and they can design energy and ancillary
markets to include demand response. The extent to which RTOs/ISOs can integrate demand
response is limited, however. Retail rates are the jurisdiction of the states, and RTOs/ISOs are
not structured to interact with small customers or to determine demand baselines.
In most settings, regulated utilities (i.e., load-serving entities, distribution system operators)
directly serving customers are the main intermediary for retail rates and customer interaction.
This means that retail customers are not legally allowed to cut out the middle-man,
participating directly in wholesale power markets and gaining direct exposure to variability in
reliability and price. Instead, LSEs, with regulatory approval, serve the function of creating price
26
and event signals and interacting with retail customers, but their institutional options also are
limited. Many LSEs, for example, have programs that curtail individual loads to reduce peak
demand. If aggregated, such individual load control also could potentially be sold in the
wholesale market as an ancillary service product, although at the time of this writing such an
arrangement has not been demonstrated at full scale. The LSE could face various local regulatory
restrictions, however; for example, on the number of times it can curtail load, thus eliminating
the option of frequent but short-duration spinning reserves. In the PJM Interconnection in the
United States, where the RTO/ISO coordinates demand response, some LSEs view PJM as a
competitor in aggregation services (Greening 2010).
Another source of customer-related complexity that varies across different regulatory
environments is the legal treatment of third-party aggregators on the customer-side of the meter.
Third-party aggregatorsin locales where they are allowed to operatecan develop demandresponse programs without prior approval and restrictions by regulators, although the ability of
these aggregators to set prices and demand response-event thresholds and frequency might be
unclear, thereby limiting investment.
This disjointed regulatory structure gives rise to a situation in which federal regulators can
require system operators to implement demand-response programs that impose costs on local
utilities, but these utilities must seek approval from local regulators to recover costs from
customers (Greening 2010). These persistent disconnects between distribution and transmission
systems pose a variety of challenges to the integration of distributed resources and raise issues
such as data sharing and systems control. These and other broader concerns are becoming
increasingly important for grid planning and operations.
In many ways, the regulatory obstacles to demand response revive the conversation about retail
electricity market reforma process that has been less widespread than wholesale market
reform. 18 The question is whether residential demand response could emerge more quickly in a
competitive retail market arrangement than in fully integrated monopoly arrangement. In
Denmark, a national smart-grid strategy seeks to finalize the rollout of retail smart meters by
2015, in time for a new model of variable (hourly) pricing schemes at the retail level, connected
to the planned wholesale accounting system (Danish Ministry of Climate, Energy, and Buildings,
2013). In the European Union, four different task forces on smart grids recently have been
working to clarify appropriate market models (Eurelectric 2013). Regulatory reforms that have
been suggested include recalibrating the roles of RTOs/ISOs, LSEs, and third-party aggregators
based on their roles in providing information. For example, RTOs/ISOs could provide a market
platform, with information on price elasticity associated with bids; LSEs and aggregators could
provide market research and information to customers on risks and benefits (Greening 2010).
Also proposed is the unbundling of utility servicesrestricting utilities and LSEs to incentive
programs and price and event signals (the utility side of the meter)and allowing other market
providers to offer services on the customer side of the meter (Cappers et al. 2012). This type of
structure is in use in Finland, where demand response aggregators are market participants and
DSOs only are allowed to provide indiscriminate aggregator access to the smart meters.
18
Retail electricity market reform will be discussed in greater detail in a future 21st Century Power Partnership
report.
27
Over the next several years, these important regulatory questions could be translated into action
in countries that have plans to launch comprehensive energy-market reform, for example Japan,
India, and Mexico. Generally speaking, all three countries are starting from scratch in the
wholesale energy and capacity markets, as well as in the definition ofand demand-side
participation inretail markets. After a long period of vertically integrated, monopolistic market
design, the Japanese power sector is moving towards both unbundling and retail competition
(Ministry of Economy Trade and Industry 2013). The new energy reforms recently approved by
the Japanese Cabinet primarily focus on unbundling the generation, transmission, and retail
sectors by breaking the DSOs into private-sector actors, with a second phase planned to spur
retail competition.
Similarly, India is considering pathways to increase the fiscal health and efficiency of retail
DSOs, while simultaneously seeking to integrate increasing amounts of wind energy, and reduce
the widespread incidence of involuntary load-shedding. Leaders in the Indian power sector seek
a more market-based approach to load management, based on voluntary response to dynamic
tariffs (ISGAN 2013a). Smart meters, which will support this dynamic tariff scheme, still are in
early stages of deployment, but there are plans to dramatically increase deployment. Enacting
operational rules that clarify the interaction between retail demand response, wholesale energy,
and ancillary services markets could be important in the emerging Indian regulatory framework.
In Mexico, smart-meter deployment has been piloted in various communities by the national
utility, CFE, as a means to increase reliability and to reduce operating costs and non-technical
losses (ISGAN 2013b). The president of Mexico recently proposed broad restructuring of the
power sector, with a near-term focus at the wholesale level. At the same time, significant new
wind generation is expected in Mexico. Looking forward, some of the flexibility necessary to
integrate this wind might be accessible from demand response at the retail level, providing that
the regulatory framework is made clear.
4.1.2 Customer-related Barriers
A second major barrier to incorporating demand response is customer willingness and ability to
participate in ways that provide clear system benefits. In most cases, this means allowing
equipment to be dispatched automatically, either by the system operator or a third-party
aggregator participating in wholesale markets. To best serve as a resource for grid integration
and respond to year-round variability and uncertainty, dispatchable equipment should be
available all year (e.g., water heaters as opposed to air conditioners), and at a range of timescales
(Cappers et al. 2012).
Communications standards are needed to enable secure load control, accurate metering, and a
platform for transacting data with individual customers. Nevertheless, some customers have
expressed concern about smart meters and outside control of appliances, and regulators are
navigating the questions about who should pay the extra costs of automation equipment and the
marketing of demand-response programs. Additionally, in many settings retail customers also
hold long-standing expectations of flat electricity prices.
Several proposals have been made to reduce these barriers, including rate-based recovery of
infrastructure investment, marketing efforts that illustrate potential savings under dynamic rate
structures, incentives and rebates for smart appliances, and the encouragement of third-party
28
aggregators, particularly if utility services are unbundled (Greening 2010; Cappers et al. 2012).
Designing an appropriate mix of these measures requires attention to promoting customer
participation within specific technology, market, and regulatory scenarios (Greening 2010).
Some European projects investigate both technological and social acceptance issues, such as the
Ecogrid.eu project (20112014), in which 2,000 private customers located on the island of
Bornholm, Denmarkwhich is supplied by 50% renewablescan participate in the real-time
market. The participants houses are being equipped with devices that use remote control and
intelligent control to promote flexible demand. The customers can see the real-time prices and
set their individual automatic flexible demand. Experience with different types of smart metering
and social acceptance is being gathered in this project.
Similarly, in the United States, a series of consumer-behavior study projects initiated in 2010 aim
to investigate the impact of both technology and pricing variables on smart-grid deployments.
The studies investigate the demand impact of various technology packagessmart meters plus a
range of in-home informational devicestogether with variable pricing plans, such as prices
pegged to real-time wholesale prices versus tiered prices linked to critical peak hours
(Department of Energy 2011).
Across jurisdictions there is an emerging view that, regardless of individual consumer behavior,
it is important to create the right market structures to allow third-party aggregators to innovate
new products and arrangements to control a large number of load devices, such as water heaters,
heat pumps, or electrical vehicles. The city of Kalundborg, Denmark, for example, has provided
an open platform and incubator program for companies to test business models for controlling
electricity, water, heating, transport, and buildings (Smart City Kalundborg 2013).
4.1.3 Market Rules
Power markets evolved to accommodate conventional dispatchable generators. This makes it
challenging to incorporate retail demand response, where participation is mediated by factors
that include retail rate structures and limitations on duration and frequency. Changes to tariffs
and reliability rules might better value demand response.
Real-time pricing offers a direct avenue for mass-market participation in demand response
markets by allowing customers to experience the variability in pricing and adjust their demand
accordingly (Hogan 2010; Cappers et al. 2012). This would obviate the need for most demandresponse programs and the associated difficulties in designing market rules to allow their
participation. Real-time and other scarcity pricing also could help demand response to mitigate
market power by offering a means for moderating supply shortfalls and controlling price
excursions. Price risks could be mitigated by allowing demand to participate in forward markets
(Greening 2010). Although real-time pricing could be structured as an optional alternative to
regulated tariffs, this option nevertheless would require the support of state regulators, who
historically have worked to insulate customers from variability.
Barring this approach, market rules would have to be designed specifically to include demand
response in the bulk power system. Hogan (2010) described the difficulties in valuing demand
response in energy markets as the difference between reselling something you have purchased,
and selling something that you would have purchased, without actually purchasing it. One
29
complication is establishing a baseline methodology, and this methodology can differ among
forecasting, impact estimation, and billing (Cutter et al. 2012). Direct dispatch, however, or the
option to dispatch via capacity payments, simplifies these calculations (Cutter et al. 2012). In
FERC Order No. 745, the Commission described a net benefits test to identify the costeffectiveness of using demand response to balance supply and demand. This rule requires
RTOs/ISOs to pay demand response at the LMP rate when the net benefits test shows that a
demand-response resource is cost-effective.
In Finland, part of the zonal Nord Pool spot market, sufficient electricity to cover demand is
bought on the day-ahead market and the transaction is financially binding. In this market,
demand response can be built into the bid with price and volume steps. At later markets, demand
response will be offered as a deviation from the original schedule. At real time, any remaining
deviation in the balance of the LSE is addressed using the regulating power market, which has a
15-minute activation time. Demand response also can participate in that market.
Participation in ancillary markets might be more straightforward when automated demand
response is relatively indistinguishable from generation, and new market rules are better at
valuing the speed and accuracy of demand response, which usually is faster than the typical 5- to
10-minute services (Kirby et al. 2011). 19 Nevertheless, changing utility business models and
requirements of demand-response resources regarding, for example, attributes of performance
and revenue availability, are some of the most effective ways to reduce barriers to participation
in ancillary services markets (Cappers et al. 2013).
Other proposed changes include separating regulation up from regulation down to be inclusive of
loads that provide only unidirectional services (Cappers et al. 2012). Market-clearing software
could better incorporate the participation of demand response by including individual operating
constraints, such as duration, frequency, and notification times (Kirby et al. 2011). Forecasting to
reflect uncertainty also would improve operations and long-term planning (Kirby et al. 2011).
There also are concerns that prices for ancillary services could fall below sustainable levels with
significant participation by demand response, which can have zero opportunity costs (Kirby et al.
2011). Co-optimization with the much larger energy markets however, so far has limited the
impact of new resources on prices (Cappers et al. 2013). In the Nordic power system, a large
portion of the primary frequency reserve is served by industrial loads. The opportunity cost can
be high, however, as this method often leads to short interruptions in the industrial processes.
4.2 Distributed Generation
Distributed generation, which is generation located within distribution networks or on the

customer side of the network (Ackermann et al. 2001), can help decrease transmission and
distribution losses, and offset the need to upgrade infrastructure. In particular, microgrids
which can dispatch and manage local generation and demandhave the infrastructure to interact
with the wholesale power markets. Some types of distributed generation, such as combined heat
and power, can readily participate in wholesale power markets. Other types, such as residential
19
See, for example, PJMs new (October 2012) performance score to calculate compensation for regulation services,
Enhanced Certification, Measurement, Differentiation. This service provides greater compensation for faster
response.
30
PV, only will interact with the bulk power system as penetrations increase. Distributed
generations potential negative impacts on the grid include voltage increases, power fluctuations,
and unintentional islanding.
Combined heat and power plants primarily use fossil fuels to produce both electricity and lowtemperature steam for district heating. In Denmark, these plants are required to participate in
wholesale power markets, and a third of the plants also participate in real-time energy markets. 20
Their electricity generation therefore is optimized by the power marketswhen competitively
priced, combined heat and power produces electricity and its heat byproduct. When Denmarks
significant wind generation reduces prices, combined heat and power plants cease electricity
production and rely on thermal storage to maintain heating (Kiviluoma and Meibom 2010). The
thermal storage enables combined heat and power to complement wind power rather than
compete with it.
Residential PV currently remains primarily of interest at the distribution level. In the United
States, states regulate residential PV through the LSEs and residential tariffs, and there is little
interaction with the bulk power system. Residential PV in many jurisdictions is valued according
to the retail rate its power offsets; therefore, it is valued higher than it would be through
wholesale markets. As PV prices continue to fall, penetration likely will increase significantly.
Structuring the wholesale power market to accommodate this generation without curtailment
would create a disincentive for centralized (curtailable) PV. Increased penetrations also likely
will lead to revisions in interconnection standards to require PV to provide reliability services
such as reactive power supportmirroring the evolution in standards and expectations of wind
generation as its penetration increased. Germany already has instituted low-voltage ride-through
standards for grid-connected PV, even at the residential level (Passey et al. 2011).
Economic signals and system operator controls on the distribution grid that are similar to
wholesale power markets collectively could help integrate wholesale and retail markets
(Sotkiewicz and Vignolo 2006). Currently, there are no pricing mechanisms on the distribution
grid due to the complexity involved. Having transparency on the distribution grid via prices
would both create economic opportunities for distributed energy resources and improve bulkpower operations on systems with variable renewable energy (Rahimi and Ipakchi 2012).
4.3 Storage
Storage is an asset that can act as a generator, load, or alternative to transmission, and it can
provide significant flexibility for the bulk power system. Except for storage that can be centrally
dispatched, such as compressed air energy storage and pumped hydro, storage faces some of the
same barriers to participation in wholesale markets as demand response, including incomplete
valuation (e.g., by reducing costs of plant cycling), restricted access to markets (e.g., behind-themeter storage), and conflicting regulatory structures as described below (Sioshansi et al. 2012).
Although some market products discussed above would be well suited for storage (e.g., ramping,
voltage support), other characteristics of storage still would be inadequately valued. For
example, distributed storage can alleviate distribution-related congestion, but LMPs reflect only
20
In Denmark, real-time energy markets are called regulating power markets.
31
transmission congestion. Also, the energy in behind-the-meter storage (typical of customerowned thermal energy storage) cannot be dispatched and is limited to utility rates, which lack
scarcity and variable pricing that could improve its economics.
Regulatory structures also pose considerable challenges for complete valuation of storage
(Sioshansi et al. 2012). Storage can provide generation, transmission, and distribution benefits,
but in the United States it can only be classified as one type. Generation is valued in wholesale
power markets, whereas transmission and distribution assets are rate-based. The FERC has not
allowed rate-based transmission and distribution assets to participate in energy markets, and a
full market-based approach would inadequately value the transmission and distribution services
of storage. Both choices result in suboptimal use of storage. One way to get past this barrier is to
disaggregate the services by allowing the storage owner to sell storage capacity to a third party
(Sioshansi et al. 2012).
32
8 References
ABRACEEL (2012). Relatorio Anual (Annual Report) 2012, Brazilian Association of Energy Traders
(ABRACEEL).
ACER (2013). Pursuant to Article 11 of Regulation (EC) No 713/2009, ACER reports on: Capacity Remuneration
Mechanisms and the Internal Market for Electricity.
Ackermann, T., G. Andersson, et al. (2001). "Distributed generation: a definition." Electric Power Systems Research
57(3): 195-204.
Awerbuch, S. (2006). "Portfolio-Based Electricity Generation Planning: Policy Implications For Renewables And
Energy Security." Mitigation and Adaptation Strategies for Global Change 11(3): 693-710.
Bauknecht, D., G. Brunekreeft, et al. (2013). Chapter 7 - From Niche to Mainstream: The Evolution of Renewable
Energy in the German Electricity Market. Evolution of Global Electricity Markets. Boston, Academic
Press: 169-198.
Bhusan, B. (2005). ABC of ABT: A Primer on Availability Tariff.
Blum, R. (2013). Experience with High Flexible Power Plants in Denmark, Consequences for the Power Producers
and Coal-fired Power Plants. EU-China Workshop on Future Flexible Power System for Renewable Energy
Grid Integration. Beijing, DONG Energy.
Bowring, J. E. (2013). Chapter 9 - The Evolution of the PJM Capacity Market: Does It Address the Revenue
Sufficiency Problem? Evolution of Global Electricity Markets. Boston, Academic Press: 227-264.
Brew-Hammond, A. (2010). "Energy access in Africa: Challenges ahead." Energy Policy 38(5): 2291-2301.
Brown, A. and R. Salter (2011). "Can Smart Grid Technology Fix the Disconnect Between Wholesale and Retail
Pricing?" The Electricity Journal 24(1): 7-13.
Cain, M. B., R. P. ONeill, et al. (2012). History of Optimal Power Flow and Formulations: Optimal Power Flow
Paper 1. Washington, DC, Federal Energy Regulatory Commission.
California Independent System Operator (2010a). Integration of Renewable Resources: Operational Requirements
and Generation Fleet Capability at 20% RPS.
California Independent System Operator (2010b). Market Issues & Performance Annual Report, Department of
Market Monitoring.
Caplan, E. (2012). "What Drives New Generation Construction? An Analysis of the Financial Arrangements behind
New Electric Generation Projects in 2011." The Electricity Journal 25(6): 48-61.
Cappers, P., J. MacDonald, et al. (2013). Market and Policy Barriers for Demand Response Providing Ancillary
Services in U.S. Markets. Berkeley, CA, Lawrence Berkeley National Laboratory.
Cappers, P., A. Mills, et al. (2012). "An assessment of the role mass market demand response could play in
contributing to the management of variable generation integration issues." Energy Policy 48(0): 420-429.
Cochran, J., L. Bird, et al. (2012). Integrating Variable Renewable Energy in Electric Power Markets: Best Practices
from International Experience. Golden, CO, National Renewable Energy Laboratory.
Council of European Energy Regulators (2013a). CEER Response to the European Commission Consultation Paper
on generation adequacy, capacity mechanisms and the internal market in electricity.
Council of European Energy Regulators (2013b). Status Review on the Transposition of Unbundling Requirements
for DSOs and Closed Distribution System Operators.
Coutu, R. (2011). Capacity Markets in the United States, ISO New England.
Cramton, P. and S. Stoft (2006). The Convergence of Market Designs for Adequate Generating Capacity with
Special Attention to the CAISOs Resource Adequacy Problem: A White Paper for the Electricity
Oversight Board.
Cutter, E., C. K. Woo, et al. (2012). "Maximizing the Value of Responsive Load." The Electricity Journal 25(7): 616.
Danish Energy Agency. (2013). "Energy Policy Toolkit on System Integration of Wind Power: Experiences from
Denmark." from http://www.ens.dk/sites/ens.dk/files/climate-co2/low-carbon-transition-unit/danishenergy-policy-toolkits/system_integration_of_wind_power.pdf.
DB Climate Change Advisors (2009). Paying for Renewable Energy: TLC at the Right Price, Deutsche Bank Group.
Dehamna, A. (2013). "Matching Renewable Power, Worth Billions, to Load." Navigant Research Blog,
from http://www.navigantresearch.com/blog/matching-renewable-power-worth-billions-to-load.
Department of Energy (2011). U.S. Department of Energys Approach for Conducting Consumer Behavior Studies
within the Smart Grid Investment Grant Program.
EirGrid and SONI (2012). DS3: System Services Consultation - New Products and Contractual Arrangements.
42
Ela, E. and D. Edelson (2012). "Participation of Wind Power in LMP-Based Energy Markets." Sustainable Energy,
IEEE Transactions on 3(4): 777-783.
Ela, E., B. Kirby, et al. (2012a). Effective Ancillary Services Market Designs on High Wind Power Penetration
Systems. IEEE Power and Energy Society General Meeting. San Diego.
Ela, E., M. Milligan, et al. (2012b). Alternative Approaches for Incentivizing the Frequency Responsive Reserve
Ancillary Service, National Renewable Energy Laboratory: 21.
Ela, E. and M. O'Malley (2012). Probability-Weighted LMP and RCP for Day-Ahead Energy Markets using
Stochastic Security-Constrained Unit Commitment. 12th International Conference on Probabilistic
Methods Applied to Power Systems. Istanbul, Turkey.
EMC Development Company, I. (2012). "Comments of EMC Development Company, Inc to the Pennsylvania
Public Utility Commission." Retrieved September 11, 2013,
from http://www.puc.state.pa.us/pcdocs/1182371.pdf.
EnerNex Corporation (2010). Eastern Wind Integration and Transmission Study. Knoxville, TN. Golden, CO,
National Renewable Energy Laboratory.
ENSO-E (2013). European Commission Consultation on Generation Adequacy, Capacity Mechanisms and the
Internal Market in Electricity - ENTSO-E Response paper.
Estache, A. and L. Wren-Lewis (2009). "Toward a Theory of Regulation for Developing Countries: Following JeanJacques Laffonts Lead." Journal of Economic Literature 47(3): 729-770.
European Commission (2012a). Communication from the Commission to the European Parliament, the Council, the
Europan Economic And Social Committee and the Committee of the regions: "Making the internal energy
market work".
European Commission (2012b). Consultation Paper on Generation Adequacy, Capacity Mechanisms and the
Internal Market in Electricity.
European Wind Energy Association (2012). Creating the Internal Energy Market in Europe.
Federal Energy Regulatory Commission (2005). Principles for Efficient and Reliable Reactive Power Supply and
Consumption.
GE Energy (2008). Analysis of Wind Generation Impact on ERCOT Ancillary Services Requirements. Taylor, TX,
ERCOT.
GE Energy (2010). Western Wind and Solar Integration Study. Golden, CO, National Renewable Energy
Laboratory.
Gratwick, K. N. and A. Eberhard (2008). "Demise of the standard model for power sector reform and the emergence
of hybrid power markets." Energy Policy 36(10): 3948-3960.
Greening, L. A. (2010). "Demand response resources: Who is responsible for implementation in a deregulated
market?" Energy 35(4): 1518-1525.
Guasch, J. L., J.-J. Laffont, et al. (2003). Renegotiation of Concession Contracts in Latin America, World Bank
Publications.
Hirst, E. and B. Kirby (1997). Creating Competitive Markets for Ancillary Services. Oak Ridge, TN, Oak Ridge
National Laboratory.
Hogan, M. (2012). What Lies Beyond Capacity Markets, Regulatory Assistance Project.
Hogan, W. (2010). "Demand Response Compensation, Net Benefits and Cost Allocation: Comments." The
Electricity Journal 23(9): 19-24.
Hogan, W. W. (1993). "Markets in Real Electric Networks Require Reactive Prices." The Energy Journal 0(3): 171200.
Holttinen, H., J. Kiviluoma, et al. (2012). Ancillary services: technical specifications, system needs and costs.
Deliverable D2.2.
Holttinen, H., J. Kiviluoma, et al. (2013). Design and operation of power systems with large amounts of wind
power. Espoo, Finland.
IEA (2011). World Energy Outlook. Paris, France, OECD/IEA.
IEA (2012). World Energy Outlook. Paris, France, OECD/IEA.
ISGAN (2013a). Dynamic Tariff Structures for Demand Side Management and Demand Response in India. ISGAN
Discussion Paper. Forthcoming.
ISGAN (2013b). Reduction of non-technical losses through the implementation of smart grids. ISGAN Discussion
Paper. Forthcoming.
Keane, A., M. Milligan, et al. (2011a). "Capacity Value of Wind Power." IEEE Transactions on Power Systems
26(2): 564-572.
43
Keane, A., M. Milligan, et al. (2011b). "Capacity Value of Wind Power." IEEE Transactions on Power Systems
26(2).
Keay, M., J. Rhys, et al. (2013). Chapter 2 - Electricity Market Reform in Britain: Central Planning Versus Free
Markets. Evolution of Global Electricity Markets. Boston, Academic Press: 31-57.
Kind, P. (2013). Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail
Electric Business, Peter Kind, prepared for Edison Electric Institute.
Kirby, B. (2007). Ancillary Services: Technical and Commercial Insights, Wrtsil North America Inc.
Kirby, B., M. Milligan, et al. (2010). Providing Minute-to-Minute Regulation from Wind Plants. The 9th Annual
International Workshop on Large-Scale Integration of Wind Power into Power Systems and Transmission
Networks for Offshore Wind Power Plant. Qubec, Canada.
Kirby, B., M. O'Malley, et al. (2011). Load Participation in Ancillary Services: Workshop Report, U.S. Department
of Energy.
Kirschen, D. and G. Strbac (2004). Fundamentals of Power System Economics. West Sussex, England, John Wiley
& Sons, Ltd.
Kiviluoma, J. and P. Meibom (2010). "Influence of wind power, plug-in electric vehicles, and heat storages on
power system investments." Energy 35(3): 1244-1255.
Kiviluoma, J., P. Meibom, et al. (2012). "Short Term Energy Balancing with Increasing Levels of Wind
Energy." IEEE Transactions on Sustainable Energy 3(4): 769-776.
Lee, A., O. Zinaman, et al. (2012). Natural Gas and Renewable Energy: Discussion Platforms for Greater
Collaboration. Golden, CO, National Renewable Energy Laboratory.
Liebreich, M. (2013). "The New Energy ROI: Resilience, Optionality, Intelligence." Retrieved 30 September 2013,
from http://about.bnef.com/blog/liebreich-the-new-energy-roi-resilience-optionality-intelligence/.
Lopes, J. A. P., N. Hatziargyriou, et al. (2007). "Integrating distributed generation into electric power systems: A
review of drivers, challenges and opportunities." Electric Power Systems Research 77(9): 1189-1203.
Miller, M., L. Bird, et al. (2013). RES-E-NEXT: Next Generation of RES-E Policy Instruments, IEA-RETD.
Miller, N., K. Clark, et al. (2011). Frequency Responsive Wind Plant Controls: Impacts on Grid Performance. Power
and Energy Society General Meeting, 2011 IEEE.
Miller, N. W. and K. Clark (2010). Advanced controls enable wind plants to provide ancillary services. Power and
Energy Society General Meeting, 2010 IEEE.
Milligan, M., H. Holttinen, et al. (2012). Markets to Facilitate Wind and Solar Energy Integration in the Bulk Power
Supply: An IEA Task 25 Collaboration. 11th Annual International Workshop on Large-scale Integration of
Wind Power into Power Systems as Well as on Transmission Networks for Offshore Wind Power Plants.
Lisbon, Portugal: 9.
Ministerio de Industria Energa y Turismo (2012). Procedimiento de operacin P.O. 3.9.
Ministerio de Industria Energa y Turismo (2013). Propuesta de Real Decreto por el que se regulan los mecanismos
de capacidad e hibernacin y se modifican determinados aspectos del mercado de produccin de energa
elctrica.
Ministerio de Industria Energa y Turismo (draft). Procedimiento de operacin P.O. 7.5.
Ministry of Economy Trade and Industry. (2013). "Cabinet Decision on the Policy on Electricity System Reform."
Retrieved 7 October 2013, from http://www.meti.go.jp/english/press/2013/0402_01.html.
Navigant (2012). Smart Electric Meters, Advanced Metering Infrastructure, and Meter Communications: Global
Market Analysis and Forecasts.
NERC (2009). Accommodating High Levels of Variable Generation. Princeton, NJ, NERC.
NERC (2011). Methods to Model and Calculate Capacity Contributions of Variable Generation for Resource
Adequacy Planning. New Jersey.
Newell, S., K. Spees, et al. (2012). ERCOT Investment Incentives and Resource Adequacy, The Brattle Group,
prepared for ERCOT.
Passey, R., T. Spooner, et al. (2011). "The potential impacts of grid-connected distributed generation and how to
address them: A review of technical and non-technical factors." Energy Policy 39(10): 6280-6290.
Pfeifenberger, J. P. and A. Hajos (2011). Demand Response Review, The Brattle Group.
Pinguelli Rosa, L., N. Fidelis da Silva, et al. (2013). Chapter 15 - The Evolution of Brazilian Electricity
Market. Evolution of Global Electricity Markets. Boston, Academic Press: 435-459.
Porter, K. and J. Rogers (2009). Central Wind Power Forecasting Programs in North America by Regional
Transmission Organizations and Electric Utilities. Golden, CO.
Poyry (2011). The challenges of intermittency in North West European power markets.
44
Rahimi, F. A. and A. Ipakchi (2012). "Transactive Energy Techniques: Closing the Gap between Wholesale and
Retail Markets." The Electricity Journal(0).
Ranjit, L. R. and K. O. Sullivan (2002). A Sourcebook for Poverty Reduction Strategies, Volume 2. Washington,
D.C., World Bank.
Rebours, Y. G., D. S. Kirschen, et al. (2007). "A Survey of Frequency and Voltage Control Ancillary ServicesPart
II: Economic Features." IEEE Transactions on Power Systems 22(1): 358-366.
Red Elctrica de Espaa (2012). Full Report: The Spanish Electricity System in 2012.
Ruttledge, L. and D. Flynn (2011). System-wide inertial response from fixed speed and variable speed wind
turbines. Power and Energy Society General Meeting, 2011 IEEE.
Schleicher-Tappeser, R. (2012). "How renewables will change electricity markets in the next five years." Energy
Policy 48(0): 64-75.
Singh, H. and A. Papalexopoulos (1999). "Competitive Procurement of Ancillary Services by an Independent
System Operator." IEEE Transactions on Power Systems 14(2): 498-504.
Sioshansi, R., P. Denholm, et al. (2012). "Market and Policy Barriers to Deployment of Energy Storage." Economics
of Energy & Environmental Policy 1(2).
Smart City Kalundborg. (2013). "Smart City Kalundborg." from http://www.smartcitykalundborg.dk/en.
Smith, J. C., S. Beuning, et al. (2010). Impact of variable renewable energy on US electricity markets. Power and
Energy Society General Meeting, 2010 IEEE.
Sotkiewicz, P. M. and J. M. Vignolo (2006). "Nodal Pricing for Disribution Networks: Efficient Pricing for
Efficiency Enhancing DG." IEEE Transactions on Power Systems 21(2): 1013-1014.
Stoft, S. (2002). Power System Economics: Designing Markets for Electricity. Piscataway, NJ, IEEE Press.
Tabors, R. D., S. Englander, et al. (2012). "Who's on First? The Coordination of Gas and Power Scheduling." The
Electricity Journal 25(5): 8-15.
Thomas, R., T. Mount, et al. (2006). "Markets for Reactive Power and Reliabilty: A White Paper."
Zhao, F., P. B. Luh, et al. (2010). "Bid Cost Minimization Versus Payment Cost Minimization: A Game Theoretic
Study of Electricity Auctions." IEEE Transactions on Power Systems 25(1): 181-194.
45
Disclaimer
This document was prepared as an account of work sponsored by the United States Government. While
this document is believed to contain correct information, neither the United States Government nor any
agency thereof, nor The Regents of the University of California, nor any of their employees, makes any
warranty, express or implied, or assumes any legal responsibility for the accuracy, completeness, or
usefulness of any information, apparatus, product, or process disclosed, or represents that its use would
not infringe privately owned rights. Reference herein to any specific commercial product, process, or
service by its trade name, trademark, manufacturer, or otherwise, does not necessarily constitute or
imply its endorsement, recommendation, or favoring by the United States Government or any agency
thereof, or The Regents of the University of California. The views and opinions of authors expressed
herein do not necessarily state or reflect those of the United States Government or any agency thereof,
or The Regents of the University of California.
Ernest Orlando Lawrence Berkeley National Laboratory is an equal opportunity employer.
TheImpactofGlobalCoal
SupplyonWorldwide
ElectricityPrices
Overviewandcomparisonbetween
Europe,theUnitedStates,Australia,
Japan,ChinaandSouthAfrica
OECD/IEA 2012
ReportbytheIEACoalIndustryAdvisoryBoard
The views expressed in this paper do not necessarily reflect the views or policy of the International Energy Agency (IEA)
Secretariat or of its individual member countries. The paper does not constitute advice on any specific issue or situation.
The IEA makes no representation or warranty, express or implied, in respect of the papers content (including its
completeness or accuracy) and shall not be responsible for any use of, or reliance on, the paper. Comments are welcome,
directed to carlos.fernandezalvarez@iea.org.
OECD/IEA,2014
INTERNATIONAL ENERGY AGENCY

The International Energy Agency (IEA), an autonomous agency, was established in November1974.
Its primary mandate was and is two-fold: to promote energy security amongst its member
countries through collective response to physical disruptions in oil supply, and provide authoritative
research and analysis on ways to ensure reliable, affordable and clean energy for its 28 member
countries and beyond. The IEA carries out a comprehensive programme of energy co-operation among
its member countries, each of which is obliged to hold oil stocks equivalent to 90 days of its net imports.
The Agencys aims include the following objectives:
n Secure member countries access to reliable and ample supplies of all forms of energy; in particular,
through maintaining effective emergency response capabilities in case of oil supply disruptions.
n Promote sustainable energy policies that spur economic growth and environmental protection
in a global context particularly in terms of reducing greenhouse-gas emissions that contribute
to climate change.
n Improve transparency of international markets through collection and analysis of
energy data.
n Support global collaboration on energy technology to secure future energy supplies
and mitigate their environmental impact, including through improved energy
efficiency and development and deployment of low-carbon technologies.
n Find solutions to global energy challenges through engagement and
dialogue with non-member countries, industry, international
organisations and other stakeholders.
IEA member countries:

Australia
Austria
Belgium
Canada
Czech Republic
Denmark
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Japan
Korea (Republic of)
Luxembourg
Netherlands
New Zealand
Norway
Poland
Portugal
Slovak Republic
OECD/IEA, 2014
Spain
International Energy Agency
Sweden
9 rue de la Fdration
Switzerland
75739 Paris Cedex 15, France
Turkey
www.iea.org
United Kingdom
United States
Please note that this publication
is subject to specific restrictions

that limit its use and distribution.
The terms and conditions are available online at
http://www.iea.org/termsandconditionsuseandcopyright/
The European Commission

also participates in
the work of the IEA.
TheImpactofGlobalCoalSupplyonWorldwideElectricityPrices
Page|1
CoalIndustryAdvisoryBoard
TheIEACoalIndustryAdvisoryBoard(CIAB)isagroupofhighlevelexecutivesfromcoalrelated
industrialenterprises,establishedbytheIEAin1979toprovideadvicetotheIEAExecutive
Directoronawiderangeofissuesrelatingtocoal.TheCIABcurrentlyhasover35membersfrom
around20countries,contributingvaluableexperienceinthefieldsofcoalproduction,tradingand
transportation,electricitygenerationandotheraspectsofcoaluse.
FormoreinformationabouttheIEACoalIndustryAdvisoryBoard,pleasereferto
www.iea.org/ciab,orcontactCarlosFernndezAlvarezattheIEA(carlos.fernandez@iea.org)or
BrianHeath,CIABExecutiveCoordinator(mail@ciab.org.uk).
Acknowledgements
This report is part of the 2013 Work Programme of the Coal Advisory Board (CIAB) and was
preparedby theCIABWorkProgrammeActivity6 Group.TheprojectleaderwasHansWilhelm
SchifferofRWE,whowasinstrumentalinthedevelopmentofthisreport,aswasHendrikVossof
Page|2 RWE.Thefollowingindividualsservedasleadersandcontributorstothereportonbehalfoftheir
respectiveorganisations:
Europe
Leader:HansWilhelmSchiffer,RWE(Germany)
Contributors:HendrikVoss,RWE(Germany)
MaggiRademacher,E.ONKraftwerke(Germany)
RolandLbke,GermanCoalAssociation
NigelYaxley,AssociationofUKCoalImporters
RinaldoSorgenti,Assocarboni(Italy)
UnitedStates
Leader:CartanSumner,PeabodyEnergy(USA)
Contributors:VeronikaKohler,NationalMiningAssociation(USA)
StuDalton,EPRI(USA)
Australia
Leader:JustinFlood,DeltaElectricity(Australia)
Contributors:GregSullivan,AustralianCoalAssociation
PeterWormald,DeltaElectricity(Australia)
PeterMorris,AustralianCoalAssociation
Japan
Leader:MasatoUchiyama,JPOWER(Japan)
China
Leader:NannanSheng,ShenhuaGroup(China)
SouthAfrica
Leader:GinaDownes,Eskom(SouthAfrica)
Contributors:NikkiFisher,AngloOperationsLtd.(SouthAfrica)
JulianBeere,AngloOperationsLtd.(SouthAfrica)
Finally,muchappreciationisowedtoBrianHeathoftheCoalIndustryAdvisoryBoard,andCarlos
Fernndez Alvarez of the International Energy Agencys Gas, Coal and Power Markets Division,
withsubstantialinputfromHaraldHecking,andJanetPapeforeditingandNancyKluth/Cornelia
Grevenstukforformatting.
Tableofcontents
Acknowledgements...........................................................................................................................2
Executivesummary...........................................................................................................................6
Keymessagesofthisreport:.....................................................................................................6 Page|3
Europe................................................................................................................................7
UnitedStates......................................................................................................................7
Australia.............................................................................................................................7
Japan..................................................................................................................................8
China..................................................................................................................................8
SouthAfrica........................................................................................................................9
Introduction.....................................................................................................................................11
Structureoftheelectricitymarkets........................................................................................11
Marketdesign..........................................................................................................................11
Fuelsupply...............................................................................................................................12
Developmentsincoalandelectricityprices............................................................................12
Europe.............................................................................................................................................14
Structureoftheelectricitymarket..........................................................................................14
Marketdesign..........................................................................................................................16
Powerplantfuelsupply...........................................................................................................20
Thedevelopmentofhardcoalandelectricityprices..............................................................21
TheUnitedStates............................................................................................................................26
Marketdesign..........................................................................................................................29
Developmentofhardcoalandelectricityprices.....................................................................31
Australia..........................................................................................................................................33
Marketdesign..........................................................................................................................35
Developmentofhardcoalandelectricityprices....................................................................36
Japan...............................................................................................................................................40
Marketdesign..........................................................................................................................40
Developmentofhardcoalandelectricityprices....................................................................43
China................................................................................................................................................45
Marketdesign..........................................................................................................................46
Fuelsupply...............................................................................................................................47
Developmentsincoalandelectricityprices............................................................................48
SouthAfrica.....................................................................................................................................49
Structureoftheelectricitymarketandenergymixinpowergeneration..............................49
Marketdesign..........................................................................................................................51
Page|4
Howhaveconsumerpricesforelectricitydevelopedsince2000,differentiated
accordingtoimportantcustomergroups?......................................................................54
Conclusion.......................................................................................................................................55
Listofacronymsandabbreviations................................................................................................56
References.......................................................................................................................................57
Listoftables
Table1Overviewofmarketcharacteristicsindifferentregions...................................................9
Table2EU27powergenerationbyenergycarrier.....................................................................14
Table3Proportionofcoalpriceincreaseswhichispassedthroughtoelectricityprices...........20
Table4Developmentsinhardcoalpricesandwholesaleelectricityprices...............................21
Table5Averageretailpriceofelectricity,byendusesector.....................................................32
Table6Taxoneachfossilfuel.....................................................................................................42
Table7Eskomsgenerationcapacitybyfueltypeasat31March2013.....................................49
Listoffigures
Figure1WholesalemarketplacesforelectricityandenergyproductsinEurope2013........17
Figure2NorthwesternEuropeanmeritorderthatdecidesthepowerplantdispatch..............17
Figure3MeritorderoftheGermanwholesaleportfolio,2012versus2005..............................19
Figure4DevelopmentsinselectedprimaryenergypricesfreeGermanborder(nominal)........22
Figure5Germanelectricitypriceforprivatehouseholds...........................................................23
Figure6Germanelectricitypriceforindustry(70to150GWh/year).........................................24
Figure7NetpowergenerationntheUnitedStatesthrough2040(TWh)..................................26
Figure8Stateswithmorecoalbasedelectricitygenerallyhavelowerrates.............................27
Figure9USelectricityfuelsources,2009to2013.......................................................................27
Figure10NERCinterconnections.................................................................................................28
Figure11CoalfuelledelectricitygenerationsupplychainintheUnitedStates.........................30
Figure12Utilisationrates............................................................................................................30
Figure13Annualrealpriceofcoal,priceofelectricityforallsectors.........................................31
Figure14Australiaselectricitymarketstructurefor2010/11....................................................33
Figure15FuelsourcesforelectricityinAustralia,byenergysource2010/11............................34
Figure16HistoricalandforecastenergygrowthintheNEM......................................................34
Figure17NSWelectricityprice(timeweighted,allperiods)andexportcoalprice..................37
Figure18Retailelectricitypriceindex.........................................................................................37
Figure19Retailelectricitypricecomponents..............................................................................38
Figure20RetailpriceofelectricityinAustraliaincomparison....................................................39
Figure21Japaneseenergymixinpowergeneration..................................................................40
Figure22Marketclearingpriceandgeneratingcostsofeachfuel.............................................41
Figure23Electricitygenerationfullcostsofcoalfiredandgasfiredin2010and2030.............42
Figure24CIFpricesoffossilfuelandelectricitypricesinJapan.................................................43
Figure25Generatingelectricityfuelcostsoftenpowerutilities.................................................44
Figure26Consumerpricesofregulatedpublicutilities..............................................................44
Figure27ElectricityconsumptiongrowthinvariouspartsofChinainthefirsthalfof2013.....45
Figure28CoalexportingandimportingregionsinChina,2010..................................................47
Figure29Eskomselectricitysalesbycustomer,2012................................................................49
Figure30Projectedcoaldemand................................................................................................50 Page|5
Figure31ComparisonofincreaseinelectricitypricesandConsumerPriceIndexinflation......52
Figure32Eskomselectricityrevenuesandoperatingcosts.......................................................53
Listofboxes
Box1Thefundamentalcorrelationbetweencoalandelectricityprices....................................22
Box2Spain:tacklingtheelectricitydeficit..................................................................................25
Executivesummary
Hardcoal1isthemostimportantprimaryenergysourceinpowergeneration,with36%ofglobally
generated power relying on this fuel. Its significance varies by world region. In countries with
large resource endowments such as China or South Africa, the share of hard coal power
Page|6 generationismorethan80%.InratherimportdependentregionssuchasEuropeorJapan,the
share is lower, but with 15% and 25%, respectively, hard coal plays a significant role in power
generationaswell.Irrespectiveofhardcoalsshareofpowergenerationinaregion,theinfluence
ofcoalpricesonelectricitypricesisnearlyalwaysconsiderable.
The report at hand therefore provides an analysis of the impacts of global hard coal supply on
worldwideelectricityprices.Itconductsmarketstudiesofsixpowermarkets,namelyEurope,the
United States, Australia, Japan, China and South Africa. Each of these regions is evaluated
concerning its respective power market structure, market design, coal supply and the
interrelationofcoalandelectricityprices.
Keymessagesofthisreport:
Hardcoalisthedominantfuelinglobalpowergenerationbecausefullgenerationcosts
arewellbelowthoseofoil,gasorrenewables.Inregionswherepowerpricesarebased
onfullcostsduetoregulation,lowfullcostsofcoalplantsdirectlyimplylowelectricity
prices. When power prices are based on shortrun marginal costs (the merit order
principle), the fuel costs of the pricesetting plant matter. Therefore, inexpensive coal
servestodecreasethepriceofelectricity,whenthepricesettingplantisacoalfiredone.
In Europe and Australia, coal prices have an increasing impact on electricity prices. In
thosecountries,aswellasinmanyUSstates,powerpriceformationisbasedonthemerit
orderprinciple.Expandingrenewableenergygenerationandsluggishorconstantpower
demand increase the frequency of hard coal plants being the pricesetting power unit.
The more often these plants set the price, the higher the coal prices impact is on the
electricityprice,irrespectiveofthecoalsshareintotalpowergeneration.
InJapan(withtheexceptionoftherelativelysmallderegulatedmarket)orSouthAfrica,
wherepowersystemsarepredominantlymonopolistic,coalpriceshavesomeimpacton
powerpricesaswell.Electricitypricesarestateregulated,basedonfullcosts.Risingcoal
pricesincreasefuelcostsandthusalsofullcostsandpowerprices.However,othercost
componentssuchascapitaloroperatingcostsinfluenceelectricitypricesaswell.
Theshareofhardcoalinpowergenerationisinpartdrivenbytheresourceendowment
of a region. As such, the United States, Australia, China and South Africa exhibit rather
high shares of hard coal power generation, being selfsuppliers of lowercost domestic
coal. But hard coal also plays a major role in power generation in Japan or Europe,
althoughbotharehighlydependentonhardcoalimports,sincecoalpricesarewellbelow
pricesofalternativeenergysources.
Given future expansion of renewables, coal power generation in certain regions might
decline.However,thecoalpriceimpactonpowerpricescannonethelessincrease,ascoal
plantsarelikelytoincreasinglybecomethepricesettingpower units.Therefore,future
securityofcoalsupplyisnecessarytokeepwholesaleelectricitypricesstable.
Hardcoalisdefinedascoalofgrosscalorificvaluenotlessthan5700kcal/kgonanashfreebutmoistbasisandwithamean
randomreflectanceofvitriniteofatleast0.6.Hardcoalcomprisesanthraciteandbituminouscoal,i.e.cokingcoalandother
bituminouscoal.
Europe
TheEuropeanUnionhadatotalpowergenerationof3260TWhin2012,ofwhichhard
coalcontributedashareof15%.
In the light of liberalised European power markets, liquid wholesale exchanges such as
the EPEX spot have emerged with price formation following the merit order principle. Page|7
Nonetheless, European countries still have considerable differences concerning market
structureandsupplymix.
In2012,hardcoalfiredpowerplantswerepricesettinginGermanyinnearly80%ofthe
hours. This share has increased from 50% within the last years due to the strong
expansionofrenewables.
GiventheincreasingdegreeofmarketintegrationintheEuropeanUnion(EU)andnearly
bottleneckfree power exchange in northwest Europe, hard coal thus has a dominant
priceimpactontheneighbouringwesternmarketsaswell.
TheimpactofthecoalpriceonthewholepowerpricevariesinEuropewithrespectto
the share of coal costs at total variable costs, the frequency of coal plants being price
setting, the supply mix and the interconnections to other countries. High coal price
impactscanbeidentifiedfortheEasternEuropeanmarketsortheUnitedKingdom.
Onlyaminorpartofretailpowerpricesisexplainedbythewholesaleprice.Retailprices
alsoincludetaxes,networkfeesorchargesforsubsidiestorenewableenergy.
TheEuropeanUnionimportsmorethan60%ofitsthermalcoaldemandfromtheworld
marketatpriceshistoricallysignificantlybelowthosefornaturalgasorcrudeoil.
UnitedStates
In the United States, 42% of electricity was produced by coal over the fiveyear period
20092013.
TheUSelectricitymarketisseparatedintothreemainpowergridsanddifferentregional
wholesalemarkets.Regulatorymodelsvarybystatebetweenfullregulationofvertically
integrated utilities where prices are regulated, and regulation of the distribution only,
wheremarketssetthepowerprice.
Stateswithhighersharesofcoalfiredgenerationexhibitlowerpowerprices.
Historically,coalandelectricitypriceshavebeenrelatedtoeachother.
Coal prices exhibit less volatility than natural gas prices, thus fostering power price
stability.
TheUnitedStatesisselfsufficientwithrespecttohardcoalconsumption.
Australia
Hardcoalaccountsfor47%ofAustralianelectricitysupply.However,thisshareislikelyto
decrease because Australian energy policy targets 41 TWh coming from renewables by
2020.
The National Electricity Market is the dominating market region in Australia and the
wholesale price, determined by the merit order principle, tends towards shortterm
marginalcostswhenthereisexcessgeneratingcapacity,andotherwisetoaveragecosts.
Due to a downturn in power demand and increasing renewables generation, excess

capacity has increased and highercost hard coal plants dominate pricesetting in peak
periods instead of still more expensive gas or hydro plants as before. In offpeak
situationsligniteorlowercosthardcoalplantsarepricesetting.
Page|8
With the exception of some hard coal plants supplied by exportoriented mines, coal
powerplantsaremainlysuppliedbycaptiveminesordomesticmineswithlimitedexport
options,whichmakescoalpricesindependentofhighercoalexportprices.
Therefore, the Australian electricity wholesale price has remained rather flat and has
evolvedseparatelyfromexporthardcoalprices.
However,retailpriceshaveincreasedsharplysince2006duetohighernetworkcostsand
costsofcarbonandrenewablesintegration,butpricesarewellbelowothercomparable
countriesbecauseofthehighshareofgenerationfromdomestichardcoal.
Japan
Before and after Fukushima, generation from hard coal has made up 25% of Japanese
electricitysupply.
The Japaneseelectricity marketis dividedintotenregionalstateregulated monopolies,

with each monopoly integrating generation, transmission and distribution. The retail
sector is becoming rather deregulated, but only 2% of supplies have been sold through
thederegulatedmarketsofar.
In the regulated sector, electricity prices are determined by fullcost pricing, whereas
wholesale prices in the smaller deregulated market are determined at the Japanese
ElectricPowerExchange(JEPX)usingthemeritorderprinciple.
Coalpricesdoinpartdriveregulatedelectricityprices,sinceelectricitypricesarebased
onfullcostsofgenerationandonpriceadjustmentsforchangingfuelcosts.
Deregulated power prices are rather uninfluenced by coal prices, since gasfired power
plantsmainlysetthewholesalemarketclearingprice.
Japanisfullydependentonhardcoalimports.Hardcoalismainlypurchasedonthebasis
oflongtermcontracts.
China
Morethan80%oftotalChinesepowergenerationcomesfromcoalpowerplants,which
hadatotalcapacityof834GWin2013.
Besides five big national independent power producers, there are numerous smaller
regionalgeneratingutilitiesandlocalstateownedgenerators.
Retail electricity tariffs are strictly regulated by the government, which tries to keep
tariffslowinordertopreservepublicacceptanceandtopreventinflation.
Powergeneratorssellpowertothegridoperatoratregulatedongridtariffs,whichvary
byregionandareadaptedtocoalprices.
Plantspurchasecoalatwidelyliberalisedprices,whichareinfluencedby(international)
supplyanddemanddevelopments.
In times of high coal prices, the power sector cannot pass the costs on to the enduser
and thus either faces losses or reduces generation, which in turn can lead to power
supplydisruptions.
SouthAfrica
95% of South African power demand is supplied by Eskom, a fully stateowned and
verticalintegratedutility.Coalfiredplantscomprise85%ofEskomsgeneratingcapacity.
However,thecountryistryingtoincreasetheshareofindependentpowerproducers.
The National Energy Regulator of South Africa (Nersa) sets a revenue cap based on Page|9
Eskoms full generation costs, which is then translated into a variety of tariffs
differentiatedbycustomergroups.
Table1Overviewofmarketcharacteristicsindifferentregions
Europe
Hard coal
in power
generation
15% out of
3 260 TWh of
total power
generation
42%
(five-year
average)
Electricity
market
structure
Liberalised
competitive
power
markets,
advancing
market
integration,
variety of
national
energy
policies (e.g.
renewables
subsidies)
Three main
power grids
and different
regional
wholesale
markets,
regulatory
models vary by
state (full
regulation vs.
distribution
regulation)
Merit-order
principle at
wholesale
markets
Price
formation
United States
Australia
Japan
China
85% of
Eskoms
generating
capacity, 92%
of 232.8 TWh
produced
47%
25%
NEM
dominates
market region,
competitive
energy only
market
Ten regional
state-regulated
monopolies,
vertically
integrated over
generation,
transmission,
distribution and
partly retail,
retail at minor
share
deregulated
Five big
independent
power
producers,
smaller
regional
generating
utilities and
local stateowned
generators,
two grid
operators
Eskom is stateowned
vertically
integrated
monopoly
company
In regulated
states, price is
based on fullcosts and fuel
cost adjustment. Restructured states
follow meritorder pricing.
Merit-order
principle at
NEM
wholesale
market, price
ceiling
Regulated price
based on fullcosts and fuel
cost adjustment
system,
deregulated
retail: meritorder price at
JEPX
On-grid
electricity tariff
regulated by
government
with fuel
adjustment
based on coal
prices
Revenue cap
for Eskom
based on fuel,
operating and
capital costs,
revenue cap
broken down to
tariffs for
consumer
groups
Fully selfsupplied,
mostly captive
mines but
some coal
supplies have
dependence
on coal export
prices
Fully
dependent on
hard coal
imports,
purchased
mainly over
long-term
contracts
In 2012 China
imported
300 million
tons (Mt) and
produced
more than
3500 Mt
domestically
South Africa is
fully selfsupplied,
mostly captive
mines,
domestic coal
price is onethird of coal
export price
High impact,
since mainly
hard coal
plant are price
setting due to
sluggish
demand and
increasing
share of
renewables
Regulated
retail: medium
impact since
coal costs
influence fullcosts and thus
the power
price;
unregulated
retail: rather no
significance as
gas plants are
usually price
setting
Hard coal
supply
60% of hard
coal demand
is imported to
EU
Fully selfsupplied
Electricity
price
impact on
hard coal
High impact,
since midmerit coal
plants set the
price in 80%
of the hours
due to renewables expansion and high
cost differentces from gas
plants.
Coal prices
have been
relatively stable for decades
and directly
correlated with
lower rates.
Many restructured states
have signifycant gas capacity, gas generation and typically higher
rates.
83%
South Africa
Low impact
since government tries to
keep retail
prices down;
thus high coal
prices imply
losses for
power or grid
utilities
Medium impact since coal

costs are part
of total power
generation
costs, comprising capital
costs and other
operational
costs
Eskom therefore is incentivised to minimise costs by dispatching according to variable

costs. However, the current low supply reserve margin makes all plants run at full
capacity.
Coalpowerplantsaredomesticallysuppliedbyeitherdedicatedminesorthroughshort
and mediumterm contracts from exportoriented mines. Historically, domestic coal
priceshavebeenroughlyonethirdofinternationalpricesbecauseoflowercoalqualities,
lower transport costs and constrained export infrastructure limiting international price
impacts.
Primary energy costs for coal account for a significant part of power generation costs.
However, they are not perfectly correlated with electricity prices, as full power
generationcostscompriseothercostcomponentsaswell,suchascapitalcostsandother
operationalcosts.
Page|10
Introduction
Coalistheworldsprimaryenergysourceforpowergeneration,accountingforsome36percent
ofglobalelectricitygeneration.Itssignificancevariesgreatlyamongcountriesandworldregions.
Afundamentalparameteristheresourceendowmentofeachspecificregion.Usually,hardcoalis
of particularly great importance if there are domestic deposits that are economically mineable. Page|11
ThisisthecaseintheUnitedStates,Australia,ChinaandSouthAfrica.Incountriesorregionsthat
areentirelyorpredominantlysuppliedwithhardcoalfromtheworldmarket,suchasJapanand
the European Union, hard coal makes a significant contribution towards ensuring security of
supply.
Coalplaysaspecialroleinthepriceformationprocessontheelectricitymarkets.Inthisrespect
the costs of hard coal often have a significantly greater influence on electricity prices than the
percentage share of hard coal in power generation. Therefore, hard coal price swings
disproportionatelyaffectwholesaleelectricitypricesintheareaswhichwerestudied.Thestudy
athandhighlightsthesignificanceofhardcoalforallcontinents,usingtheexamplesoftheabove
markets.
Structureoftheelectricitymarkets
Theutilitystructureintheregionsunderexaminationdifferssignificantly,rangingfromasingle,
dominant utility (France and South Africa) all the way to a competitive market situation with a
wholehostofmarketactors(theUnitedStatesandGermany).
Electricitygridsandtheircrossborderconnectionsarestructuredverydifferently,resultingmost
notably from the countries specific geographic features. Japan being an island country has a
purelyinternalgridwithoutanyexternalconnections.Owingtotheirvastsize,theUnitedStates
andAustraliaevenhaveseveralgridregionsthatarehardlyinterlinked.InnorthwestEuropeand
South Africa, the electricity grid has been fully integrated for several years now. Some
transmissionbottlenecksstillexistingatthenationalbordersarecontinuouslyreduced.
It is assumed that the electricity demand in all countries under examination in this paper will
remainconstantorwillslightlyincreaseinthefuture.ThisisespeciallytrueoftheOECDcountries
for which only a moderate economic growth has been forecasted. The situation is different in
South America, where demand is growing and new coalfired capacity is under construction.
Electricity demand is expected to grow in China, and even though the Chinese government is
trying to diversify primary energy sources, coal will remain the backbone of Chinese power
generation.
Marketdesign
Intermsofmarketdesign,thereareagainsignificantregionalvariations,rangingfromnearlyfull
regulationtopriceformationinthemarket.InJapanandSouthAfrica,electricitypricesaresetby
the regulatory authorities according to the fullcost principle. In China, the regulator sets retail
pricesandtriestokeeppriceslow.FollowingtheEuropeanpath,theliberalisedmarket,whichis
currently still very small, is to be expanded. In Europe, electricity prices are largely determined
accordingtothemarketprinciple.However,therearealsocertainexceptions,suchasrenewable
energy,whichispromotedwithspecialsubsidies(especiallyinGermany).
InAustralia,themarketprincipledetermineswholesaleelectricityprices,althoughretailpricingis
largely regulated, and the United States has the full range of different regimes evident in
individual states. One feature all regions have in common is that the electricity grids, being
naturalmonopolies,arefullyregulated.
Therearewholesaleexchangesinmanyregions;theirsignificancedependsonthespecificdegree
ofregulation.InEurope,largequantitiesofelectricityaretradedatvariousexchanges,withthe
pricesbeingidenticalinthedifferentmarketplacesmostofthetime.Bycontrast,inJapanonly
Page|12 1%ofelectricityistradedattheexchange.
Asamatterofprinciple,electricitypriceformationinEuropefollowsthemeritorderprinciple
withtheexceptionofrenewableenergyremuneration.ButalsoinJapan,themeritorderisused
asguidanceforpricing. Inprinciple,themonopolyEskominSouthAfricaalsoappliesthe merit
order approach in order to minimise costs; however, all power plants are owned by the same
operator.InChina,dispatchiscentrallyplanned,whichleadstocertaininefficiencies.
CO2 emissions are priced differently. In South Africa, at present, the electricity price includes a
relativelysmallenvironmentalprotectionmarkup;theintroductionofaCO2taxisplannedforthe
future. Japan and Australia already have a CO2 tax. The European crossborder CO2 certificate
systemiscurrentlythefirstofitskind.IntheUnitedStates,thereareonlygeographicallylimited
systemstodate,however,extensionofisunderconsideration.
Despite all the differences concerning market design, coalfired power generation plays a huge
roleinallcountries.Thisbecomesparticularlyclearwhenlookingatthepowerplantsutilisation
levels.Inallregionsunderconsideration,theexistingcoalfiredpowerplantsareneededinsome
50%to95%ofallhourstocoverelectricitydemand.Whenelectricityconsumptionrises,e.g.in
the morning hours of a day, additional hard coalfired power plants are frequently operated to
coverthedemand.Inderegulatedelectricitymarkets,theplantsgenerationcostsincurredinthis
waymustbereimbursedviatheelectricityprice.Ifthegenerationcostsofcoalfiredpowerplants
goup,themarketpriceofelectricitywilldirectlyriseinthesehours.Inananalogousmanner,the
sameappliesifthecoalplantsgenerationcostsfall.Inthisway,theliberalisationoftheglobal
powermarketshelpstodirectlyimplementthepriceeffectofhardcoaldescribedabove.
Fuelsupply
The quantity of hard coal imported and exported primarily depends on the domestic deposits
existinginthespecificcountry.Ascoalisanimportantenergycarrierinallregions,awidevariety
of forms is possible. in Japan, for instance, the entire demand for coal is covered by imports,
whileparticularlyAustraliaandSouthAfricamineconsiderablymorecoalthanrequiredtomeet
domestic demand, which makes them not only selfsuppliers but also exporters of hard coal.
Chinaistheworldsbiggestproducer,consumerandimporterofcoal.
Developmentsincoalandelectricityprices
IntheUnitedStatesandEurope,mostnotablyinGermany,thereisastrongcorrelationbetween
developmentsincoalandelectricityprices.WhilethishasbeenthecaseintheUnitedStatesfor
decades now, in Europe, the dependence of electricity price levels on hard coal prices has
increasedmorerecentlyasaresultofthestrongexpansionofexpensiverenewables.Theirfeed
inpriorityhascausedthemeritordertochange,sothatcoalfiredpowerplantsaresettingthe
pricetoagreaterextent.InAustralia,sluggishdemandmakescoalplantsbecomemoreandmore
price setting as well. In Japan the merit order has also changed, albeit with other implications.
Due to the decommissioning of nuclear power stations in the aftermath of the Fukushima
disaster,themarginalplantsarenowadays,aboveall,naturalgasfiredstations.Thepriceofcoal
isonlyimportantinsofarasitmustbetakenintoaccountbytheregulatorsasbeingpartofthe
full costs when setting prices. In South Africa the situation is similar. In China, coalfired power
plantshavetopurchasecoalatmarketprices,whereastheysellelectricitytothegridoperatorat
regulatedtariffswhichincludesomefuelcostpassthroughmechanism.Sinceenduserelectricity
pricesareregulatedaswellandkeptlowbythegovernment,generatorsorgridoperatorsface
lossesfromrisingcoalprices.
Globalcoalpriceshaveslightlyriseninrecentyears,bothinrealandnominalterms.Beforethe Page|13
economiccrisisstarted,thepriceinEuroperosesharply,withacorrespondingimpactonpower
prices;conversely,lowercoalpricesin2012hadabearisheffectonwholesalepowerprices.
Electricitypricesvaryconsiderablyinthedifferentworldregions.Thelowpriceofcoal(especially
comparedwithotherenergycarriers)hashadadampeningeffectontheelectricitypriceinthe
United States and South Africa. In this respect, US states with a higher coal share in electricity
generation also have lower electricity costs. A change in the philosophy of depreciation values
andtheneedtofinancenewcapacityhascausedtheelectricitypriceinSouthAfricatoincrease
significantly in the last few years. In Europe, higher electricity prices are most notably resulting
fromsharpincreasesinburdensimposedbytheAdministration.Althoughderegulationhasledto
afallinpricesinJapan,thiswaspartlyoffsetbyhighercostsfollowingFukushima.InAustralia,
thepriceforhouseholdswentupowingtothegridexpansion.
Europe
Structureoftheelectricitymarket
Page|14 Thecreation ofacrossbordermarketforelectricityintheEuropeanUnionhasgivenrisesince
1998tooneoftheworldslargestinterconnectedpowersupplyregionsandonewhichhasbeen
subjecttoacommonpriceformationprocess.
PowergenerationintheEU27totalled3295terawatthours(TWh)(gross)in2012.Thestructure
hasabreakdownbyenergycarrierasfollows:
Table2EU27powergenerationbyenergycarrierin2012
Energy carrier
Percentage
Nuclear
26.8%
Hard coal
16.5%
Lignite
10.3%
Natural gas
17.6%
Oil
2.2%
Other non-renewable sources
5.9%
Hydropower
11.1%
Other renewables
9.6%
Source:Eurostat,2014.
Bothasregardstheenergymixandthemarketstructure,therearestillconsiderabledifferences
amongtheEUstates.
Greeces and the Czech Republics power generation, for instance, rely heavily on domestic
lignite. In Poland, hard coal is the most important source of electricity generation, but
supplementedbythecountrysligniteasanothersignificantpillar.IntheNetherlands,naturalgas
is the heavyweight, as is the case in Italy, where natural gas accounts for 54% of electricity
generation. In Austria, hydropower is abundantly available thanks to the countrys natural
conditions.ThisisalsotrueofSweden,albeitwithsomequalifications.There,useisalsomadeof
nuclearenergytogeneratepower.InFrance,morethantwothirdsofpowergenerationisbased
onnuclearenergy.Bycontrast,countriessuchasItalyandAustria,onpoliticalgrounds,donot
usenuclearenergy.InthecaseofItaly,a2011referendumhasreconfirmedthestepawayfrom
nuclear of 1987. Germany, in the aftermath of the 2011 reactor accident in Fukushima, has
decidedtophaseoutnuclearenergycompletelybytheendof2022.IntheUnitedKingdomthe
generationmixisstronglydependentonthecompetitivepositionbetweencoalandgas.In2012
around 40% of electricity was coalbased an increase of over 30% from 2011 as a result of
continuinghighgaspricesandrelativelylowgenerationcostsforcoalfiredplants.Spain,withits
limiteddomesticresourcesexceptforcoal,hasadiversemixofnuclear,coal,combinedcyclegas
turbines(CCGTs)andrenewableswindandsolaraswellashydro.Giventhecurrentgasandcoal
prices, coalfiring generation exceeded CCGTs by about 40% in 2012. Notably, the Spanish coal
capacity is at less than half of CCGTs capacity. Notwithstanding, the Spanish government has
beenprioritisingdomesticcoalbyapplicationofanEUdirectivethatentitlesmemberstatestodo
soongroundsofsecurityofsupply.
The most important reasons for the considerable variations in the energy mix among the EU
member states are differences in their endowment with natural energy resources and their
variousenergypolicies.
Although the EUs energy policy in a spirit of solidarity among the member states aims at
ensuring the central Community goals of a functioning single market, guaranteed security of
supply,thepromotionofenergyefficiency,anexpansionofrenewableresourcesandthelinkup Page|15
totheenergygrids,memberstatesretainresponsibilityfortheconditionsofuseoftheirenergy
resources, the choices made between different energy sources and the determination of the
generalenergysupplystructure.
Despite common EU energy politics, political interventions at the country level have grown in
frequency in recent years, increasing risks for energy investors. Recent examples in Germany
include:theintroductionofanucleartaxin2010,thedecisiontoexitfromnuclearpowerin2011
andplantclosurerestrictionsin2012.Intheneighbouringcountries,Belgiumaddedanucleartax
inBelgiumin2011,theNetherlandsaddedacoaltaxin2012andtheUnitedKingdomintroduced
both a carbon floor price in United Kingdom in 2013, and an emissions performance standard,
which prevents the construction of new coalfired power stations without carbon capture and
storage (CCS), whilst allowing the unabated construction of gas plants. Similar measures have
beenintroducedinotherEUmembercountries.
Likewise,themarketstructureintheEuropeanpowergenerationsectoralsovariessignificantly
betweenmemberstates.Examplesofstateswhereonesinglepowerproducerplaysadominating
roleareFranceandGreece.Bycontrast,alowdegreeofconcentrationcanbenotedforcountries
such as the United Kingdom, Germany and the Netherlands. In Germany, the EUs largest
electricity market, for example, the four largest power producers together account for a 45%
share in total generation capacity and produce 60% of the power generated. In addition, there
are more than 100 independent power plant operators with plants of more than 10 MW
regional and local providers as well as over one million operators of small PV, wind, water,
biomass and biogas plants. In Spain, the five largest generators produce around 70% of all
generatedpower,withmanysmallproducersofcombinedheatandpower(CHP),wind,photo
voltaic(PV),etc.
Thenationalelectricitygridshavebeenlinkedbyinterconnectorsforseveraldecadesprimarilyto
ensuregridsecurity.Withtheliberalisationoftheenergymarketsattheendofthe1990s,cross
border trade in electricity was added. Electricity trading initially had to face systemrelated
constraints. In recent years, however, there has been an increasing coupling of the national
markets.
AmilestoneintheintegrationoftheEUselectricitymarketswasreachedinNovember2010with
the coupling of the northwest European markets (Germany, France, the Netherlands, Belgium
andLuxembourg).Since then,thenationalelectricityspotmarketsofnine countrieshave been
coupledatawholesalelevel.Thepositiveimplicationsthismovewasexpectedtohaveformarket
resultsfromoptimalutilisationofcrossbordercapacitieshavematerialised.Insome60%of
the hours, for instance, the same price can now be noted on the wholesale market in France,
Germany,Belgium,theNetherlandsandLuxembourg.BeforetheCentralWesternEuropeMarket
Couplingbecameeffective,thiswasthecaseinlessthan1%ofthehoursinayear.TheNordic
regionisexpectedtobecoupledwithWesternEuropeinthenextphase.TheEUCommissionand
theEuropeanAgencyfortheCooperationofEnergyRegulators(ACER)aimatcouplingthespot
markets as a target model for the entire EU by 2015. However, in the short and medium term
thereastilllimitedinterconnectorcapacitiespreventingacompletelybarrierfreemarketregion
acrosstheEU.
From the year 2005 on, electricity demand has been largely constant in the EU. Once the
economiccrisishasbeenovercome,consumptionisexpectedtoriseagainalthoughlimitedto
thescaleofanannual1%onaverage.Dependingspecificallyontheinitialcyclicalsituationand
onspecificeconomicperspectives,developmentsarelikelytovaryamongthememberstates.In
Germany,forexample,electricityconsumptionisexpectedtobelargelystableinfuture,asitisin
the United Kingdom, whereas for other states Eastern Europe in particular growth
Page|16
perspectives of over 1% per year are assumed. Growth figures could be significantly higher if
othersectorsi.e.transportandheatbecomemoredependentonelectricity.
Marketdesign
For the power generation industry, liberalisation of Europes energy markets has meant that
competition has become the determining market principle apart from renewables which are
supported by state subsidies. Unlike the grid business, which is subject to state regulation as a
naturalmonopoly,marketpricesforconventionalpowergenerationaredirectedbysupplyand
demandonly.
Since the opening of national markets in 1998, liquidity in electricity trading has grown con
tinuouslyalloverEurope.
Germanyselectricitytradingmarket,withachurnrateofaboutten,isthemostliquidelectricity
tradingplatforminEurope.(Churnratereferstotheratiobetweentradingvolumeandphysical
consumption.)Thereasonsarethesizeofthemarketandtheheterogeneityofthemarketactors,
alongwithGermanysgeographiclocationasaEuropeanhub,andevergreatertransparency.
Europehasabout12powerexchanges.ThemostimportanttradingcentresforCentralWestern
Europe are the Leipzigbased European Energy Exchange (EEX) and the French exchange
Powernext,basedinParis.GermanandFrenchfuturestradeinelectricityisbundledinEEXPower
Derivates, a majorityowned EEX subsidiary registered in Leipzig. Being Europes most liquid
electricitywholesalemarket,theGermanwholesalemarketservesascrucialreference:thebase
load contract for the following year has further extended its role as benchmark contract for
electricityincontinentalEurope.
In addition to a liquid futures market, there is also a liquid spot market for electricity in
continental Europe. The French Powernext exchange and the European Energy Exchange in
Leipzig have bundled their electricity spot market activities for Germany and France and
combined them in a crossborder joint venture called European Power Exchange (EPEX Spot)
based in Paris. EPEX Spot operates the shortterm power exchange trade in Germany, France,
AustriaandSwitzerland.ItthusformsthecoreofthespotmarketintheCentralWesternEurope
region.
BesidestradingviathevariousEuropeanexchanges,thetrading activitiesintheelectricityarea
mainlytakeplaceonoffmarkettradingplatforms,knownasoverthecounter(OTC)platforms.
Since liberalisation, trading volumes in the various EU countries have grown. However, marked
differences in trends have emerged, these being due, inter alia, to decisions on the necessary
regulatoryconditions.
Priceformationonthewholesaleelectricitymarketfollowsthemeritorderprinciple.InCentral
Western Europe, the generation capacities installed there are in direct competition with one
another.DispatchofpowerplantsdependsontheCentralWesternEuropeanmeritorderandon
demand.
Themeritorderoftheexistingpowerplantsisdeterminedbythelevelofthevariablecostsofthe
variousplants.Sincethevariablecostsofrenewableenergysourcesapartfrombiomassare
virtuallyzero(windandsun)orrelativelylow(water),theirsupplyisattheveryleftinthemerit
order.Furthermore,renewablesareprioritisedinelectricityfeedinthatisguaranteedbystatute.
AftertherenewableenergiesatcurrentfuelandCO2pricesthestillavailablenuclearpower
stationsandlignitepowerplantssupplyelectricityaccordingtothemostfavourableconditions, Page|17
followed by plants based on hard coal. Gas has the highest variable costs at the moment
(Figure2). Only in exceptional situations are oilbased power plants still dispatched to cover
generalelectricitydemand.ThisholdstruefornearlyallEUmemberstates.
Figure1WholesalemarketplacesforelectricityandenergyproductsinEurope2013
Source:EEX,2013.
Figure2NorthwesternEuropeanmeritorderthatdecidesthepowerplantdispatch
EUR/ MWh
Germany
Belgium
France
Switzerland
Austria
Netherlands
Installed renewable capacity

Feed-in fluctuating as a function of supply
Hydro
Wind
PV
Lignite
(LG)
Other
REN
Nuclear (NC)
BK NC LG Hard coal
Gas/ Oil
Technology
Country
GW
Source:RWEanalysis,2013.
Pricesformatthepointofintersectionoftheresultingsupplycurveandthedemandcurve.This
guarantees an efficient dispatch of the power station fleet, since total generation costs are
minimisedinanyloadsituation.The market clearingpricereflectsthevariablecostsofthelast
powerplantjustneededtocoverthedemandconcerned(marginalplant).Themarketpricethus
formedispaidtoallpowerplantoperatorswhichhavesuppliedelectricityquantitiesbelowthis
price,irrespectiveofthelevelofthevariablecostsofthepowerstationconcerned.Thus,thereis
Page|18
onlyoneelectricitypriceatthewholesalelevel.
Themarginsbetweenthewholesalepriceandthevariablegenerationcostsofthevariouspower
stationsareneededtocoverthefixedcostsforoperationandmaintenanceandtocompensate
forthecostofcapital.
Since 2005, power plants, but also the plants of industry, have been subject to the Emissions
Tradingcheme(ETS)whichisregulatedEUwide.FortheplantsthataresubjecttotheETS,the
CO2 emission caps are binding for the period up to 2020. The prescribed reduction after 2012
followsapaththatprovidesforanannual1.74%reductioninCO2emissionsuntil2020.Thiswill
achievethe21%fallinCO2emissionsaimedatby2020,comparedwith2005,fortheplantsthat
aresubjecttotheETS.
The economic crisis in Europe in particular together with the heavily subsidized expansion of
renewables has significantly dampened the demand for CO2 emission certificates. Whereas
between mid2005 and mid2008, CO2 prices of up to EUR30/t were achieved in places,
quotationshaveweakenedsincethen.Mostrecently(16December2013),theystoodatamere
EUR5/tCO2.
TheEuropeanUnionisevaluatingoptionstotheETS.Thismaybedoneviaashorttermsupply
adjustment to raise the price of allowances (socalled backloading) and may go as far as a
structuralreformtothetradingsystem.
ThepricesforCO2certificatesareacomponentofthevariablecostsoffossilfiredpowerplants.
DependingonthelevelofthefuelandCO2costs,theycanchangepowerstationsdispatchmerit
order. In view of relatively high gas prices in Europe and the low CO2 prices, the CO2 ETS is at
presentnottriggeringafuelswitchfromcoaltogas.Infact,gaspowerplantsareattheveryright
inthemeritorder.
AnanalysisforGermanyshowsthefollowingutilisationofhardcoalandgasfiredpowerplantsin
2012.Thedataperfuelclassvaryowingtoaplantsageandefficiency:
lignite:approximately80%to95%,
hardcoal:approximately50%to80%,
naturalgas:uptoapproximately20%.
The utilisation of the plants follows directly from their position in the merit order. The higher
theirvariablegenerationcosts,thefewerhourstheyaredemandedbythemarket.IntheUnited
Kingdom, coal plants have operated in midmerit for several years, with load factors typically
around40%,butcoalloadfactorshaveincreasedmorerecentlyasaresultofhighergasprices.In
the future they will be increasingly constrained by Industrial Emissions Directive requirements
andbytheUKgovernmentscarbonfloorprice(whichisessentiallyacarbontax).
In the hours in which gas capacities are needed to cover electricity demand, the shortterm
generation costs of these plants determine the level of the electricity prices in exchange
wholesaletrade.In2012,therefore,forabout20%ofalltradedhours,electricitypriceswereset
bygasfiredpowerstations.Thissharehasfallenfromroughly50%inrecentyears.Thereasonfor
thisisthestrongexpansionofrenewables,whichhasmeantthatwheretheshareofwindand
solarishightheexistinggasfiredpowerplantsaswellassectionsofthehardcoalportfolioare
nolongerneededastemporarysubstitutes.Asaresult,theinfluenceonelectricitypricesexerted
by hard coal power stations positioned more to the left in the merit segment has risen. In this
way,theelectricitypricesintheremaining80%ofthehoursarealmostcompletelydetermined
by the generation costs of the existing hard coalfired power plants. The reason is that power
consumptionevenafterdeductionofthefeedin tarifffromrenewablesonlyinexceptional
casesfallssolowthatthelowcostlignitefiredandnuclearpowerstationsaswellarenolonger Page|19
fullyneededtocoverdemand.
Owing to the marketrelated positions of hard coal in the midmerit segment, hard coal on the
German market is thus very largely pricesetting, although hard coals share in the power
generationquantityin2012stoodatamere19%.
Owingtothecrossbordertradeinelectricitywithneighbouringmarkets,hardcoalsdominating
priceimpact ontheelectricity marketsbecomes perceptibleinthewholeof northwest Europe.
ThefrequentlybottleneckfreeexchangeofelectricitywithBeneluxandFranceleadstoadirect
passing on of the prices to neighbouring western markets. In the neighbouring northern and
easternmarkets,thepriceeffectfromthehardcoalcapacitiesinDenmark,PolandandtheCzech
Republicisincreasedevenfurther.IntheUnitedKingdomlowcoalpricescontributetotheswitch
fromgas,butinterconnectivitywiththerestofEuropeislimited.
Figure3MeritorderoftheGermanwholesaleportfolio,2012versus2005
EUR/ MWh
EUR/MWh
Note: The costs for nuclear power generation have risen as since 1 January 2011 utilities have been required to pay a tax on fuel
elements.
Source:RWEanalysis,2013.
However, although the EU electricity markets are linked via interconnector capacities, the
available transfer capacities vary significantly. Some markets are already fully integrated, while
othersstillshowregularscarcitieswhenavailableinterconnectorcapacitiesarefullyexploited.In
asimplifieddescription,thecurrentsituationoftheinterconnectedtransmissiongridresultsina
fewdifferentmarketzoneswithintheEU.
CentralWest: the Netherlands, Belgium, France, Luxembourg, Germany, Switzerland*,

Austria,DenmarkWest
East:Poland,theCzechRepublic,Slovakia,Hungary,Slovenia
North:Norway(notanEUmemberstate,butintegratedintheliberalisedEUelectricity
market),Sweden,Finland,DenmarkEast
Page|20
Baltics:Lithuania,Latvia,Estonia
GB/Ireland:theUnitedKingdom,theRepublicofIreland
Iberia:Spain,Portugal
Italy
SouthEast:Romania,Bulgaria,Greece
Duetothedifferentproportionofcoalfiredgenerationcapacitiesinthesemarkets,theimpactof
coal prices on electricity prices varies slightly. The following table indicates to what extent
increasing costs for hard coal are directly passed through to electricity prices at the national
powerexchanges.
Table3Proportionofcoalpriceincreasespassedthroughtoelectricityprices
Central-West
60% - 70%
East
70% 80%
Baltics
40% 50%
North
GB/Ireland
40% 50%
50% 60%
Iberia
40% - 50%
Italy
30 40%
South-East
60 70%
Source:RWEanalysisbasedoncommoditypricedevelopments,2013.
Powerplantfuelsupply
In the European Union, some 60% of hard coal needs are covered by imports from third
countries.InGermany,theimportshareevenreached80%in2012.Thepricesofsteamcoalin
Germany are entirely determined by world market prices. This is also true of the hard coal
quantitiesthatwillstillbeminedatahighercostinGermanyuntil2018.Thedifferencebetween
extractioncostsandimportpricesthecrucialvaluesinthisconnectionarethequotationscost,
insurance and freight (CIF) Rotterdam is offset by subsidies from the federal budget. In Italy,
100% of its hard coal stems from tertiary country sources; however, with coal accounting for a
mere12%ofallenergygeneration,effectsarestilllimited.
In Germany, power plant operators pay only market prices for hard coal. This is true of both
imported and domestic hard coal. Most coal imports are done on a floating basis indexed to
financialtradinginstrumentssuchastheAPI2/API4.Buyersandsellerscanthenfixpricelevelsin
thetradedmarketeitheronexchangesorintheoverthecountermarket.IntheUnitedKingdom
all coal is freely traded with no subsidy, so indigenous producers must compete with imported
prices.
Thecompetitionbetweenhardcoalandgasplaysahugeroleinpowergeneration.Althoughthe
cost of capital for a coalpower plant with comparable output is higher than for a gasfired
power station, currently the costs of hard coal as input energy in Europe are much lower than
naturalgas.Thetechnicaldispatchabilityissimilarinbothcases.
For electricity price formation on the wholesale market, only the variable costs, i.e. mainly fuel
and CO2 costs, are relevant. The variable powergeneration costs for hard coal despite the
usuallyhigherefficiencyofgasfiredpowerstationsaremuchloweratpresentthanforplants
onagasbasis.Ifweassumeunchangedfuelpriceratios,theCO2pricewouldhavetorisetoover
EUR30/ttotriggeraswitchinthedispatchorderofhardcoalandgaspowerplants.
A CO2 price at this level would have a considerable impact on wholesale electricity prices. The
corresponding rise in electricity prices would jeopardise the competitiveness of the power
consumingindustryunlesscomparableburdensfortheelectricitypricefromaCO2regimeareput
inplaceoutsideEurope.
Thedevelopmentofhardcoalandelectricityprices
ThechieftradingplatformforimportedcoalinWesternEuropeistheDutch/Belgianregion,with
the ports of Amsterdam, Rotterdam and Antwerp (ARA). Price formation in the ARA region is
taken as the reference for Western Europe as a whole. Price developments are shown in the
following table. Since the start of the millennium, the prices of steam coal have risen by more Page|21
than 100%. Price volatility, too, has increased significantly. During the 2007/2008 boom, there
were extreme price peaks at times. With the start of the financial and economic crisis, price
developmentshavestabilisedatahigherlevelafteradeclineassociatedwiththebusinesscycle.
Thenecessaryinlandtransportofthehardcoaltothedomesticpowerplantsleadstoadditional
logisticscostsrangingbetweenEUR5/tandEUR15/tforhardcoal,dependingonthelinkupof
thelocationstowaterwaysortherailnetwork.
Wholesale electricity prices have evolved partly in parallel with the course taken by hard coal
prices, although in places, a divergence can be noted (e.g. 2007). An important reason for this
wastheseverefallintheCO2pricefromoverEUR30/tinmid2006topracticallynilinthecourse
of2007.(ThemassiveerosionoftheCO2priceswasduetothefactthatemissionrightscouldnot
betransferredtothesecondtradingperiodoftheETS,whichbeganon1January2008.)Inmid
2008,theCO2priceagainreachedapeakofaroundEUR30/t.Thereafter,adefinitedeclinewas
noted triggered above all by the economic crisis in Europe and by the strong expansion of
renewables, which has meant that the more expensive gasfired power plants became price
settingineverfewerhours.Whereasonlyafewyearsago,gasbasedpowerstationswereprice
settinginhalfofthehours,thisisonlythecasenowadaysinabout20%ofthehours.
Ifthehardcoalpricerisesby10%,i.e.intheaboveexamplefromEUR90/tcetoEUR99/tce,fuel
costs increase by EUR 1.1/MWhth, equivalent to EUR 2.9/MWhel. The effect is a rise in variable
costs(withanunchangedCO2price)by8.7%.Ifthehardcoalfiredpowerstationispricesetting
in80%ofthehours,thewholesaleelectricityprice(ontheaboveassumptions)maybepresumed
togoup7% ifthehard coalpriceincreasesby10%.WhereCO2pricesarehigher,theeffect in
relativetermswouldbelower.
Table4Developmentsinhardcoalpricesandwholesaleelectricityprices
Year
Spot price for steam

coal free Western
European seaports
Average import price

for steam coal free
German border
USD/tce
EUR/tce
Base load
Peak load
2000
42
2001
46
53
25
36
2002
37
45
23
32
42
2003
50
40
29
43
2004
84
55
28
38
2005
71
65
46
56
2006
74
62
51
64
2007
101
68
38
49
2008
175
112
66
79
2009
82
79
39
47
2010
107
85
44
51
2011
143
107
51
57
2012
109
93
43
49
2013
95
79
38
43
Source:VDKi,BAFA,EEX,2013.
Wholesale electricity price

(spot price) EUR/MWh
Box1Thefundamentalcorrelationbetweencoalandelectricityprices
Theimplicationsofariseinhardcoalpricesforthewholesaleelectricitypriceshownbyanexample:
Theassumptionsintheexampleofthefollowing:
coalprice(6000kcal/kg):USD90/tCIFnorthwestEurope
transportcoststothepowerplant:USD10/t
Page|22
exchangerate:USD1.30/EUR.
Fromthis,weobtainacoalprice,freepowerplantofEUR90/tce,equivalenttoEUR11/MWhth.With
anassumedelectricefficiencyinthepowerplantof38%,fuelcostsamounttosomeEUR29/MWhel.
WithalikewiseassumedCO2priceofEUR5/t,theCO2costsperMWhofelectricitygeneratedamount
toEUR4.50/MWhel(CO2 emissionfactorof900kg/MWhelforahardcoalfiredpowerstationhaving
38%efficiency).Intotal,thevariablecostsamounttoEUR33.50/MWhel.
Consumer prices for electricity (Germany as an example) plummeted initially after the
liberalisationofthepowermarketin1998.Liberalisationwasassociatedwith adeparturefrom
theprincipleofpriceformationaccordingtoaveragecosts.Sincethen,onlythetransmissionand
distributionfunctionsasnaturalmonopolyhavestillbeensubjecttostateregulation.
The prices of hard coal and natural gas, free German border, fell to EUR 34 and 53/tce,
respectively, in 1999. In the sequel, hard coal and gas prices rose again, and this development
even accelerated from mid2003 on. In 2008, hard coal and gas prices, at EUR 112 and 237/t
respectively,reachedalevelthatwasequivalenttoaquadruplingofthecomparablevalueinthe
year 1999 (Figure 4). In the wake of the 2009 economic crisis, prices fell, although this was
followedbyrenewedstabilisation.Thevariablecoststhatdeterminethepriceofelectricitywere
additionallyimpactedafter2005bythequotationsforCO2emissioncertificates.
Figure4DevelopmentsinselectedprimaryenergypricesfreeGermanborder(nominal)
EUR/tce
450
400
350
Second oil crisis
300
250
200
First oil
crisis
Crude oil
150
Nat. gas
100
50
Hard coal
(steam coal)
0
1973
1977
1981
1985
1989
1993
1997
2001
2005
2009
2013 *
*JanuarytoSeptember2013
Source:FederalOfficeofEconomicsandExportControlBAFA(2013):www.bafa.de.
Developments in consumer electricity prices (calculated without taxes and burdens imposed by
government) reflect the course taken by variable costs. Consumer electricity prices, including
taxesandlevies,havedoubledinGermanysince2000,duetothefollowing:(1)thereallocation
chargeinfavourofrenewableenergy,whichhadincreasedtoEUR52.88/MWhby2013;(2)the
electricity tax, which was introduced in 1999 and then successively raised to EUR20.50/MWh;
and(3)thenewlylaunchedreallocationchargesongridaccessfees(Figure5).Bothindustryand
householdscaneasilyswitchelectricityproviders.
Page|23
Figure5Germanelectricitypriceforprivatehouseholds
28.84
2.05
25.23
0.08
1.79
2.33
13.94
1.28
0.19
1.79
1.92
12.91
1998
20.64
21.65
2.05
2.05
1.31
0.19
17.96
1.79
0.29 1.16
2.05
0.31 1.02
1.79
16.11
2.05
0.88
1.79
0.31
3.71
1.79
1.79
0.51
3.46
0.25
3.30
0.35 1.79
2.68
1.79
2.48
2.22
19.46
17.11
23.69
23.1
Eurocent/kWh
8.62
9.71
2000
2002
2.05
0.24
2.05
10.82
11.75
12.19
13.00
2004
2006
2007
2008
2.05
2.05
0.03
0.13 3.53
1.79
1.79
3.78
4.03
25.89
2.05
0.15
0.25
0.455
5.277
3.59
1.79
4.13
1.79
4.60
Electricity tax
Offshore
realloc. charge
CHP Act*+
sec. 19
EEG**
Local govt.
charges
VAT
Generation,
transport, sales
14.11
13.89
13.80
14.17
14.42
2009
2010
2011
2012
2013
* Total burden from CHP Act fell as from 2002; as from 2012, shown including section 19 reallocation charge, ans as from 2013
includingoffshorereallocationchargeforliability(owingtoreliefforindustry,growingburdenforhouseholds)
**RenewableEnergySourcesAct;from2010,applicationofOrdinanceonNationwideEqualizationScheme(AusgleichMechV)
Source:BDEW,2013.
Theenergyconsumingindustryhasonlybeenalittleburdenedbythesestateimposedleviesand
reallocation charges, so that it has been possible to keep electricity prices for industries with
relativelyhighpowerconsumptionfairlystable(Figure6).
Despite Spains electricity deficit (see Box 2), electricity prices for household consumers range
amongst the highest in the European Union. The situation is slightly better for industrial
consumption, at roughly EUR 115per MWh and Spain takes eighth place amongst the EU
member states (notably, the United Kingdom and Italy have higher prices). However, Spanish
electricitypricelevelsarestillsignificantlyaboveaverage.Generationcostsareinlinewithother
countries. According to Red Elctrica de Espaa, the system operator, generation costs were at
EUR 59.4/MWh in 2012, compared with EUR 60.22/MWh in 2011. This includes the wholesale
market price (EUR 48.75/MWh) as well as ancillary services (EUR 4.6/MWh) and capacity
payments(EUR6.1/MWh).
Withalargeproportionoffedingenerationfromrenewables,CHPandmustrunnuclear,CCGTs
andcoalfiredplantshavebecomemarginalsuppliers.WhileCCGTsusedtobemoreimportantin
price setting than coal, this trend reversed from October 2011. According to the Comisin
NacionaldeEnerga,theSpanishregulator,in2012,coalsweightinpriceformationinthedaily
wholesalemarketwasaround65%withCCGTsaccountingforaround30%.
Figure6Germanelectricitypriceforindustry(70to150GWh/year)
10.07
8.56
8.69
0.90
1.10
7.01
7.66
7.59
2007
2008
2009
7.91
Page|24
0.90
8.63
2.83
1.77
6.86
7.24
2010
2011
10.64
9.26
2.78
4.28
6.48
6.36
2012
1 - 6 2013
Notes:
1. Eurostatdatabefore2007notcomparableowingtochangeinsurveymethodology.
2. Nonrefundable levies and taxes (local government charges, EEG charge, CHP charge; as from 2012: section19 reallocation
charge)cannotbestatedseparately.
3. Dependingonpurchasingbehaviour/griduse,thenonrefundabletaxesandleviesvaryindividually.
Source:Eurostat;2013,GermanAssociationofEnergyandWaterIndustries(BDEW),2013.
Box2Spain:tacklingtheelectricitydeficit
The main issue in the electricity and the energy sectors in Spain is the socalled electricity deficit.
Althoughitbeganin2000,theamountsofthefirstyearswereassumableforthesystem.However,
from2005theannualdeficitaccountedformorethanEUR1billionperyear,andfrom2008to2012,
annual electricity deficits reached the EUR 5 billion mark. The deficit creates heavy damage for all
stakeholdersbygeneratingasignificantburdenforfutureconsumerswhilesendingthewrongprice
signals to the current ones. In addition, the companies obliged to finance the deficit (only the five
mainutilities)havetofaceothersdebt.Finally,thepublicbudgetisalsoaffectedbytheelectricity
deficit,asitsfinalfinancialguaranteethroughFADE(FondodeAmortizacindelaDeudaElctricaor
FundtoPayofftheElectricityDebt)jeopardisesthecountryssolvency.Itisnosurprisethatthemain
effortsoftheSpanishgovernmentregardingelectricityaredevotedtoendingthisdeficit.
TheelectricitydeficitisthedifferencebetweentariffsassetbythegovernmentthroughtheMinistry
of Industry (with its different names), and the regulated costs. Spain applies European Union
directives and therefore generation and retail are deregulated.2 But transmission and distribution,
togetherwithrenewablesandCHPsubsidies,thepaymentoftheaccumulateddebtandothercosts
ofthesystem,makeuptheregulatedcosts.
It might be largely due to the social sensitivity to tariff increases that the Spanish government set
tariffswhichdidnotcoveralltheregulatedcosts,generatingagrowingdebtwithinthesystemtoa
fewutilitiesobligedtoassumethedeficitformorethanadecade.In2009,thegovernmentcreated
FADEinordertofinanceitandalleviatethemainutilitiesfinancialsituations.InSeptember2013,the
accumulateddebtaccountedformorethanEUR36billion.GiventhataroundEUR10billionhasbeen
paidoff,theoutstandingEUR26billionroughlyequalstheelectricitybilloftheentirecountryforone
year,or3%ofSpainsannualgrossdomesticproduct(GDP).Thisamountisduetobepaidbyfuture
consumers.
Inordertoexplainhowthiscouldoccur,someanalystsquotethePVbubbleoranexcessofsubsidies
forrenewables.Asamatteroffact,photovoltaiccapacityinstalledinSpainincreasedfromhardly100
MWin2006tomorethan3GWin2008,withincomesoverEUR400/MWh.Currently,photovoltaic
capacity is over 4 GW plus more than 2 GW of thermosolar developed with subsidies around
EUR300/MWh. Nevertheless, accepting that part of the increase in the regulated costs has been
causedbyrenewablessubsidies,themajorcause,asstatedabove,isthatthesettingoftariffswould
notbreakeven.
Since2010,theSpanishgovernmenthasbroughtaseriesofambitiousreformsonitswaytoputan
endtothedeficit,includingcuttingsubsidiestorenewables,taxinggenerationactivity,creatingsome
ad hoc taxes for the different generation technologies, reducing payments for distribution and
transmission,etc.Thelastreform,announcedinJuly2013,includedoneRoyalDecreelawtoensure
urgent application of the measures, a new Electricity Act, seven Royal Decrees and five Ministerial
Regulations,whichclearlyshowstheambitionbehindthereforms.Unfortunately,evenifthedeficitis
overcome,thedebtwillremainforyears.
Infact,retailisnotcompletelyliberalized,assomecustomersareeligibletobesuppliedbytheLastResourceRetailer,who
willapplytheLastResourceTariff.
Page|25
TheUnitedStates
Page|26 CoalistheleadingsourceofelectricityintheUnitedStates.TheUnitedStateshasanestimated
27%oftheworldscoalreservesdistributedacrossmorethan30states.OnaBritishthermalunit
(Btu) basis, coal comprises 85% of Americas recoverable demonstrated fossil fuel reserves,
compared to 10% for gas and 5% for oil. The Powder River Basin alone has coal reserves
equivalent to at least eight times the energy contained in Saudi Arabias Ghawar oil field and
13timesmorethanRussiasnaturalgasUrengoyfield.
Coal is the foundation of US electricity production and its abundance, distribution, affordability
and reliability are correlated with socioeconomic growth. Throughout the last century in the
United States, GDP expanded twentyfold, the population increased by 220 million people, life
expectancyincreased26yearsandcoalprovidedmorethan50%ofthenationselectricpower.
Overthelastdecadealone,coalproducedover18800terawatthours(TWh)ofelectricitymore
thangas,nuclear,oil,wind,andsolarcombined.TheU.S.EnergyInformationAdministration(EIA)
projectsthatby2020,annualelectricpowerconsumptionwillincreaseby314TWhandcoalwill
still be the nations leading source of electricity. Such beneficial electricity is the key to more
peoplelivingbetterandlivinglonger.
Figure7NetpowergenerationntheUnitedStatesthrough2040(TWh)
2500
2000
Coal
1500
1000
500
Gas
Nuclear
Other renewables
Hydro
0
1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Source:EnergyInformationAdministration,AnnualEnergyOutlook,2013.
CoalplaysanessentialroleinmaintaininglowelectricitypricesacrosstheUnitedStates.Thefact
thatcoalprovidesstableandaffordablepowerissupportedbythefollowingmap,indicatingthat
citizens across a vast portion of the country in states heavily dependent on coal experience
averageretailelectricityrateswhicharelessthanthenationalaverageof9.8centsperkilowatt
hour(kWh).
Figure8Stateswithmorecoalbasedelectricitygenerallyhavelowerrates
Page|27
This map is without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and
boundaries,andtothenameofanyterritory,cityorarea.
Source:EnergyInformationAdministration,2013.
Figure9USelectricityfuelsources,2009to2013
45%
42%
40%
35%
30%
26%
25%
19%
20%
15%
10%
7%
5%
5%
1%
0%
Coal
Gas
Nuclear
Hydro
Renewables
Oil
Source:UnitedStatesEnergyInformationAdministration,2013.
TherearevarioustypesofpowerprovidersintheUnitedStates:
Shareholderownedelectriccompaniesprovidealmost70%ofthenationselectricity.Theysell
electricityatretailratestovariouscustomerclassesandatwholesalerates(forresale)tostate
andgovernmentownedutilities,publicutilitydistrictsandruralelectriccooperatives.
Municipallyownedelectricutilitiesareownedbythemunicipalitiesinwhichtheyoperate,and
arefinancedthroughmunicipalbonds.Thereareabout2000suchutilitiesprovidingabout11%
ofthenationspower.
IndependentPowerProducers(IPPs)sometimescalledNonUtilityGenerators(NUG)area
powerplantsnotownedbyapublicutility.Thereareover1700IPPprojectsintheUnitedStates,
Page|28 includingqualifiedfacilities(QFs).IPPshavebuiltamajorityofnewpowergenerationinthepast
decade.
Federallyowned utilities are agencies of the United States federal government involved in
generation and/or transmission of electricity, most of which is sold at wholesale prices to local
governmentowned utilities and to shareholderowned companies. They provide approximately
6%ofUSelectricity.ThesegovernmentagenciesaretheArmyCorpsofEngineersandtheBureau
of Reclamation, which generate electricity at hydroelectric projects. In addition, the Tennessee
ValleyAuthorityproducesandtransmitselectricitywithintheSoutheastregion.
ElectriccooperativeswereconstitutedviatheRuralElectrificationAdministrationin1936.They
provideabout13%ofthenationspower.Thereareupwardsof1000cooperativesintheUnited
States but most are distribution only. About 60 of them are generation and transmission
cooperativesthatprovidewholesalepowertotheirmemberdistributioncooperatives.
Industrial: There are thousands of industrial sites in the United States and. many have local
energyplantsthatproducesteamandelectricity.
The United States does not possess a national power grid, but instead has three main power
grids:
EasternInterconnection
WesternInterconnection
TexasInterconnection
Figure10NERCinterconnections
NERCregions
FRCCFloridaReliabilityCoordinatingCouncil
MROMidwestReliabilityOrganization
NPCCNortheastPowerCoordinatingCouncil
RFCReliabilityFirstCorporation
SERCSoutheasternElectricReliabilityCouncil
SPPSouthwesternPowerPool
TRETexasRegionalEntity
WEECWesternElectricityCoordinatingCouncil
Source:NorthAmericanElectricReliabilityCorporation,2013.
The Eastern and Western Interconnections have limited interconnections, and the Texas
Interconnect is only linked to the others via directcurrent lines. Both the Western and Texas
InterconnectionsarelinkedwithMexico.TheEasternandWesternInterconnectsarelinkedwith
Canada.TheNorthAmericanReliabilityCorporation(NERC)workswitheightregionalentitiesto
improvethereliabilityofthebulkpowersystem.
TheUnitedStatesimportsandexportselectricityfromandtoCanadaandMexico.In2011,theUS
net electricity imported was 37.3 million megawatthours, representing less than 2% of total
generation.CanadaisthelargestelectricitytradingpartnerwiththeUnitedStatesimportingover Page|29
51millionmegawatthoursandexportingslightlyover14millionmegawatthours.
Marketdesign
The states in America follow different regulatory models. Many states follow a costplus
regulatedmodelbutsomehavederegulated.Inregulatedstates,utilitiesareverticallyintegrated
andprepare integratedresourceplans toservetheirload.Supplyand distributionratesareset
througheconomicregulation.Inderegulatedstates,whichaccountforapproximately37%ofUS
electricity, supply rates are set by markets, generally on a meritorder principle. Distribution
services are still fully regulated and distribution rates are set through economic regulation.
Deregulated utilities do not prepare integrated resource plans; however, the states where they
arelocatedretainsomeauthoritytodirectgenerationanddemandsideresources.
UnitedStatesutilitiesareregulatedbybothfederalandstateregulatorybodies:
TheFederalEnergyRegulatoryCommission(FERC)regulateswholesaleelectricitymarkets
andinterstatetransmissionservices
State utility commissions regulate retail sales, distribution services, siting issues, and a
varietyofassociatedactivities.
During the 1990s, the United States experienced several major power outages. In an effort to
mitigatethisproblem,theFERCimplementedOrder2000,providingforthecreationofregional
wholesale markets. Regional Transmission Organisations (RTOs) and Independent System
Operators (ISOs) have organised market regions in which they operate a dayahead market
and/orrealtimeenergyandancillaryservicesmarkets.Themeritorderprincipleappliestoday
ahead markets. Independent market monitors enforce market rules and identify market power
problems.
Carbon dioxide is not priced in the United States. On 20 September 2013, the United States
Environmental Protection Agency (EPA) proposed a set of regulations under its New Source
PerformanceStandard(NSPS)thatwouldarbitrarilysetalimitonCO2emissionsfromcoalbased
electrical generation at 1100 lb/CO2 per MWh. This standard is currently not achievable with
eventhemostadvancedcoalfuelledcombustiongenerationtechnologycommerciallyavailable.
TheEPAacknowledgestheeconomicimpactoftheproposedregulation,statingthatDOE/NETL
estimatesthatusingtodayscommerciallyavailableCCStechnologywouldaddaround80%tothe
costofelectricityforanewpulverizedcoal(PC)plant.Alternativeenergysourcesarehighercost
andunabletoreplacecoalatscale.
TheEPAsproposedCO2orderappliesonlytonewunits.Withrespecttotheexistingfleet,itis
unlikelythattheEPAwouldfollowthesamepath,giventhereliabilityandcostissuesassociated
with alternative fuels. Furthermore, the EPA proposal is highly controversial, breaks new legal
ground, and is certain to be appealed if issued. On 27 March 2013, the United States Senate
unanimously passed a budget resolution amendment stipulating that any carbon emissions
standardmustbecosteffective,basedonthebestavailablescienceandbenefitlowincomeand
middleclassfamilies.
In2012,theUnitedStatesproduced915Mt,exported113Mt,andimported8Mtofcoal.Atotal
of810Mtwasdomesticallyconsumed,ofwhich92%wasusedtogenerateelectricity.
Over the past 150 years, the United States has built a vast infrastructure for extracting,
Page|30 transportingandutilisingcoalforelectricpower,asthefollowingmapindicates.
Figure11CoalfuelledelectricitygenerationsupplychainintheUnitedStates
1 200+ active coal mines

95 000 miles of Class 1
railroads
12 000 miles of
commercially navigable
waterways
1 400 coal-based
generators with 343 GW
nameplate capacity
The United States coalfuelled electricity generation supply chain is unmatched in the world.
Research at Penn State University estimated that the United States coal power supply chain
providedoverUSD1trillioningrosseconomicoutput,7%ofUSGDP,6.8millionjobs(5%+ofthe
USworkforce)andUSD362billioninannualhouseholdincome.Coalpowerplantsaresupplied
by both longterm and spot market contracts. Only a handful of power plants have dedicated
mines.Furthermore,astheheartofUScompetitiveness,coalhasalonghistoryofavailability.In
2011,forinstance,coalpowerplantsintheUnitedStateshada60%utilisationrate.
Figure12Utilisationrates
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Coal accounts for

30% of generation
capacity and
produces 42% of
Americas electricity.
Gas comprises 40%
of capacity and
produces 26% of the
nations power.
Coal makes these extensive contributions with minimal subsidies. Data from the United States
DepartmentofEnergyindicatesubsidiestosolarelectricityperMWhareUSD775.64,whilewind
subsidiesareUSD56.29.ThenuclearsubsidyisUSD3.14,hydropowerUSD0.82andtheoil,gas
andcoalsubsidyisonlyUSD0.64.
Page|31
Developmentofhardcoalandelectricityprices
From 1980, the average coal price trended downward until roughly 2005, when new United
States EPA regulations exerted upward pressure. In the past few years, increased shale gas
productionhasedtoareducedcostofgastoproduceelectricpowerbuttheissueofvolatilityof
priceremains.InJune2011thepriceofgasforpowerproductionwasUSD5.20permillioncubic
feet(mcf).ByJune2012,thepricehaddeclined38%toUSD3.20per
mcf. By June 2013, however, the price had increased by 42% to
The price of coal to
USD4.56per mcf. The following graph is proof positive that long
produce electricity was
termstablecoalpricinghasbeenamajorfactorinthestabilityofUS
un-changed from 2011
to 2012 and declined
electric power prices. This pricing has provided competitive
1% through June 2013.
advantage,enablingenergyintensivemanufacturersandindustriesto
makelongterminvestmentdecisions.
60
12
50
11
40
10
30
9
Price of coal
8
20
10
0
Price of electricity
centsUSD/kWh
USD/shortton
Figure13Annualrealpriceofcoal,priceofelectricityforallsectors
7
6
*RealUSD2005
Table5Averageretailpriceofelectricity,byendusesector(centsperkWh)
Page|32
Year
Residential
Commercial
Industrial
All Sectors
2000
8.24
7.43
4.64
6.81
2001
8.58
7.92
5.05
7.29
2002
8.44
7.89
4.88
7.2
2003
8.72
8.03
5.11
7.44
2004
8.95
8.17
5.25
7.61
2005
9.45
8.67
5.73
8.14
2006
10.4
9.46
6.16
8.9
2007
10.65
9.65
6.39
9.13
2008
11.26
10.36
6.83
9.74
2009
11.51
10.17
6.81
9.82
2010
11.54
10.19
6.77
9.83
2011
11.72
10.23
6.82
9.9
2012
11.88
10.12
6.7
9.87
The cost of energy is an increasingly important issue in the United States since, over the last
decade,energybillsforthemiddleclasshavenearlydoubledasapercentageofaftertaxincome.
During this period, the nominal price of coal to produce electric power averaged just
USD1.78permBtu,whilethepriceofnaturalgasaveragedUSD6.07permBtu.
Coalpriceswererelativelystablecomparedtothehighvolatilityofgasprices.Inmid2003,gas
toproducepowerwasUSD3.61perthousandcubicfeet;by2005ithadreachedUSD6.69and
spiked to USD 12.41 in 2008. During the decade, coal never exceeded the equivalent price of
USD2.50.
TheUnitedStateshasextensiveexperiencewiththeadverseimpactofhighandvolatilenatural
gaspricesonfamilies,businessesandinstitutions.Notonlydoesthepriceofnaturalgasincrease,
butelectricityratesriseaswell.Coalhasservedasanimportantbuffer,withaprovenabilityto
moderateelectricityratesthroughoutperiodsofvolatileandrisingnaturalgasprices.
Australia
Australias electricity supply industry is split across geographical regions due to large distances Page|33
that make full interconnection uneconomic. It is dominated by the National Electricity Market
(NEM)theworldslongestinterconnectedpowersystemontheeastcoastofAustralia.This
market covers five states which together consume nearly 90% of Australias 226 TWh annual
electricitydemand.TheremainderofdemandcomesfromWesternAustralia,whichoperatesa
separate market in the southwest of the state, and the northern territory which operates a
separatesupplysystem.
Figure14Australiaselectricitymarketstructurefor2010/11
Source:AustralianBureauofResourceandEnergyEconomics(BREE).
Morethan69%ofAustraliaselectricityissuppliedbycoal.Thisispredominantlyhard,orblack,
coal which makes up 47% of Australias electricity supply. This mix is largely determined by
geographical resource allocations. The southern states, Victoria and South Australia, have
abundantligniteresourcesandseemostoftheirgenerationcomingfromthissource.NewSouth
Wales (NSW), Queensland and Western Australia have abundant hard coal resources. Hydro
generation is sourced from the mountainous southeast of NSW as well as from Tasmania.
Although Australia has abundant gas resources, the fuel has not been developed as a power
generation source on a large scale due to the costcompetitiveness of coal in Australia and its
predominantlyremotewesternAustralianlocationuntilrecentdiscoveriesineasternAustralia.
The four largest generating companies in the NEM control 52% of the generation capacity. The
remainder of the capacity is owned by 11 market participants, with a number of smaller
companies also providing small amounts of generation capacity. The hard coal generators in
Australiaarecontrolledbyeightcompanies.Mostofthesestationsformpartoflargerportfolios,
whileonlytwoareindependentgenerators.
Figure15FuelsourcesforelectricityinAustralia,byenergysource2010/11
Note:Otherincludesoil,bioenergy,solarPVandmultifuelfiredpowerplants.
Source:BREE.
Electricity demand has been falling in the east coast NEM due to poor economic conditions for
themanufacturingsector,fuelswitching,growthofrenewables,strongenergyefficiencypolicies
and retail price increases. The Australian Energy Market Operator (AEMO) expects a return to
growth from 2013/14. However there are substantial risks to this outlook, not least of which is
thecontinuingstrengthoftheAustraliandollar.
Figure16HistoricalandforecastenergygrowthintheNEM
290
270
Annual energy (TWh)
Page|34
250
230
210
190
170
150
Actual
2012 low scenario
2012 medium scenario
2011 low scenario
2011 medium scenario
2011 high scenario
Source:AustralianEnergyMarketOperator,2012.
2012 high scenario
Although the forecast is for a return to growth in electricity demand, the current federal
governmentpolicyisfor41000GWhofsupplytocomefromrenewablesourcesby2020under
the Renewable Energy Target Scheme. This is likely to take a significant portion of the growth
from hard coal generators and militate against more substantial investment in new gas
generation.
Page|35
Marketdesign
The National Electricity Market (NEM) provides a framework for competition in the electricity
supply industry. The NEM is a gross pool, energy only market. Generators submit bids for the
dispatchoftheircapacityforeach30minutetradingperiodthroughouttheday.TheAustralian
Energy Market Operator (AEMO) stacks the bids in order of increasing price and the wholesale
poolpriceisthensetatthelevelwheredemandismet.
Generatorstypicallysubmitcostreflectivebidswithatendencytowardsshortrunmarginalcost
duringperiodswhenthereisexcessgeneratingcapacity.Atpeaktimes,poolpricesarelimitedto
AUD12900/MWh.Thishighpriceceilinghasproducedsignificantvolatilityduringhighdemand
periods,whichhassupportedreturnstogeneratorsmuchclosertoaveragecost.However,with
demandgrowthturningnegative,excesssupplyhasreducedvolatilityandreturnstogenerators
aredecreaasing.
TheNEMpoolpriceissupportedbyafinancialhedgingmarketthatprovidesderivativesviaOTC
andfuturescontracts.Alllongtermcontractsforthesupplyofelectricityatthewholesalelevel
arefinancialderivativeswiththeNEMpoolpriceastheunderlyingcommodity.
AustraliahasimplementedacarbontaxofAUD23pertonneofCO2.Thisfixedpricemechanism
will remain in place for another two years, with prices rising to 24.15 in 2013/14 and then to
AUD25.40 in 2014/15. Beyond this period the carbon pricing scheme will move to a traded
marketlinkedtotheEUETS.Significantpoliticalrisksurroundsthisscheme,asthecurrentfederal
governmenthasintroducedlegislationtoabolishthecarbonpricefrom1July2014.However,the
government is unlikely to have the required numbers in the senate to pass the legislation until
1July 2014 and has indicated that if passed after this date, the changes would apply
retrospectively.
The carbon price adds to the costs of all generators according to their emissions intensity.
Wholesale electricity prices have responded as expected by increasing broadly in line with the
averageemissionsintensityofdispatchedgeneration.Thishascausedasubstantialreductionin
revenue for hard coal generators, since the average emissions intensity is below that of most
hardcoalplant.Furthermore,lignitegeneratorswerecompensatedfortheimpositionofacarbon
pricebuthardcoalgeneratorswerenot.Thishasnotimpactedthewholesalepriceofelectricity,
buthasgivenacompetitiveboosttotheownersoflignitegenerators.
The utilisation factor of generating plant in Australia varies by ownership and plant type.
However, utilisation factors typically range between 80% and 95% for lignite generators and
between 50% and85% for hard coal generators. Gas plants operate at much lower utilisation
levelsthanthis.ThisalignswiththepositionoftheplantinthemeritorderoftheNEM,whichis
determinedbyfuelcostandcarboncost.Carboncostshavenotbeensetatahighenoughlevel
to cause meritorder switching between lignite and hard coal generators, which means that
utilisation remains broadly similar after the incorporation of the carbon tax in generator cost
structures. However, capacity at a number of highercost black coal generators has been
mothballed until wholesale demand has improved, and last year there were a small number of
closuresofrelativelyold,highcostplants.
Priortothedownturnindemand,gasandhydroplantssetthepriceduringthepeak.However,
thedemanddownturnhasresultedinanincreaseinexcesscapacity.Peakperiodpricesettingis
nowdominatedbytherelativelyhighercosthardcoalplants,withoffpeakperiodpricingcoming
fromligniteor(other)hardcoalplantwithlowercostfuelsupplies.
Page|36
Australiahasamixoffuelsupplyarrangementsforpowerstations.Anumberofhardcoalpower
stations in Queensland are supplied by captive mines. These mines supply coal to the power
stations at, or near, the production cost of fuel. The remaining hard coal power stations in
Australia are predominantly supplied by rail or by conveyor from independent coal mining
operations. This introduces competitive supply arrangements, although some have longterm
contractsinplaceouttothe2020s,andinonecase,to2032,andhavelimitedoptionstoexport
coalduetoinfrastructureorregulatoryconstraints.Sotheyconsiderthemselvestobecaptive.
HardcoalgeneratorsinNewSouthWales(NSW)andQueenslandarelocatedincloseproximity
tomainlyexportorientedminesandinfrastructure.Mostcoalthatissuppliedtodomesticpower
stations via rail is therefore exposed to an export opportunity cost. This has meant that new
domesticcoalsupplycontractsarenegotiatedaroundthenetbackexportparityprice.Asexport
prices have risen in recent years, domestic coal prices have increased accordingly. While this
dynamicaffectsmarginalcost,theaveragefuelcosttogeneratorsisoftenlowerduetolongterm
contractsthatwerenegotiatedpriortohighexportcoalprices.
CoalcostsforAustralianhardcoalplantsrangefromAUD0.75/GJtoanupperlimitequivalentto
thenetbackexportprice.ThishasbeenwelloverAUD3/GJbuthasnowretreatedbelowthese
levelsduetolowerinternationalthermalcoalprices.Marginal coalcostsforligniteplant range
fromAUD0.10/GJtoAUD0.60/GJ,withgassupplycostshistoricallynearAUD4/GJforcombined
cycleplantandAUD6/GJforpeakingplant.
Hardcoalplantsfacedpressurefromproposalsforgasfiredgenerationwiththedevelopmentof
coalseamgasinbothNewSouthWalesandQueensland,alongwiththeimpositionofacarbon
price.However,thispressureappearstohavebeenrelievedduetothedevelopmentofanLNG
export industry on the east coast of Australia. Domestic gas prices are expected to increase to
reflectnetbackexportparitypricingwhich,atcurrentLNGprices,willlikelybebetweenAUD8
10/gigajoule (GJ). This, coupled with the Renewable Energy Target requirements, (which act to
crowd out gas), will make gas plants uncompetitive in a lowgrowth environment, unless the
carbonpricerisessignificantly.Moreover,thefinanceindustryisunwillingtofinanceanewblack
coalfired generator in the absence of a longterm strategy (i.e. 30plus years) to deal with the
carbonprice.
Whilecoalpricesandwholesaleelectricitypricesincreasedsubstantiallybetween2000and2007,
wholesale electricity prices (nominal terms) in Australia decreased between 2006 and 2012,
whereascoalpricescontinuedtoincreaseduringthisperiod.
Figure17NSWelectricityprice(timeweighted,allperiods)andexportcoalprice(FOBexNewcastle)
ElectricityPrice(AUD/MWh)andCoalPrice
(AUD/GJ)
120
100
Page|37
80
60
40
20
0
ExportCoalPrice(Newcastle)
WholesaleElectricityPrice(NSW)
Source:AustralianBureauofStatistics,2013.
The primary driver behind electricity prices in the NEM is the supply/demand balance. This is
demonstratedbythepeakin2006/07andthedeclineinspotpricesfrom2009/10.The2006/07
spot price maximum was brought on by a significant drought that caused water shortages to a
number of NEM generators. The result was capacity withdrawal and an increased opportunity
cost of water. These factors, combined with high demand, resulted in a tight supply/demand
balanceandhighpricesduringallperiodsoftheyear.However,therecentdeclineindemandhas
resultedinasignificantcapacityoverhangandsupplythatfaroutweighsdemand.Thishascaused
competitionfordispatchvolume.Thissituationhas beenexacerbatedbyrenewablegeneration
whichisdispatchedaheadofgasand coalgeneration,causingtheprice tobesetloweronthe
supplycurve.
Figure18Retailelectricitypriceindex
8
7
6
5
4
3
2
1
Source:AustralianBureauofStatistics.
Jun2012
Dec2010
Jun2009
Dec2007
Dec2004
Jun2006
Jun2003
Dec2001
Jun2000
Jun1997
Dec1998
Dec1995
Jun1994
Dec1992
Dec1989
Jun1991
Jun1988
Dec1986
Jun1985
Jun1982
Dec1983
Dec1980
At the consumer level, the picture is very different. Retail electricity price have been rising in
recentyears.However,againthisisnotduetotheimpactofcoalprices.Increasedexpenditure
on transmission and distribution networks has been the primary cause of the sharp increase in
retailpricesfrom2006.
This is demonstrated in the different price components for retail customers in 2011/12 and
Page|38 2012/13 (Figure 19). The clear increase in network costs has contributed to the final price
increases.Anothercomponentthathasbeenincreasingisthegreencost,whichreflectscarbon
costs and costs due to the mandating of renewables through the Renewable Energy Target.
However,theincreaseinthiscomponenthasbeenovershadowedbythenetworkcomponent.
Figure19Retailelectricitypricecomponents
100
90
80
70
Carbon
60
OtherGreen
50
Retail
40
Network
30
Wholesale
20
10
0
07/08Residential
12/13Residential
Source:NSWIndependentPricingandRegulatoryTribunal(IPART).
Even with these increases, the retail price of electricity in Australia is well below many
comparable nations. This can largely be attributed to the relatively high level of coalfired
generation.
Figure20RetailpriceofelectricityinAustraliaincomparison
Page|39
Source:SenateSelectCommitteeonElectricityPrices,DepartmentofResources,EnergyandTourism,2012.
Japan
Page|40 Japanselectricitymarketisdividedintotenregionalareas.Atotaloftenregionalpowerutilities
monopolise generation, transmission and distribution in each area. The ten power utilities
accountfor87%ofJapanstotalelectricitysupply.
JapansenergymixinpowergenerationhassignificantlychangedinthewakeoftheFukushima
crisis.Onlytwonuclearpowerunitsoutofatotalof50arecurrentlyoperatinginJapan.Gasand
oilfired power plants are the main replacements for nuclear power. The Japanese energy mix
beforeandaftertheFukushimacrisisisshowninFigure21.
Figure21TheJapaneseenergymixinpowergeneration
100%
80%
9%
12%
9%
7%
10%
8%
60%
28%
29%
29%
40%
25%
25%
25%
26%
29%
29%
20%
Fukushima
Crisis
39%
25%
11%
0%
FY2008
10%
14%
FY2009
Nuclear
FY2010
Coal
Gas
Oil
FY2011
10%
18%
43%
28%
2%
FY2012
Renewable
Source:FederationofElectricPowerCompaniesofJapan,2013.
As an island country, the Japanese power system is independent and unconnected from its
neighbours.
The governments energy policy after the Fukushima crisis is still uncertain. However, power
consumptionisgenerallyexpectedtobeconstantortoincreasegradually.
Marketdesign
Theregulatedsectorissuppliedbytenregionalpowerutilitiesandgovernedbystateregulation.
Theelectricitypricesinsuchamarketaredeterminedonthefullcostpricingprinciple(toensure
investment return and full recovery of variable costs) and are subject to the governments
approval.
Althoughderegulationoftheretailsectorhasprogressed,andapproximately62%oftheelectric
power consumers have the choice to purchase electricity from suppliers other than the ten
regional monopolies, as little as 2% of the countrys generated power is supplied through the
deregulatedmarket.
JapanspowermarketdesignhasbeenreexaminedaftertheFukushimacrisis.Thegovernment
hasmadepolicyproposalstofullyderegulatetheretailpowermarketby2016.
In addition, there is a fuel cost adjustment system in the regulated sector. This adjustment is
based on the approved energy portfolio (nuclear, coal, gas, oil and renewable) of each power
utilityandcalculatedinproportiontotheJapanesecustomsstatistics.Regulatedpowerpricesare
adjustedbythesefuelcosts.Inthederegulatedsector,asimilarfuelcostadjustmentsystemis
often employed between the many electricity power consumers and the ten regional power
utilities
Page|41
Theelectricitypowertariffissetbasedonfullcostcalculationswithconsiderationofmeritorder.
In the deregulated power market (Japan Electric Power Exchange, JEPX), electric power is bid
freely,givingtheeffectofameritorder.
Currentlypowermarketclearingpricesaredeterminedbygasfiredpowergeneration,whichhas
higherpricesthancoalfiredandlowerpricesthan oilfiredgeneration.However,whennuclear
power generation was base load (before the Fukushima crisis), coalfired power generation
determinedelectricityclearingpricesinoffpeakdemandatnightandinspringandautumn.
Figure22Marketclearingpriceandgeneratingcostsofeachfuel
[JPY/kWh]
35
30
25
20
15
10
0
2005
2006
2007
2008
Marketclearingprices(JPEX)
2009
2010
Oil
2011
Gas
2012
Coal
Note:FuelcostcalculationCIFprices:Japanesecustomsstatistics
Thermalplantefficiency:40%Calorificvalue:coal25.7MJ,oil38.2MJ,gas54.6MJ
Sources:Japanesecustomsstatistics(CIFprices);JapanElectricPowerExchange;(marketclearingprice)(JPEX),2013.
Carbondioxidecostshavebeenaddedontotheelectricitypricesasanenvironmentaltaxsince
October2012.Japandoesnothaveacapandtradesystem.Eachfossilfuelwastaxedatitsown
rateasenergytaxuntil2012.Noweachfossilfuelhasanaddedon289JPY/t(CO2)tax.Eachfuel
taxisshowninthetablebelow.
Table6Taxoneachfossilfuel
Energy tax
Page|42
CO2 tax
Total
Coal
700 [JPY/t-coal]
670 [JPY/t-coal]
1 370 [JPY/t-coal]
Gas
1 080 [JPY/t-gas]
780 [JPY/t-gas]
1 860 [JPY/t-gas]
Oil
2 040 [JPY/kl-oil]
760 [JPY/kl-oil]
2 800 [JPY/kl-oil]
Source:MinistryofFinance,Japan,2011.
Intheregulatedmarket,thepriceissetbasedonaweightedaveragecostofvariousgenerations.
Itappearsthat70%,actualvaluein2011,ofcoalfiredpowerplantsyearlyoutputcontributesto
theelectricitypricesetting.Inthederegulatedmarket,coalfiredpowerplantsdonothavedirect
influenceonpowerpricing.
Japanesecoalimportsfromoverseasaccountedfor99.4%ofcoalsuppliesin2011.Importsfrom
Australia,IndonesiaandRussiaaccountedfor96%ofhardcoalimports.
Coalfiredpowerplantspaymarketpricestosuppliers.MosthardcoalusedinJapanisimported.
Coalfired power generators pay both free on board (FOB) and freight for imported coal. Most
coalimportsareonlongtermcontracts.Someareonafloatingpricinglinkedtoindexessuchas
globalcoal.
ThemarginalcostofcoalfiredpowerplantsislessthangasfiredplantsinJapan;thereforecoal
firedpowerplantshavehigherutilisationratios.
Carbondioxidecostsofcoalfiredgenerationwerehigherthangasfiredplantsin2010andwillbe
higher in 2030, according to national policy. However, the total electricity costs of coalfired
plantswillstillbelessthangasfiredplantsin2030.
Figure23Electricitygenerationfullcostsofcoalfiredandgasfiredin2010and2030
[JPY/kWh]
12
10
[10.90]
[10.70]
[10.30]
[9.50]
8
6
4
2
0
2010
2030
2010
Coalfired
othercosts
2030
Gasfired
fuelcosts
CO2costs
Note:Powerplantsareassumedtobemostmodern.CO2 costsarecalculatedasmodellingcostsin2011byusingactualpricesand
estimates in the typical European markets of CO2. These costs were calculated before Japans introduction of the current CO2 tax.
ThereforethecurrentCO2taxisnotincludedinthemodellingsots.FuelcostsarebasedonIEAestimates.
Source:NationalPolicyUnit,Japan,2011.
Since2000,electricitypriceshadbeenonadownwardtrend(untiltheFukushimacrisis)because
thederegulationoftheretailsectorhadprogressedsince2000andtheratiooffixedcostshad
been reduced. During times of soaring fuel prices, such as in 2008, electricity prices rose
temporarily. After the Fukushima crisis, electricity prices increased because the energy mix Page|43
changedsignificantlyandmoreelectricitywascomingfromhighercostgeneratingplants.
Figure24CIF*pricesoffossilfuelandelectricitypricesinJapan
Electricityprices
[JPY/kWh]
CIFfuelprices
[JPY/1000kcal]
25
10
20
15
10
0
2000
0
2003
Electricityprices
2006
Oil
2009
Gas
Coal
*CIF:cost,insuranceandfreight
Source:TheInstituteofEnergyEconomicsJapan.2013.
In the regulated market there is a degree of correlation between coal and electricity prices
becauseelectricitypricesarebasedonthefullcostpricingprincipleandthefuelcostadjustment
system.Thiscorrelationisinterpretedascausation.
Inthederegulatedmarket,thereisnostrongcorrelationbetweencoalandelectricityprices.This
isbecausegasfiredpowerplantsdeterminetheelectricitymarketclearingpriceinthewholesale
market.
Figure25Generatingelectricityfuelcostsoftenpowerutilities
200
Page|44
150
100
valuein1980 =100
50
1980
1984
Water
1988
Bus
1992
1996
Letters
Railway
2000
2004
Gas
2008
Electricity
2012
Telephone
Source:MinistryofEconomy,TradeandIndustry,Japan,2012.
Since 2000, the consumer price index in the electricity sector had been on a downward trend
(untiltheFukushimacrisis).Thereisnodifferentiationbetweencustomergroups.
Figure26Consumerpricesofregulatedpublicutilities
[JPY/kWh]
20
[16.66]
[15.21]
[16.38]
15
fuelcost
othercost
10
0
2000
2006
2008
Note:basedon10powerutilities'regulatoryfilings.
Source:StatisticsBureau,MinistryofInternalAffairsandCommunications,Japan,2013.
China
InMarch2002,ChinasStateCouncilofficiallyapprovedthePlanforElectricityIndustryReform, Page|45
whichledto theestablishmentofelevenlargecorporations,includingtwogridcompanies,five
power producers and four auxiliary companies. All the power generation assets of the former
StateElectricPowerCompanywererestructuredandreorganisedtobedividedintofivenational
independentpowerproducers(IPPs)withequallysizeablecapacities,i.e.ChinaHuanengGroup,
China Datang Corporation, China Huadian Corporation, China Guodian (Group) Corporation and
ChinaPowerInvestmentCorporation.ThegridsegmentoftheStateElectricPowerCompanywas
divided into the State Grid Corporation of China (SGCC) and China Southern Power Grid. State
Grid manages five regional grid companies covering Chinas north, northeast, east, central and
northwestern areas. Besides the big five, which together hold round about 50% of overall
generationcapacity,thereareanumberofsmallerregionalgeneratingutilities,pluslocalstate
ownedgenerators.
InSeptember2011thefourauxiliarycompanieswentthroughfurtherreorganisationtobecome
two power construction conglomerates; The Power Construction Corporation of China was
incorporatedbasedonSinohydroandHydrochina,whiletheChinaEnergyEngineeringGroupwas
established with the combined assets of the China Gezhouba Group Corporation and the China
PowerEngineeringConsultingGroupCorporation.
Chinaconsumed2.5trillionkWhofpowerduringthefirsthalfof2013,upby5.1%onayearon
year basis. The growth rate, however, declined slightly by 0.4%. In particular, electricity
consumptionofthesecondaryindustryroseby4.9%yearonyear.Industrialandmanufacturing
consumption both grew by 4.8%. Electricity consumption of the tertiary industry grew by 9.3%
yearonyear,indicatingastillbriskpowerdemandinthemarket.Arisingtertiaryindustryisalso
settobolstergrowthofboththeeconomyandpowerconsumptioninChina.Inthefirsthalfof
2013,urbanhouseholdconsumptionroseby3.9%yearonyear,arelativelyslowgrowthseenin
recentyears(Figure27).
Figure27ElectricityconsumptiongrowthinvariouspartsofChinainthefirsthalfof2013
Source:IEA,2013.
In the first half of 2013, electricity consumption in east, central, west and northeast of China
increased by 4.0%, 3.2%, 9.3% and 4.0%, respectively. Power demand is expected to increase
during this decade. According to the International Monetary Fund (IMF), China is expected to
grow at 8.4% per year between 2013 and 2018. Even though Chinas economic structure is
expected to change towards a less industrial and more serviceoriented economy, economic
growthandpowerdemandarelinked.Therefore,powerdemandwillincreasesubstantiallyuntil
Page|46
2020.
According to the National Bureau of Statistics of China, by the end of June 2013, output from
large power plants amounted to 2.43 trillion kWh, up by 4.4% yearonyear. The average
utilisationtimeofgenerationunitsreached2173hoursforthefirstsixmonthsof2013,downby
64hoursyearonyear.Inparticular,generationfromcoalfiredunitsincreasedby2.6%yearon
year,with2412utilisationhoursduringthefirstsixmonthsof2013.Therefore,coalcurrentlyhas
a share of more than 80% of total generation in China. Even though China aims at diversifying
primary energy sources in power production, coal generation is expected to further increase
duringthisdecade.
Marketdesign
In the Chinese electricity value chain, limited competition has only been established in power
generation, whereas transmission, distribution, and retail are strictly regulated by the
government. Endusers buy electricity from one of the two stateowned grid companies, which
each hold a regional monopoly over both transmission and distribution. The retail tariff is
regulatedbythestategovernment.Thesettingofthepriceisnottrivial,as,ontheonehand,it
hastobesufficientlyhighinordertoencourageinvestmentinthedifferentvaluestagessuchas
power plants or the grid, while on the other hand, setting a too high tariff would lack public
acceptance and could foster inflation. This is one reason why electricity prices for private
householdsareextremelysubsidised.Tariffsforindustrialconsumersarehigherthanforprivate
households.
The grid companies buy electricity from the generators. The price at which generators sell
electricityisalsostrictlyregulated.Thesocalledongridelectricitytariffhastraditionallybeen
oneofthemostsensitivedriversforpowerproducers,gridcompanies,endusersandinvestors.
Powergeneratorsatleasthavetoearntheirvariablecostsinordertomakethemproduce.Inthe
long run, their investment has to amortise. Therefore, a too low ongrid electricity tariff might
hamperinvestmentinnewcapacities.
Thereisnotonesingleongridelectricitytariffwhichisvalidforallpowerproducersallacrossthe
country. The tariff is differentiated by generation technology; wind generation and nuclear
generation, for example, receive a higher tariff than coalfired power plants. Additionally, the
different ongrid electricity tariffs vary among regions and provinces. Tariffs in East and South
Chinaaretraditionallyhigherthaninthecentralorwesternprovinces.Onereasonforthatisthe
highersocialandeconomicprogressofthecoastalandsouthernregions.Anotherreasonatleast
forcoalpowerplantsmightbe the higherfuel costswhichpowerplantoperatorsinSouthand
EastChinahavetobearcomparedtothoseplantsoperatinginthecoalrichnorth.
Besides pricing formation in the Chinese electricity market, the dispatch of generating units is
another important issue: as discussed for the case of Europe, the meritorder principle
determines the dispatch. Conversely, in China, the electricity dispatch is traditionally based on
local governments annual plans, which assign a certain number of generating hours to each
plant.Intimesoflowerthanforeseendemand,allthermalpowerplants,regardlessoftheirfuel
efficiencyorcosts,areadvisedtoreducegeneration.Sincethisdispatchmechanismusuallydoes
notyieldanefficientplantdispatch,in2008infiveprovinces,theChinesegovernmentissuedtrial
rules to establish a more efficient dispatch mechanism. Although this dispatch mechanism
achievedsubstantialenergyandthereforecostsavings,itisseenascriticaltoimplementitona
nationwidelevel:powerplants,whichunderthenewdispatchsystemwerelessusedthanbefore,de
factosufferedfromdecliningearnings,suchthattheirassetvaluedecreased(IEA,2012a).
Page|47
Fuelsupply
Withitsabundantcoalreserves,Chinaisbyfartheworldslargestcoalproducer,withanannual
production of more than 3500Mt in 2012. Chinese coal consumption is even higher, making
China a net importer of coal. In 2012, imports amounted to more than 300Mt. About half of
Chinesecoalconsumptioncomesfromthepowersector.
However,coalsupplyandconsumptionarenotdistributedevenlyacrossChina.Themajorpartof
Chinese coal consumption and also coal power generation is located in South and East China,
whereasmostoftheproductioncomesfromthenorthernandwesternprovinces.Therefore,coal
transportationplaysanimportantrole.Mostofthecoaltransportiscarriedoutbyrail.However,
coaltransportbyshipfromnorthtosouthalongtheChinesecoastisbecomingmoreandmore
relevantandmadeuproughly600Mtin2012(Figure28).
Figure28CoalexportingandimportingregionsinChina,2010
Russia
Russia
Kazakhstan
Mongolia
Kirg.
Beijing
Taj.
Tianjin
Pakistan
North
Korea
Rep. of
Korea
Japan
Shanghai
Nepal
Bhu.
Bang.
Exporting regions
Over 100 Mt
10-100 Mt
Less than 10 Mt
India
India
Importing regions
Myanmar
Lao
PDR
Thailand
Hainan
Vietnam
Over 200 Mt
100-200 Mt
10-100 Mt
Less than 10 Mt
This map is without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.
Source:IEA,2012.
Dependingonthelocationofacoalpoweredplant,thefuelsupplyandthereforethefuelcosts
can vary strongly among different provinces in China. In the coalrich northern regions, many
coalpowered plants are supplied mine mouth (i.e. the coal is mined in close proximity to the
plant). Others purchase coal from regional domestic markets at rather lower coal prices. In the
coastal and southern regions, fuel supply, and therefore fuel prices, are more often related to
internationalmarkets.Arbitragebetweenimportedcoalanddomesticcoaltransportedthrough
thecountrycanoftenbeobserved.
Developmentsincoalandelectricityprices
Page|48 Coal and electricity prices in China are basically disconnected from each other due to the
differentpricingmechanismsmentionedbefore.Whereascoalmarketsareliberalisedandprices
aremainlydrivenbysupplyanddemandfundamentals,electricitytariffsarestrictlyregulatedby
the government. Operators of coalfired power plants therefore face the problem that,
particularlyintimesofhighcoalprices,theirfuelcostswillnotnecessarilyberecovered.
ThedomesticChinesecoalmarketwaswidelyliberalisedin2012whentheNationalDevelopment
and Reform Commission (NDRC) announced that it would stop setting prices for coal contracts
betweenpowerplantsandcoalmines.Before,theNDRCsetcoalpricesincontractsbelowspot
prices to keep the margins of coal power plants and to reduce pressure on power prices. As a
consequence,intimesofhighspotmarketprices,coalminesusuallystoppedsellingcoalatthe
lowercontractprices.Thus,powergeneratorshadtopurchasecoalonthespotmarkets.
Buyingcoalonspotmarkets,wherepricesaredrivenby(alsointernational)supplyanddemand,
and selling power at regulated prices, have two economic implications. In the short run, plant
operators have no incentive to purchase coal and run the plant if costs for coal exceed the
revenuesfromelectricitysales.Inparticular,duringtimesofhighcoalprices,asseenin2011,this
creates the risk of severe power supply disruptions. In the long run, private investors into new
generating capacity need market conditions which allow a reasonable return on investment. If
coalpricesaretoohighcomparedtoelectricityongridtariffs,thereturnoninvestmentmightbe
toolowformanyinvestors,suchthatacapacityshortagemightoccurinthefuture.
To cope with these problems, the NDRC has installed mechanisms to adapt power tariffs to
changingfuelcosts.CurrentregulationwhichwasintroducedinDecember2012buthassofar
not been applied once contains a cost passthrough mechanism: the ongrid tariff for coal
generatorsistobeadaptediffuelcostschangebymorethan5%peryearand90%ofthefuel
cost changes will be passed through on the ongrid tariffs, leaving the remainder 10% for the
plantoperators.Althoughthismighteasesomeproblemsforthepowergeneratorsinthefuture,
ithastobenotedthatsimilarmechanismshaveexisted,buthavenotbeenappliedonce.Evenif
thiscostpassthroughmechanismwereapplied,itwouldbasicallybearedistributionofthecoal
price risk from the generators to the grid companies: the grid companies would have to pay
higherongridtariffsifthecoalpricerises,butwouldnotbeabletopassthroughthesecoststo
the customer, since retail prices continue to be regulated by the state. Establishing electricity
pricingwhichleadstoreasonablelowpricesbutisprofitableforbothpowerplantsoperatorsand
gridcompaniesthereforeremainsacorechallengeoftheChineseelectricitymarket.
SouthAfrica
Structureoftheelectricitymarketandenergymixinpower
generation
Eskom is South Africas 100% stateowned, verticallyintegrated electricity utility. It supplies
approximately 95% of South Africas electricity from a net maximum generating capacity of
41.9GWandatransmissionanddistributionnetworkof373280kilometres(km)(Eskom,2013).
The remaining 5% of electricity supply is made up by a small group of municipal and industrial
representatives, predominantly for their own use. In 2012,approximately 42% of Eskomssales
were to (re)distributors in the form of the municipalities which also fund and maintain
distributionnetworksintheirrespectivegeographicalareas.Municipalcustomersinturninclude
industrial, commercial and residential users. A graphic depicting Eskoms sales mix for the
financialyearended31March2013isincludedbelow.
Figure29Eskomselectricitysalesbycustomer,2012
Note:Yearend,March2013
Source:Eskom,2013.
From the graphic above, it can be seen that Eskom also supplies electricity to neighbouring
countries in Africa through its membership in the Southern African Power Pool (SAPP). This is
discussedlater.
ThelargestproportionofEskomsbaseloadcomesfromcoalfiredpowerstations.Eskomhasa
netmaximumgeneratingcapacityofapproximately41900MW,comprisedasfollows:
Table7Eskomsgenerationcapacitybyfueltypeasat31March2013
Coal-fired stations
35650 MW
85.1%
Nuclear energy
1830 MW
4.4%
Hydropower (including pumped storage)
2000 MW
4.8%
Gas
2409 MW
5.8%
Wind
Source:Eskom,2013.
3 MW
---
Page|49
From the 1970s, Eskom embarked on a strategy to leverage economies of scale through the
construction of large, sixpack power stations, each with a capacity of 3600 MW or larger.
These power stations were built adjacent to the coalfields in order to minimise coal transport
costs.ManyoftheadjacentcoalminessupplycoaltoEskombyconveyoronalongterm,cost
plus basis. This fleet of power stations is aging and many of the power stations are nearing
retirementage.
Page|50
A period of very low economic growth (and thus power demand) at the end of the 1980s and
early 1990s resulted in a delay in the introduction of new electricity supply capacity. This was
followedbyamorerecent,higheconomicgrowthinthelate1990sandearly2000s.Thelackof
investment in new supply capacity over this time has narrowed the electricity supply reserve
margin.
Additional coal supplies will be required for power stations running at higher load factors or
longer lifetimes beyond what was originally planned for. In addition, Eskom has two new large
coalfired power stations under construction (approximately 4800MW each) due to be
commissionedbetween2013and2019.Thefigurebelowshowstheprojectedcoalrequirements
forEskomto2030.
Figure30Projectedcoaldemand
Source:Eskom,2012.
With existing mines being depleted, approximately 60 million additional tonnes are required in
thenextfivethesevenyears.
In 2003, the South African Cabinet made a policy decision to introduce independent power
producers into the electricity supply industry, such that future electricity generation capacity
would be divided between Eskom (70%) and the IPPs (30%). In 2007, the Cabinet designated
EskomasthesinglebuyerofpowerfromtheIPPsinSouthAfrica.
In 2011, the Department of Energy published the current iteration of the Integrated Resource
Plan(IRP)forSouthAfrica(IRP2010).Thisplanspecifiesthenewgenerationcapacityrequirement
forSouthAfricafortheperiod2010to2030.TheIRPisexpectedtobeupdatedonaregularbasis.
ThefigurebelowshowstheIRP2010sproposednewbuildto2030.
Theneed toacceleratedevelopmentinAfricaiswidelyrecognisedandaccesstoclean,reliable
energy is vital to that task. Excluding South Africa and Egypt, it is estimated that no more than Page|51
20%. and in some countries, as little as 5% of the population has direct access to electricity
(Eskom2010).Todealwiththechallengeoffinancingnewgenerationcapacity,somecountries
have sought to increase the level of generating capacity to work towards the integration of
nationalpowergridsandtocreatecrossborderpowerpools.
TheSouthernAfricanPowerPool(SAPP)isthefirstformalinternationalpowerpoolinAfrica.It
wascreated withtheprimaryaimofprovidingreliableandeconomicalelectricitysupply tothe
consumers of each of the SAPP members, consistent with the reasonable utilisation of natural
resources and the effect on the environment. The current countries/utilities that are SAPP
members include Mozambique (Electricidade de Moambique, HCB, Motraco), Botswana
(Botswana Power Cooperation), Malawi (Electricity Supply Commission of Malawi), Angola
(Empresa National de Electricidade), South Africa (Eskom); Lesotho (Lesotho Electricity
Corporation); Namibia (Nam Power), Democratic Republic of the Congo (Socit National
dlectricit), Swaziland (Swaziland Electricity Board), Tanzania (Tanzania Electric Supply
Company), Zambia (Zambia Electricity Supply Corporation) and Zimbabwe (Zimbabwe Electricity
SupplyAuthority).
SAPP has made it possible for members to delay capital expenditure on new plants due to the
existence of interconnections and a power pool in the region. This is an important aspect in
developingtheeconomiesofsouthernAfrica.
WhileEskom(andhenceSouthAfrica)iscurrentlyanetexporterofelectricity,netinternational
sales(saleslesspurchases)representedonly2.8%ofEskomstotalsalesin2013.Themajorityof
the imports are from Cahora Bassa (HCB) in central Mozambique, with small volumes from
Lesotho. Eskom exports firm power to the national utilities of Botswana (BPC), Namibia
(NamPower),Swaziland(SEC)andLesotho(LEC).
Marketdesign
Historically, the National Electricity Regulator (NER) was the regulatory authority that presided
overtheelectricitysupplyindustry(ESI)inSouthAfrica.TheNationalEnergyRegulatorofSouth
Africa(Nersa)replacedtheNERintermsoftheNationalEnergyRegulatoryAct40of2004.Under
theElectricityRegulationAct4of2006,itisrequiredtoissuelicencestoallplayersinvolvedinthe
production and supply of electricity and to regulate prices and tariffs that are supplied by
electricitylicensees.
Formuchofthepastthreedecades,electricitypricesinSouthAfricahavebeenlowanddeclining
inrealterms,ascanbeseeninthefigurebelow,whereelectricitypriceincreasesdidnotkeepup
with inflation. However, from 2008 the trend in prices took a dramatic turn. This increase in
electricitypricesistheoutcomeofapolicytochargecostreflectivetariffs.
Figure31ComparisonofincreaseinelectricitypricesandConsumerPriceIndexinflation(1980to2011)
Page|52
Source:Eskom,2012.
The movetowardscostreflectivepricesin the electricitysectorstartedwithEskomsfirstprice

applicationtoNersa,includingthefollowingcomponents:
primaryenergy,includingcostsrelatingtoIPPs;
operatingcosts,includingintegrateddemandmanagementprogrammes;
depreciation,basedonEskomsrecentlyvaluedreplacementassetbase;and
returnonassets.
In regulatory terms, a price that fully addresses all of the above components would be cost
reflective.DemonstratingthatEskomisonasoundfinancialfootingisanecessaryprecondition
toraisingtheinvestmentrequiredtofundthebuildingofnewelectricalsupplycapacityprojects.
Between 2008 and 2011, real electricity prices rose by 78%. However, despite the significant
increases,electricitypricesinSouthAfricaarestilllowbyinternationalstandardsanddonotyet
reflectthefulleconomiccostofsupplyingpower(Deloitte,2012).
Eskomcontinuestoapplyformultiyearpricedeterminations(MYPD)fromNersa.Afterextensive
stakeholder engagement, Nersa then makes a decision on what revenue will be permitted per
year for the period requested. As a result of Nersas previous two multiyear price
determinations,electricityrevenueshaveexceededoperatingcosts.
Effectively,adeterminationismadeontheaveragepriceincrease,whichisthentranslatedintoa
rangeoftariffswhicharedifferentiatedaccordingtocustomerclass.Itisimportanttonotethat
individualcustomersmaynotexperiencethisaveragepriceincrease;somecustomersexperience
higher increases and other customers experience lower increases (including subsidies, where
governmenthasidentifiedasocialimperative).Redistributorsalsoincorporatetheirownnetwork
costsandrevenuerequirementstodecideontheirfinalelectricityprices.
Figure32Eskomselectricityrevenuesandoperatingcosts
0.50
0.45
0.40
c/kWh
0.35
Page|53
0.30
0.25
0.20
0.15
0.10
0.05
0.00
2009
2010
Operating costs
2011
2012
Revenues
NERSA
Target 2012
Notes:Excludingdepreciation,inc/kWh.
Source:Eskom,2012.
Since Eskom has a monopoly on electricity production in South Africa, the average electricity
priceisdeterminedbyNersathroughtheprocessoutlinedabove.Ontheproductionside,Eskom
does minimise costs through dispatching plant according to lowest variable costs, a significant
portionofwhichisattributabletofuelinputs.Currently,thelowelectricitysupplyreservemargin
necessitates that all plant run whenever possible and costorder dispatch is not currently
possible.Thissituationisexpectedtopersistuntilsufficientnewcapacityisbroughtonline.
Although there is currently no explicit carbon price in South Africa, carbon constraints were
factored into the most recently promulgated national electricity supply plan (IRP2010) and the
electricitypricealsocarriesanenvironmentallevyofZAR3.5c/kWh.Moreexplicitcarbonpricing
hasbeenproposedintheformofacarbontax.Todate,theinformationprovidedconcerningthe
proposedcarbontax(NationalTreasury,2013)isthat:
acarbontaxwillbeimplementedinJanuary2015;
thefirstphaseofimplementationwillbe2015to2020;
thebasictaxfreethresholdonemissionsremainsat60%duringthisfirstphase;
the60%maybereducedorremovedinthesecondphase;
certain industries may be allowed to increase this threshold by up to 10% for trade
exposure and 10% for process emissions, plus 5% to 10% for offsets (but how these
offsetswillbeassessedisstilltobedefined);
thetaxvalueissetatZAR120pertonofCO2eandwillincreaseby10%annuallyduring
thefirstphase;and
Scope2(includingelectricity)emissionswillbetaxed.
Considering the regulatory rules governing tariff increases in the electricity sector, any
environmentaltaxislikelytobepassedthroughtoconsumers.
TheDepartmentofEnvironmentalAffairsiscurrentlydevelopingacarbonbudgetforthecountry,
in accordance with the National Climate Change Response Strategy White Paper (South Africa
Department of Environmental Affairs,2011) and this would be expressed as desired emissions
reduction outcomes per economic sector. The interface between sectoral carbon budgets and
theproposedcarbontaxisalsobeingassessed.
Due to the low reserve margin, the coalfired power stations are fully utilised with an energy
availabilityfactorof81.2%(Eskom,2012b).Theenergyavailabilityfactorhasdeclinedfrom85.3%
(March2009)astheunplannedcapabilitylossfactorhasincreasedduetotheageingfleet.
Page|54
South African coalfired power stations are supplied exclusively by the domestic market, either
throughdedicated,costplusmines,orwiththemiddlingsproductfrommultiproductminesor
throughshortandmediumtermcontracts.Thereisanindirectconnectiontotheworldmarket
through the beneficiation choices of multiproduct mines, as well as the future investment
choices of mining houses. The impact of global coal market prices on short and mediumterm
domestic contract prices has been partially limited by the constrained infrastructure to export
coalfrominlandreserves.
Nationaldomesticcoalpricesare,onaverage,wellbelowinternationalprices.Giventhevolatility
ofcoalprices,therelationbetweendomesticandinternationalpriceshasvariedgreatlythrough
theyears.Since2008,whenexportcoalpricesattheport(RichardsBayCoalTerminal)wereon
averagealmostfivetimeshigherthanthedomesticpricesatminegate,theratiohasbeencloser
to three to one more recently. However, these prices are not directly comparable, given the
differences in qualities (yield factors and beneficiation costs) and location (transport, handling
costsandterminalcharges).
South Africa only has 2409MW of opencycle gas turbine electricity generation installed
capacity,about5%ofthetotal.Duetothelackoflocalavailabilityofnaturalorliquefiednatural
gas, these stations are run on liquid fuels. They are only dispatched during peak periods and
duringextremeemergenciesduetotheveryhighoperating(fuel)costs.
Thecostofcoalin2012constitutedaround27%ofEskomstotaloperatingcosts(calculatedfrom
Eskom,2013).TheNersadeterminationallowsEskomanaveragenominalcoalpriceincreaseof
approximately8%perannumbetween2014and2018.MeetingtheNersarulingisofconcernto
Eskom as the unit cost of coal burnt increased by approximately 14% (adjusted for contractual
penalties)betweenthefinancialyearsendingMarch2012andMarch2013.Priceincreasesreflect
bothchangesincoalsourcesandtheeffectoflongertransportdistances.
However, there is not necessarily a direct correlation between coal and electricity prices.
Electricity prices are regulated and in addition to primary energy costs, there are other cost
componentswhichvary.Basedoncertainassumptionsonthevalueofassets,undertheIRP2010,
itwasprojectedthatthecostofelectricityshouldrisetoapproximately78c/kWh(2010ZAR)in
order to reflect the full economic cost of electricity supply from the existing fleet (Republic of
South Africa, Government, 2011). This compares with an average electricity selling price of
aroundZAR45c/kWhin2010(Eskom,2012b).Thecurrentdiscrepancyinpricesreflectsasmaller
depreciationallowanceoralowerallowedrateofreturn,whichNersahasdeterminedinorderto
minimise potential negative effects of electricity tariff increases on the economy and to South
Africansociety.
Howhaveconsumerpricesforelectricitydevelopedsince2000,
differentiatedaccordingtoimportantcustomergroups?
In South Africa, different customers pay different prices for electricity. Domestic and street
lighting, for example, almost doubles industrial prices. If we compare the evolution of the
different consumer groups in the decade starting from 2001, prices in nominal terms have
doubledonaverage,butwithdifferentprofiles.Domesticandstreetlightingonlyincreased45%,
partiallyoffsettinghigherincreasesinmostoftheothergroups.
Conclusion
Global electricity markets are in transition. Major drivers across all continents are the ongoing Page|55
liberalisationmovementinordertoimplementcompetitivenessandcostefficiency,theextension
of renewable energy sources in order to increase sustainability and the need to guarantee
sufficient available generation capacities in all markets to implement and maintain security of
supply.Althoughshorttermchallengesandpoliticalmeasuresvaryacrossthedifferentelectricity
marketsintheworld,thesegeneraltargetsareinternationallyvalid.Thisisillustratedwithinfive
electricitymarketstudiesfromEurope,theUnitedStates,Australia,JapanandSouthAfrica.
It becomes obvious that the current and future market role of electricity generation from coal
supplyisimpactedbythisdevelopmentintwodimensions:
the gradual opening of electricity markets, new suppliers and expanding renewables
increasethecompetitiononcoalgeneration;and
in parallel, the typical market position of coalfired generation capacities as a result of

their permanent availability and high flexibility further increases the influence of coal
firedgenerationcostonelectricityprices.
Thecompetitivepositionofcoalfiredpowerplantsandtheirtechnicalflexibilityareusedbythe
marketstocompensateforshorttermchangesinpowerdemand,i.e.intimesofrisingelectricity
consumptionadditionalcoalplantsarerequestedbythemarkettoberampedupandintimesof
declining consumption some coal capacities are temporarily to be disconnected from the grid.
Therefore the dispatch behavior of coalfired plants is transferred into power prices on the
wholesalemarkets.Inordertoincentivisesomeplantstoconnectanddisconnectfromthegrid,
electricity prices still need to follow their specific generation cost. As a consequence the price
impactofthegenerationcostofcoalfiredplantsissignificantlyhigherthantheirmarketshare.In
some European markets it could be observed that the price impact of coal further increased,
althoughthemarketsharewaspartlysubstitutedbyrenewables.
Globally coalfired power generation covered more than 40% of global electricity demand in
2012.Accordingtotheanalysedmarketimpactofcoalfiredgenerationcapacitiestheinfluence
ofcoalgenerationcostontheworldelectricitypricesisevenhigherthantheworldmarketshare.
Based on the current outlook for the world energy markets, a remaining cost pass through of
morethan50%islikelyinthetimeframe2013to2020.
Hence,temporaryscarcitiesinthecoalsupplychainandadjacentpriceshocksforcoalaretobe
avoidedtokeepwholesaleelectricitypricesonastablelevel.
Listofacronymsandabbreviations
ABS
AEMO
ARA
Page|56 BTU
CCGT
CCS
CEER
CHP
CIF
CO2
EEX
EIA
EPA
EPEX
ETS
EU
FADE
FERC
FOB
GDP
GJ
GW
IMF
IPP
IPART
ISO
JEPX
km
kWh
mt
MYPD
NDRC
NEM
NERC
Nersa
NSPS
NSW
NUG
OTC
PC
PV
QF
RTO
SAPP
SGCC
TWh
ZAR
AustralianBureauofStatistics
AustralianEnergyMarketOperator
Amsterdam,RotterdamandAntwerp
Britishthermalunit
combinedcyclegasturbine
carboncaptureandstorage
EuropeanAgencyfortheCooperationofEnergyRegulators
combinedheatandpower
cost,insuranceandfreight
carbondioxide
EuropeanEnergyExchange
U.S.EnergyIntelligenceAdministration
U.S.EnvironmentalProtectionAgency
EuropeanPowerExchange
emissiontradingsystem
EuropeanUnion
FondodeAmortizacindelaDeudaElctricaorFundtoPayofftheElectricity
Debt
U.S.FederalEnergyRegulatoryCommission
freeonboard
grossdomesticproduction
gigajoule
gigawatt
InternationalMonetaryFund
independentpowerproducer
NSWIndependentPricingandRegulatoryTribunal
independentsystemoperator
JapanElectricPowerExchange
kilometre
kilowatthour
millionton
multiyearpricedetermination
ChinaNationalDevelopmentandReformCommission
nationalelectricitymarket
NorthAmericanReliabilityCorporation
NationalEnergyRegulatorofSouthAfrica
newsourceperformancestandard
NewSouthWales
nonutilitygenerator
overthecounter
pulverisedcoal
photovoltaic
qualifiedfacility
regionaltransmissionorganisation
SouthernAfricanPowerPool
StateGridCorporationofChina
terawatthour
SouthAfricanrand
References
References
BP(2013),BPStatisticalReviewofWorldEnergy2013:www.bp.com.
BureauofResourcesandEnergyEconomics(2013),www.bree.gov.au.
AustralianEnergyMarketOperator(2013),www.aemo.com.au.
AustralianGovernment,DepartmentofResources,EnergyandTourism(2012),www.ret.gov.au.
SouthAfricaDepartmentofEnergy(2013),www.energy.gov.za.
EnergyInformationAdministration(2013),AnnualEnergyOutlook.
U.S.EnergyInformationAdministration(2013):www.eia.gov.
InternationalEnergyAgency(2012),MediumTermCoalMarketReport2012,IEA/OECD,Paris.
InternationalEnergyAgency(2012),PolicyOptionsforLowCarbonPowerGenerationinChina:
www.iea.org.
NorthAmericanElectricReliabilityCorporation,2013,
www.nerc.com/AboutNERC/keyplayers/Pages/RegionalEntities.aspx.
WeltenergieratDeutschland(2013),EnergyforGermany2013,www.worldenergy.org.
TheFederationofElectricPowerCompaniesofJapan(2013),www.fepc.or.jp/english.
TheInstituteofEnergyEconomics,Japan(2013),http://eneken.ieej.jp/en.
Thisdocumentandanymapincludedhereinarewithoutprejudicetothestatusofor
sovereigntyoveranyterritory,tothedelimitationofinternationalfrontiersandboundaries
andtothenameofanyterritory,cityorarea.
IEAPublications
9,ruedelaFdration,75739Pariscedex15
PrintedinFrancebyIEA,March2014
Page|57
LBNL-5580E
Addressing Energy Demand

through Demand Response:
International Experiences and
Practices
Bo Shen, Girish Ghatikar, Chun Chun Ni, and
Junqiao Dudley
Environmental Energy Technologies Division
Lawrence Berkeley National Laboratory
Phil Martin and Greg Wikler
ENERNOC, INC.
Reprint version of the report prepared for AZURE

INTERNATIONAL , December 1, 2011 .
June 2012
This work was supported by AZURE INTERNATIONAL, CESP and Energy Foundation
through the U.S. Department of Energy under Contract No. DE-AC02-05CH11231.
1. INTRODUCTION
1.1. Definition of Demand Response
Demand response (DR) is a load management tool which provides a cost-effective alternative to
traditional supply-side solutions to address the growing demand during times of peak electrical load.
According to the US Department of Energy (DOE), demand response reflects changes in electric usage
by end-use customers from their normal consumption patterns in response to changes in the price of
electricity over time, or to incentive payments designed to induce lower electricity use at times of high
wholesale market prices or when system reliability is jeopardized. 1 The California Energy Commission
(CEC) defines DR as a reduction in customers electricity consumption over a given time interval relative
to what would otherwise occur in response to a price signal, other financial incentives, or a reliability
signal. 2 This latter definition is perhaps most reflective of how DR is understood and implemented
today in countries such as the US, Canada, and Australia where DR is primarily a dispatchable resource
responding to signals from utilities, grid operators, and/or load aggregators (or DR providers).
1.2. Benefits Brought by Demand Response

There are a variety of benefits brought by DR, ranging from the environmental to the economic.
Environmental benefits
By reducing electric demand to ensure the sufficiency of existing supply, rather than increasing supply to
meet rising demand, DR avoids power plant operation and its associated emissions. Moreover, because
DR capacity is distributed, there are added benefits due to the avoidance of electrical losses in the
transmission and distribution lines typically experienced from centrally-generated utility power. The USbased energy consultancy Synapse Energy Economics addressed this issue in its study of DR and air
emissions in the US market of ISO New England:
when DR operates it reduces system line losses relative to reference case system operation.
This is because when energy is provided to customers from the grid it often comes from power
plants a considerable distance from the point of end use, and energy is lost in transmission.
Usually line losses are in the range of 5 to 10 percent, but they can be higher during periods
when transmission lines are heavily loaded. In contrast, the DR resource be it a load reduction
or a generator is located at the site of energy use, so no energy is lost in transmission.
Because DR avoids line losses, a DR resources of five MW is comparable to a grid-connected
asset of slightly larger than five MWFor example, a five-MW DR resource might be credited as
U.S. Department of Energy (February 2006), Benefits of Demand Response in Electricity Markets and Recommendations for
Achieving Them: A Report to the United States Congress Pursuant to Section 1252 of The Energy Policy Act of 2005, pp. 11-12.
(http://eetd.lbl.gov/ea/ems/reports/congress-1252d.pdf).
2
http://www.energy.ca.gov/2011_energypolicy/documents/2011-07-06_workshop/background/Metrics_July_IEPR_DR_v1.pdf.
providing 5.5 MW of reserve capacity is average system line losses during DR events were
determined to be roughly 10 percent.3
In addition, because DR is often procured on a forward basis, it may not only offset the operation of
power plants but also their very construction. In this manner, the environmental benefits of DR extend
to the avoided emissions associated with the construction of the materials for the power plant itself (i.e.
cement, steel, etc.), as well as the potential ecological impact that may have resulted should the unit
have been constructed.
The use of DR for non- peak-shaving purposes such as for ancillary services, also comes with significant
environmental benefits, despite the very short duration dispatches of such resources. In many systems,
ancillary services (also known as reserves), are primarily provided by plants in running operating mode,
as there may be an insufficient number of quick-start generating units able to start, synchronize, and
export power to the grid in the requisite period of time. These plants tend to be fueled by diesel or oil,
which add to local and regional pollution. Increased use of quick-response DR can reduce the need for
power plants to run in operating mode, as well as potentially lead to a more efficient overall use of
resources within the system.
Economic benefits
The economic benefits of DR oftentimes may be more significant than the environmental benefits.
While there is a clear environmental benefit to avoiding or reducing power plant operation, the targeted
usage of DR will not save the same amount of energy as permanent load reductions that come from
energy efficiency measures. As peak periods are relatively infrequent, so too tends to be the use of DR.
Yet, the infrequent spikes in demand have a significant economic impact: in many systems, 10% (or
more) of costs are incurred to meet demands which occur less than 1% of the time.4 Reducing this peak
demand through DR programs means that the capacity requirements which drive investments in
generation, transmission, and distribution assets can also be proportionally reduced. The US-based
energy consultancy the Brattle Group, in its 2007 paper The Power of Five Percent, found that a 5%
reduction in peak demand would have resulted in avoided generation and T&D capacity costs of $2.7
billion per year.5
In addition, the use of DR during peak periods can result in significant savings in terms of energy
expenditure. In wholesale markets, spot energy prices during peak periods can skyrocket due to
increased demand. Similarly, energy prices in vertically integrated, non-wholesale market systems can
also increase during peak periods as less efficient units (i.e. with a higher heat rate) are utilized in order
to meet the rising demand. As retail energy rates tend to not reflect the true cost of energy during peak
periods, the expensive utilization of generation during these times is socialized among all customers. By
reducing the need to purchase high-priced power, all customers in a system are positively impacted. The
3
Synapse Energy Economics, Modeling Demand Response and Air Emissions in New England, September 4, 2003. Page 16.
EnerNOC, Inc. Analysis of US and Australian Electricity System Data.; Brattle Group, The Power of Five Percent, May 16, 2007
5
Brattle Group, The Power of Five Percent, May 16, 2007.
4
aforementioned Brattle report also identified energy savings on the order of $300 million per year from
the same 5% reduction in the peak demand of the US as a whole. Figure 1 further illustrates the point
that the avoided capacity costs far outweigh the avoided energy and avoided T&D costs.
Figure 1: Annual Benefits of 5% Remand Response in the US6

Indeed, it is important to recognize the financial benefits participants in these programs receive, which
are the sum of both the avoided energy costs (and demand charges) as well as the direct incentive
payments for participation and successful performance.
Id.
2. DEMAND-SIDE MANAGEMENT AND THE ROLE OF DR

2.1. Overview of Demand Side Management
Demand-side management (DSM) consists of a broad range of planning, implementing and monitoring
of activities designed to encourage end-users to modify their levels and patterns of electricity
consumption. DSM programs and initiatives are typically implemented to achieve two basic objectives:
energy efficiency (EE) and load management. EE is primarily achieved through programs that reduce
overall energy consumption of specific end-use devices and systems by promoting high-efficiency
equipment use and building design. Conversely, load management programs are designed to achieve
reductions in consumption primarily during times of peak demand, rather than on a permanent or
ongoing basis. Load management programs can include permanent-load shifting and peak-shaving
activities traditionally associated with demand response. With improvements in technology, load
management programs are also increasingly dispatched on a level playing field with supply-side
resources.
Figure 2 presents the total peak load reduction through DSM from 1998 to 2009 in the US. Peak load
reduction through energy efficiency programs increased from 13,591 MW in 1998 to 19,766 MW in 2009,
but decreased from 13,640 MW to 11,916 MW during the same period by load management programs.7
35,000
25.0%
Peak Load Reduction (MW)
15.0%
25,000
10.0%
5.0%
20,000
0.0%
15,000
-5.0%
-10.0%
10,000
Annual Growth Rate (%)
20.0%
30,000
-15.0%
5,000
-20.0%
-25.0%
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Energy Efficiency
Load Management
Annual Growth Rate of Energy Efficiency
Annual Growth Rate of Load Management
Figure 2: Peak Load Reductions from DSM Programs by Program Category8
U.S. Energy Information Administration (November 23, 2010), Demand-Side Management Actual Peak Load Reduction by
Program Category. (http://205.254.135.24/cneaf/electricity/epa/epat9p1.html)
8
US Energy Information Agency. 2009.
2.2. Role of DR in Demand-Side Management

Demand Response is normally included as part of utility DSM program or a potential DSM program
solution which helps make the electric grid much more efficient and balanced by assisting the electric
grid's commercial and industrial customers in reducing their electric peak demands, and/or shifting the
time period when they use their electricity, and/or prioritizes the way they use electricity, and in return
reduces their overall energy costs.
A key difference between DR and EE is the energy reductions for DR are time-dependent, whereas
reductions for EE are not. Demand response programs yield reductions in demand at critical times,
which typically corresponds to time of peak power demand, while EE programs yield permanent energy
savings. However, the two programs have overlapping effects: EE can permanently reduce demand
including those occurred during the peak time while demand response with well-targeted control
strategies can also produce energy savings.9
Up to 2003, EE programs in the US contributed to more than 60% of actual peak load reduction;10
however, its share dropped by almost 10% from 59.3% in 2004 to 49.9% in 2009. Meanwhile,
contributions from load management had increased by about 12% from 37.6% to 50.1% during the same
period (see Figure 3).
100.0%
90.0%
80.0%
(Unit: %)
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Energy Efficiency
Load Management
Goldman, Charles, M. Reid, R. Levy, and A. Silverstein (January 2010), Coordination of Energy Efficiency and Demand Response,
Lawrence Berkeley National Laboratory, LBNL-3044E.
(http://eetd.lbl.gov/ea/ems/reports/lbnl-3044e.pdf)
10
Peak load reductions are categorized as potential or actual. Potential peak load reductions are the amount of load available
for curtailment through load control programs such as direct load control, interruptible load control, other load management,
or other DSM programs. Actual peak load reductions are the amount of reduction that is achieved from load control programs
that are put into force at the same time as peak load and the amount of reductions that result from energy efficiency programs
at the time of peak load.
Figure 3: Share of Total Actual Peak Load Reduction by Program Category11
2.3. Coordination of Demand Response and Energy Efficiency

Demand response and energy efficiency programs could be coordinated at the customer level at least in
the following four ways:12
Offering combined programs: Although separating energy efficiency and demand response
programs are quite common, customers could be presented with both opportunities at the
same time. Furthermore, technologies that are commonly used for DR such as energy
monitoring, building automation systems and load control equipment can also be leveraged to
help inform about opportunities that would lead to energy efficiency improvements.
Coordinating program marketing and education: Program sponsors could package and promote
demand response and energy efficiency in a closely coordinated way. Because the two programs
are quite complicated to customers, program sponsors could help customers addresses both
topics under a broad DSM and management theme.
Market-driven coordination services: Effective coordination can be done not only by utilities
and Independent System Operators (a.k.a. ISO), but also by the initiative of private firms that
find a market among customers who are interested in reducing their energy costs or receiving
incentives.
Incorporating Building codes and appliance standards: Building codes and appliance efficiency
standards can incorporate demand response and energy efficiency functions into the design of
buildings, infrastructure, and power-consuming appliances/equipments. Integrating those codes
and standards can lead to significant reduction in the costs to customers of integrating demand
response and energy efficiency strategies and measures.
11
Id.
Cappers, Peter, C. Goldman, and D. Kathan (2009), Demand Response in U.S. Electricity Markets: Empirical Evidence,
Lawrence Berkeley National Laboratory, LBNL-2124E.
(http://eetd.lbl.gov/ea/ems/reports/lbnl-2124e.pdf).
12
3. REGULATORY AND POLICY FRAMEWORKS THAT PROMOTE DEMAND

RESPONSE
3.1. Demand Response Enabling Policies
DR, at least in a basic form, has been around for decades. In the US, load management and
interruptible/curtailable tariffs were first introduced in the early 1970s. The primary interest in load
management was driven in part by the increasing penetration of air conditioning which resulted in
needle peaks and reduced load factor. These programs were effectively limited to the largest industrial
customers in a given system, and in many cases never used. Deployed before the advent of the internet
or the load aggregator business model, these programs were very manual and typically featured slow
response times. With such limited capabilities, interruptible programs served less as an alternative to
generation investments, and more as a load management tool that could theoretically be used in
emergencies in reality though, they were more often than not a customer retention tool allowing
utilities to offer discounted service rates to customers large enough to fund the installation of their own
generation assets.
This base of demand response was then further spurred by two important developments: Within
traditionally-regulated, vertically-integrated utilities, the advent of integrated resource planning in the
late 1970s and 1980s made utilities increasingly aware of the system cost impacts of meeting peak loads,
and load management began to be viewed as a reliability resource. The results of this perspective were
first evident in the rise of Direct Load Control (DLC) programs that cycled residential air conditioning
units during peak periods. Even more significant, in the mid 1990s, policymakers and utilities interested
in facilitating the development of regional, competitive wholesale markets primarily based on re-design
and re-structure markets.
3.1.1 Wholesale Market Access

UNITED STATES
It is well-known to industry observers that the growth of the demand response industry in the United
States can in many ways be traced to the opportunities in these wholesale power markets, particularly
in the systems of ISO-New England13 and the PJM Interconnection14. According to the most recent
government statistics, more than 31 GW of demand response was active in the US RTO/ISO markets in
201115. While the opportunities for DR in California that emerged after the states energy crisis in 2001
certainly contributed to the growth of the industry as well, the scale of the opportunities (and the
realization of them) in the aforementioned wholesale markets has proven to be a stronger influence on
the growth of the industry in the United States.
13
The current size of the ISO-New England system is approximately 26 GW.

The current size of the PJM system is approximately 165 GW.
15
Federal Energy Regulatory Commission (2011). Assessment of Demand Response & Advanced Metering Staff Report.
November 2011. Table 2.
14
The role of government policy in the establishment of these opportunities has been an essential driver
to the growth of the DR industry in the US. The foundation of competitive power markets in the US can
be traced to the Energy Policy Act of 1992 (EPAct) and Order 888 from the Federal Energy Regulatory
Commission (FERC). EPAct began the process of electric industry deregulation and opened up the
opportunity for independent power generators to participate in wholesale markets, which FERC Order
888 furthered by requiring fair access and market treatment to transmission systems. While the
aforementioned legislation and Order were primarily focused on increasing competition among
generators, the concepts laid the groundwork for demand response to enter wholesale markets when
such resources could meet the same technical requirements as their supply-side counterparts. The
Energy Policy Act of 2005 (EPACT) further codified that a key objective of US national energy policy was
to eliminate unnecessary barriers to wholesale market demand response participation in energy,
capacity, and ancillary services markets by customers and load aggregators,16 at either the retail or
wholesale level.17
While demand response began participating at scale in wholesale power markets in the early 2000s
particularly in emergency capacity programs many market barriers remained. Fortunately, in October
2008, FERC issued Order 719, which focused on the operation of the countrys wholesale electric
markets. A major component of Order 719 was eliminating barriers to the participation of demand
response in wholesale markets operated by wholesale market operators. Order 719 permitted load
aggregators to bid demand response directly into organized markets, unless the relevant laws of the
local electric retail regulatory authority prohibit such activity.
Demand response integration into US wholesale power markets was further bolstered with the March
2011 issuance of FERC Order 745. Order 745 requires that demand response resources are paid the
Locational Marginal Price (LMP), or the wholesale market price for energy. By codifying the ability for DR
to be compensated in the same fashion as generation resources for services provided to the energy
markets, Order 745 advances the cause of equal treatment between generation and demand side
resources.
In the US, DR is primarily seen in the wholesale capacity markets, most notably in the PJM
Interconnection and ISO-New England. DR in these markets is procured in a competitive process that
places demand side resources on equal footing with generation, creating an opportunity for costeffective DR that can easily enter the market (should technical requirements be able to be met). In
addition, in both markets, capacity DR is dispatched only during the very critical peak or emergency
periods, making end-user participation relatively simple (compared to other markets to be profiled in
this paper that are solely for balancing resources). Examples of both markets are provided below.
The PJM Interconnection
16
Load aggregation is the process by which individual energy users band together in an alliance to secure more competitive
prices than they might otherwise receive working independently. Oftentimes, load aggregator companies are formed to
represent the interests of these groups of customers.
17
Cappers, Peter, C. Goldman, and D. Kathan (2009).
PJM (Pennsylvania-New Jersey-Maryland) Interconnection is a regional transmission organization (RTO)

that coordinates the movement of wholesale electricity in all or parts of Delaware, Illinois, Indiana,
Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia,
West Virginia and the District of Columbia. PJM is the largest market in the US and allows DR to
participate in all of its markets types capacity, energy, and ancillary services. Today, more than 60
entities serve as Curtailment Service Providers (CSPs), or load aggregators, in the PJM system.
Like in most systems, the bulk of the DR in PJM participates in the capacity market. Capacity markets are
particularly well-suited to peaking resources like DR which operate for relatively few hours a year and
may have trouble accessing the proper price signals from an energy-only market. PJMs current capacity
market, the Reliability Pricing Model (RPM), was instituted in 2007. In the RPM, those resources include
not only generating stations, but also demand response actions and energy efficiency measures by
consumers to reduce their demand for electricity. In this manner, demand side management is directly
integrated into the wholesale capacity market structure.
Every year PJM conducts a Base Residual Auction (BRA) for delivery of capacity three years in the future.
The BRA is held in May and the delivery year begins 3 years later on June 1st and ends on May 31st of
the following year. In addition to the BRA, PJM conducts three Incremental Auctions (IA) that are held in
advance of each corresponding delivery year. The purpose of the IA is to balance any changes in the
load forecast and to allow suppliers of capacity resources to adjust their positions. In PJMs most recent
Base Residual Auction in May 2011, the market procured 149,974 MW of capacity for the 2014/2015
delivery year. Of note, 14,118 MW of this capacity or 9.4% of the total came from demand response
resources. Once cleared through the capacity market, these DR resources become participants in PJMs
Emergency Load Response Program.
In PJM, qualifying DR resources can also participate in the wholesale energy market (both day-ahead
and real-time) as well as various ancillary service markets (primarily, the synchronized reserve market).
However, these markets are not the same drivers of DR growth that the capacity market is. The energy
market does not feature capacity incentives, and therefore requires significantly more participation to
garner the same financial opportunity. The Synchronized Reserve Market, on the other hand, requires
full response within 10-minutes of a dispatch signal and generation-grade telemetry, limiting the pool of
potential participants.
ISO New England (ISO-NE)
PJMs counterpart to the north, ISO New England, also operates a forward capacity market (FCM) in
which DR can participate alongside generation, and which accounts for the majority of demand side
participation within the New England system. Similar to PJMs BRA, the ISO-NE FCM also allows both
dispatchable demand response and energy efficiency measures to participate in the market.
ISO-NEs use of demand response may be the clearest example of a resource designed specifically for
reliability and/or emergency prevention purposes. While the ELRP in PJM is also designed for similar
9
purposes, the trigger for usage in ISO-NE is even more defined. ISO-NE treats DR provided by
curtailment and on-site generation as distinct resources, labeling the former Real Time Demand
Response (RTDR) and the latter Real Time Emergency Generation (RTEG). RTDR may be called by ISO-NE
only when the system reaches an emergency level known as Operating Procedure 4 Action 9 (OP4
Action 9). RTEG, on the other hand, cannot be dispatched until a further level of emergency has been
reached, OP4 Action 12. For customers that utilize both load curtailment and on-site generation to
provide DR capacity, they (or their DR provider), must be able to call those distinct loads separately in
order to comply with ISO-NE requirements. Today, approximately 2,000 MW, or 8% of the resources in
the capacity market, are dispatchable demand response. This figure grows to 3,400 MW, or 10% of the
ISO-NE system, in 2014/15.
Demand response resources can also provide energy to the ISO-NE market through the Real-Time Price
Response and Day-Ahead Load Response Programs. As with energy market participation in PJM, these
programs are relatively unpopular compared to the capacity market, as they require much more
frequent participation and have comparatively lower economic benefit. In both markets, sites that
participate in the energy programs tend to be among the most flexible participants in the capacity
markets who are looking for an additional economic opportunity, rather than the energy program
serving as the sole method of DR participation in the market. While ISO-NE formerly had a pilot program
testing the ability for DR to provide ancillary services the Demand Response Reserve Pilot (DRRP) it
no longer has an active mechanism for DR to provide operating or spinning reserves. DR participation in
these markets is now under active consideration, in part due to the aforementioned FERC Order 719.
UNITED KINGDOM
National Grid Short Term Operating Reserves (STOR) Market
Demand response resources also enjoy wholesale market access in the United Kingdom, albeit in a much
more limited context. Market-based opportunities for demand-side resources in the UK are currently
restricted to ancillary service markets, primarily the Short Term Operating Reserves Market. While
others exist, the parameters result in low levels of participation and or a small addressable market.18 DR
cannot access the nations wholesale energy market and unlike PJM and ISO-NE, there is no capacity
market in the UK. That said, the government, spearheaded by the Department of Energy and Climate
Change (DECC), is pushing forward legislation to launch one in the coming years and which will also
allow for demand side participation.
STOR is essentially a supply and demand balancing service that meets the need of the grid as demand
changes and as traditional power plants come online and ramp up and down, similar in many ways to
the Sycnhronized Reserve Market (SRM) in the PJM Interconnection. While not a capacity market per se,
cleared resource receive an availability payment for each hour they are in the market and available to be
dispatched. Utilization (energy) payments are also given for the actual load reduction provided. Both
features are also present in the aforementioned SRM. As a balancing market, STOR is called much more
18
For example, the Fast Reserves (FR) program has a 50 MW minimum requirement for participation.
10
frequently than the capacity programs in PJM and ISO-NE which are used primarily to address
emergency conditions. STOR participants, on average, must be prepared to respond to a dispatch every
week. Such frequent participation requires the employment of different curtailment strategies than
those that are found in capacity programs designed to shave consumption only during infrequent, peak
periods.
AUSTRALIA
Independent Market Operator Wholesale Electricity Market (WEM)
Another successful example of DR participation in wholesale markets can be found in the South West
Interconnected System of Western Australia, run by the Independent Market Operator (IMO). There are
two wholesale markets in Australia; the Whosesale Electricity Market (WEM) in Western Australia, and
the National Electricity Market (NEM) in the eastern states (except for the Northern Territory). The NEM
is an energy-only market and has very low levels of DR participation for the reasons mentioned earlier,
whereas the WEM is a capacity market similar in many ways to ISO-NE and PJM, and with a significant
penetration of DR. In the most recent Reserve Capacity Cycle, more than 8% of the capacity procured
came from demand-side resources.19
The IMO-administered WEM procures system resources through the Reserve Capacity Mechanism, in
which capacity can be traded bilaterally to the IMO directly, or to retailers. Unlike in PJM and ISO-NE
where capacity prices are the result of competitive offers, the IMO sets a price for all capacity based on
the avoided cost of a marginal new peaking unit, specifically a 160 MW open cycle gas turbine. Auctions
are only triggered if the bilateral trading mechanism secures insufficient capacity.20 As in the previously
discussed capacity markets of the US, DR and generation receives the same exact market payment.
As with PJM and ISO-NE, DR is assumed to have different levels of dispatch capability than traditional
supply-side resources. The RCM has 4 Availability Classes; Generation must all list itself as Class 1, or
available for more than 96 hours a year; DR meanwhile can offer at between 24-96 hours of dispatch.
One important distinction about DR in WA is that unlike PJM and ISO-NE; DR in the WEM can be
dispatched when it is deemed to be economic and is not dependent on emergency conditions. The
system operator is required to first utilize the plants of the former state-owned generation company,
but afterwards all dispatch is determined by the market energy price offered by the resource.
Unlike its counterparts in the US, DR in WA is limited to participation in the wholesale capacity market.
While a wholesale energy market also exists in WA, the STEM, DR resources do not have access to the
market. Meanwhile, a competitive balancing market is only just now being designed, and access for DR
is expected once the market is fully operational in the coming years.
19
The Reserve Capacity Cycle (RCC) is the process that is used in Australia to procure DR resources as part of the Reserve
Capacity Mechanism.
20
Note that to date this situation has never been experienced so no auctions have been called.
11
Capacity-based Programs in Energy-only Markets

Some wholesale market operators have taken a slightly different approach, creating DR-specific
opportunities outside of the standard wholesale markets themselves. For the most part, these are
energy-only markets, where the underlying structure is not as conducive to peaking resources like
demand response, which operate for relatively few hours per year.
In the Canadian Province of Ontario, the Independent Electricity System Operator (IESO) and the Ontario
Power Authority (OPA) launched a large scale DR program (DR3) in 2007 to provide additional capacity
to the market due to planned retirement of coal-fired power plants in the province. DR3s inclusion of a
capacity payment represented a departure from previous DR programs in Ontario that failed to gain
traction, primarily due to incentives being limited to energy payments.
Another example is the Emergency Interruptible Load Service (EILS) program in the Texas market of
ERCOT. EILS is essentially a standalone markets that exists alongside the wholesale markets open to
generation resources in ERCOT. EILS is designed to provide reserve capacity to the energy-only ERCOT
market, and is procured during four separate markets spaced evenly throughout the year. Unlike DR3,
pricing in EILS is the result of offers made by DR providers, similar to how the capacity markets in PJM
and ISO-NE work. A further similarity with PJM is that ERCOT allows EILS participating loads to provide
operating reserves in the ERCOT ancillary service markets and receive the same payment as generation
resources, similar to the SRM.
3.1.2 Bilateral Programs with Vertically Integrated Utilities and Network Operators
Access to existing wholesale markets are just one mechanism for creating and leveraging demand
response resources. In recent years, much growth in the industry has been found in bilateral programs
with vertically integrated utilities in traditionally regulated environments, and with network (T&D)
operators located within a liberalized market structure. These bilateral programs are most often used as
a way to avoid or defer investments in generation and/or T&D infrastructure, and tend to look similar in
structure to a power purchase agreement (PPA) that a utility might sign with an independent power
producer. These utility programs are likely better proxies for how the implementation of nextgeneration demand response could manifest itself in China, given the lack of a wholesale market.
There are a number of enabling policies that have encouraged the development of bilateral DR
programs throughout North America, the UK and Australia. These policies include:
Cost recovery and DSM funds
Loading orders and similar regulations
Peak demand mandates and energy efficiency portfolio standards
Cost Recovery and DSM Funds
Whether in the US, the UK, or Australia, vertically integrated utilities and distribution network operators
are regulated monopolies whose revenues are dependent on government policy and regulation. As such,
12
it is essential to understand the regulatory environments in which these utilities operate in order to
understand how regulatory policies have both contributed to, and hindered, the growth of demand
response.
Perhaps the most basic and essential enabling policy is a cost-recovery mechanisms. Under a costrecovery mechanism, a utility can recover prudently-incurred costs of DR and EE investments on a
dollar-for-dollar basis, typically through a rider or customer surcharge. Cost recovery is designed to
make a utility whole on its DR and EE investments. However, there are challenges with this approach.
First, cost recovery alone will not address the lost margin revenue the utility will face due to reduced
energy sales from DR and EE programs. Second, cost recovery does not factor in opportunity costs: DR
and EE investments displace supply-side investments for which the utility can earn a profit. Given these
opportunity costs, absent a statutory or regulatory mandate, program cost recovery alone will generally
not attract utility interest in DR and EE programs. However, in some jurisdictions, utilities are
authorized to recover additional costs associated with the lost revenue due to the energy efficiency
measures. There are also provisions for earning a fair rate of return on the DSM investment, typically at
levels that are equivalent to allowable returns on power generation assets.
Loading Orders and Similar Regulations
Loading orders are governmental proclamations that define the priority order in which resources are to
be developed. To underscore the importance of energy efficiency and demand response in Californias
future energy picture, the state government developed the Energy Action Plan established a loading
order of preferred resources, placing energy efficiency and demand response as the states highestpriority procurement resource, and set aggressive long-term goals for energy efficiency and demand
response resources. In addition, energy efficiency and demand response strategies were implemented
to address greenhouse gas emission reduction targets specified by AB32, a law adopted in California to
create regulatory policy mechanisms to combat global warming. As a result of these policies,
Californias energy efficiency and demand response efforts have proven to be very successful. California
leads the nation in term of energy saved. The state invests nearly $3 billion per year in energy efficiency
and demand response programs that target electricity and natural gas customers to install high
efficiency equipment, take measures to reduce their peak demands, and establish time-sensitive price
structures that are more in line with the actual cost of providing the electricity. Resources such as
renewable generation, distributed generation, and traditional generation are considered as the second
and third priorities, respectively in the loading order, and should only be considered once all energy
efficiency and demand response resources are exhausted.
In Massachusetts, a law known as the Green Communities Act was passed in 2008 and implemented
shortly thereafter. The law requires the states utilities to procure all available energy efficiency
resources that cost less than traditional energy sources do. The law in effect prioritizes energy efficiency
as being at the top of the loading order, ahead of renewable energy, and more traditional forms of
generation. Among the major provisions is a requirement for utilities to invest in energy efficiency when
it is less expensive than buying power. Previously companies purchased more power when demand
13
increased. The effect of the law is that the state is seeing significant investments in energy efficiency,
leading toward the ultimate goal of reducing the states use of fossil fuels in buildings by 10% and overall
greenhouse gas emissions by 20% in the year 2020.
Peak Demand Mandates, Energy Efficiency Portfolio Standards
Peak demand mandates and energy efficiency portfolio standards have recently emerged as another
mechanism to encourage DR outside of market-based opportunities. Perhaps most well known is a
mandate in the state of Pennsylvania, the so-called Act 129 legislation, signed into law in October 2008,
which requires all electric distribution companies to achieve peak demand reduction targets of 4.5% and
energy efficiency reductions of 4% by 2015. While the legislation does not expressly encourage DR over
other types of peak reduction such as energy efficiency and or solar PV, Pennsylvania utilities appear to
have determined C&I DR was the most cost effective way to reach compliance and several large deals
with aggregators have already been publicly announced.
Other states with peak demand mandates that are similar to Pennsylvania include New York, Colorado,
Michigan and Ohio. In New York, the Public Service Commission established an Energy Efficiency
Portfolio Standard (EEPS) which ordered the states utilities to achieve a 15% reduction in forecast
electricity usage by the year 2015. The states utilities are implementing aggressive EE and DR programs
in order to meet that goal, which specifies that each of the states utilities realize specific MWh and peak
MW reduction amounts by 2015. In Colorado, the Climate Action Plan (CAP) sets carbon reduction goals
for the state and proclaims that energy efficiency programs are the most important responses to the
carbon-reduction challenge. In response, the Colorado Public Utilities Commission has ordered the
states utilities to implement EE and DR programs to meet that goal. Michigan and Ohio have similar
statutory mandates to lower energy usage and peak demand.
Parity of Treatment
Traditional utility regulation favors supply-side resources over DR and EE resources. First, utilities earn a
rate of return on investments in generation, transmission and distribution infrastructure. The absence of
a parallel incentive for DR and EE investments creates a bias against demand-side resources. This has
been described in the economic literature as the Averch-Johnson Effect. That is, where a firms profits
are linked to its capital investment, as is the case with utilities under traditional regulatory structures,
there is an embedded incentive for the firm to increase its capital outlay in a manner that does not
necessarily maximize producer and consumer surplus. Stated another way, traditional regulatory
frameworks create a disincentive for utilities to meet resource needs using approaches that are less
capital intensive. Thus, faced with otherwise equivalent alternatives of building a power plant that
contributes to profitability or making investments in DR and EE that allow for cost-recovery only, a utility
would generally prefer to build a power plant (or T&D).
The government of the United Kingdom recently recognized and addressed this very challenge. In the
2010-2015 Distribution Price Control Review 5 (DPCR5), Ofgem the national electricity and gas
regulator instituted the so-called Equalisation Incentive which establishes parity in the treatment of
14
capital and operating expenditures by distribution utilities. Thus, any utility acting in its own rational
economic interest will clearly pursue the most cost-effective way to meet network needs and reliability
requirements, whether that is through traditional investments in infrastructure or through non-network
alternatives like DSR. As a result of this new regulation, one local distribution network operator
Electricity North West has already deployed a commercial scale DR program in which an aggregator is
deploying DR on specific circuits in order to defer investments in substations. Other distribution network
operators, such as UK Power Networks, are also conducting pilot projects using DR for distribution relief
as they hope to prepare themselves to launch commercial-scale programs under this new regulatory
framework.
Example Utility DR Programs
There are several examples of bilateral DR programs. In California, Pacific Gas and Electric (PG&E)
implements the Aggregator Managed Portfolio (AMP) program. AMP is a non-tariff program that
consists of bilateral contracts with aggregators to provide PG&E with price-responsive demand response.
The program can be called at PG&Es discretion. Each aggregator is responsible for designing and
implementing their own demand response program, including customer acquisition, marketing, sales,
retention, support, event notification and payments. To participate, customers must enroll through a
load aggregator. The customer in turn authorizes the aggregator to act on their behalf with respect to
all aspects of AMP, including receipt of notification of an event, receipt of incentive payments and/or
penalties. Southern California Edison (SCE) operates the Demand Response Contracts (DRC) program.
SCE has contracted with several aggregator companies to provide SCE with price-responsive and/or
demand response events that SCE may call at its discretion. Each aggregator designs their own programs,
and offers demand response program structures and options that may not be directly available through
SCE. Customers may select an aggregator with services that best meet their business needs.
More common are arrangements where a utility contracts with a single DR load aggregator for a
program in their territory (or a single provider per customer class). For example, EnerNOC, a Bostonbased load aggregator has a program in place with the Tennessee Valley Authority (TVA) in the
southeastern US, the largest public power company in the country. TVA procured a long-term, 560 MW
resource from EnerNOC which it is required to deliver in line with contract requirements over the 10year contract length. There are many other load aggregator companies operating in the various
electricity markets throughout North America. As with the aforementioned DR programs in California,
the load aggregator is responsible for all roles from customer acquisition through resource dispatch and
settlement.
As with similar DR programs, TVA has purchased a guaranteed firm resource. In addition to identifying
and enabling DR capacity in line with contract milestones, the load aggregator must also meet
performance standards when dispatched by TVA. Should the load aggregator fail to do either, financial
penalties against the aggregator may be assessed. In this manner, TVA can depend on its DR-based
virtual power plant in the same way its system planners and operators can trust a traditional
generation resource. Figure 4 provides a summary of the TVA bi-lateral program parameters.
15
Program Size
Advanced Notification
Dispatch Trigger
Availability Window
Maximum Cumulative Dispatches
Term Length
Up to 560 MW
30 minutes
TVAs discretion
April October: 12:00-20:00, Mon-Fri
November March: 5:00-13:00, Mon-Fri
40 hours per annum
10 years
Figure 4: TVA Bi-lateral DR Program Parameters

Other vertically-integrated utilities in the US that have implemented similar programs include: Arizona
Public Service, Idaho Power, NV Energy, Public Service Company of New Mexico, Puget Sound Energy,
Salt River Project, San Diego Gas & Electric, Tampa Electric, Tucson Electric Power, and Xcel Energy.
Per the aforementioned equalisation incentive now in effect in the UK, distribution network operators
(DNOs) in the country are also now deploying demand response programs to defer or avoid investments
in network infrastructure. Electricity North West (ENW), one of the 14 regulated DNOs in the UK with a
network that includes the Greater Manchester and Cumbria areas, has recently launched a DR program
along with a third-party load aggregator. Under this program, DR is deployed within specified circuits in
the network, allowing demand to be controlled on a geographically-targeted basis that will prevent the
need to upgrade the substations on those portions of the network. The program, announced in May
2011, is set to last for five years. Such network support contracts are also commonly found in Australia,
particularly in New South Wales.
The same Distribution Price Control Review that launched the equalisation incentive, also included funds
from Ofgem the UK electric regulator for Low Carbon Network (LCN) projects that will pilot new
technologies and facilitate the development of an environmentally-friendly electricity system in the
country. Many DNOs throughout the UK have successfully applied for LCN funding to pilot the use of DR
in their networks, including UK Power Networks (UKPN) and Northern Powergrid (formerly CE Electric).
ENW has also recently been awarded LCN funding from Ofgem to pilot the use of DR in new ways within
their system that, if successful, would reduce the amount of network capacity DNOs would need to have
in order to comply with reliability standards.
3.2. Encouraging End-User Participation: The Role of Incentives

The U.S. Department of Energy classifies demand response into two categories, i.e. price-based demand
response and incentive-based demand response.21 Each category has its own subcategories. Pricing
mechanisms vary on each subcategory as shown in Table 1.
Price-based demand response refers to changes in usage by customers in response to changes in
the prices they pay and include real-time pricing, critical-peak pricing, and time-of-use rates. If
the price differentials between hours or time periods are significant, customers can respond to
21
U.S. Department of Energy (February 2006).
16
the price structure with significant changes in energy use, reducing their electricity bills if they
adjust the timing of their electricity usage to take advantage of lower-priced periods and/or
avoid consuming when prices are higher. Customers load use modifications are entirely
voluntary (Table 1)
Incentive-based demand response programs are established by utilities, load-serving entities, or
a regional grid operator. These programs give customers load-reduction incentives that are
separate from, or additional to, their retail electricity rate, which may be fixed (based on
average costs) or time-varying. The load reductions are needed and requested either when the
grid operator thinks reliability conditions are compromised or when prices are too high. Most
demand response programs specify a method for establishing customers baseline energy
consumption level, so observers can measure and verify the magnitude of their load response.
Some demand response programs penalize customers that enroll but fail to respond or fulfill
their contractual commitments when events are declared (Table 1).
17
Table 1: Demand Response Options and Related Pricing Mechanisms

Price-Based (Voluntary)
Time-of-use (TOU): a rate with different unit
price for usage during different blocks of time,
usually defined for a 24 hour day. TOU rates
reflect the average cost of generating and
delivering power during those time periods.
Real-time pricing (RTP): a rate in which the
price for electricity typically fluctuates hourly
reflecting changes in the wholesale price of
electricity. Customers are typically notified of
RTP prices on a day-ahead or hour-ahead basis.
Critical Peak Pricing (CPP): CPP rates are a
hybrid of the TOU and RTP design. The basic
rate structure is TOU. However, provision is
make for replacing the normal peak price with
a much higher CPP event price under specified
trigger conditions (e.g., when system reliability
is compromised or supply prices are very high).
Incentive-Based
(Contractually Mandatory)
Direct load control: a program by which the
program operator remotely shuts down or cycles
a customers electrical equipment (e.g., air
conditioner, water heater) on short notice. Direct
load control programs are primary offered to
residential or small commercial customers.
Interruptible/curtailable (I/C) service: curtailment
options integrated into retail tariffs that provide a
rate discount or bill credit for agreeing to reduce
load during system contingencies. Penalties
maybe assessed for failure to curtail. Interruptible
programs have traditionally been offered only to
the largest industrial (or commercial) customers.
Demand Bidding/Buyback Program: customers
offer bids to curtail based on wholesale electricity
market prices or an equivalent. Mainly offered to
large customers (e.g., one megawatt [MW] and
over).
Emergency Demand Response Programs: programs
that provide incentive payments to customers for
load reductions during periods when reserve
shortfall arise. (e.g. ERCOT EILS)
Capacity Market Programs: customers offer load
curtailments as system capacity to replace
conventional generation or delivery resources.
Customers typically receive day-of notice of events.
Incentives usually consist of up-front reservation
payments, and face penalties for failure to curtail
when called upon to do so. (e.g. PJM ELRP, IMO WA)
Ancillary Services Market Program: customers bid
load curtailments in ISO/RTO markets as operating
reserves. If their bids are accepted, they paid the
market price for committing to be on standby. If
their load curtailments are needed, they are called
by the ISO/RTO, and may be paid the spot market
energy price. (e.g. PJM SRM, UK STOR)
Source: DOE (2006), p.12.
In addition to federal regulation as described in Section 3.1 and economic benefits described in Section
3.2, numbers of the U.S. utilities have taken action to expand their retail demand response programs.
One incentive factor for many of them has been concern about peak load growth and rising energy
prices.22
22
U.S. Federal Energy Regulatory Commission (December 2008), Assessment of Demand Response and Advanced Metering,
Washington D.C.
(http://www.ferc.gov/legal/staff-reports/12-08-demand-response.pdf).
18
3.2.1. Lack of Sufficient Incentives from Standard and TOU Pricing: Experience with
Interruptible Tariffs
Many utilities have offered a variety of traditional DR programs for many years. These legacy programs
are typically referred to as load management programs. There are three types of legacy load
management programs: direct load control (DLC), time-of-use (TOU) rates, and interruptible contracts.
Each of these programs use some form of incentive to encourage customers to participate. However,
the amount of the incentives or the nature of the incentives has not been sufficient to bring about
meaningful levels of demand reductions.
DLC programs allow the utility to directly control customer end-uses during certain periods when the
electrical system is under strain. The customer end-uses are directly controlled by the utility and when
events are called, those loads are either shut down, cycled on and off, or moved to a lower consumption
periods. Residential DLC programs often target air conditioners or electrical water heaters. Nonresidential DLC programs include air conditioner systems, lighting and in some regions irrigation control.
There are a number of challenges with DLC programs. First, customers tend to become frustrated with
effects of the service interruptions and oftentimes will leave the program if they are called too
frequently. Second, the incentives offered by the utilities have been insufficient to encourage their
sustained participation.
TOU rates are tariff schedules that are typically offered to residential and small business customers on a
voluntary basis and are mandatory for the largest commercial and industrial customers. The TOU rates
are structured to charge lower rates during a utilitys off-peak and partial-peak periods and higher rates
during seasonal and daily peak demand periods. By charging more during the peak period, when
incremental costs are highest, TOU rates send accurate marginal-cost price signals to customers. TOU
rates encourage customers to shift energy use away from peak periods to partial-peak or off-peak
periods and enable customers to lower their electricity bills. There are two common challenges with
TOU rates. First, the utilities have often set the TOU peak periods to be for long periods at a time, thus
limiting customers abilities to shift their loads to the lower price off-peak periods. Second, the TOU rate
programs tend to be static in nature in that the peak and off-peak prices do not change regardless of
system conditions and the true costs required to deliver electricity to customers. Because of the static
nature of the TOU rates, they cannot be counted on for meeting the peak demand needs of the utility.
In addition, the utilities often design these tariffs to be revenue neutral. That is, the price differentials
between on-peak and off-peak are intended to not change the utilitys overall revenue. This goal
oftentimes is inconsistent with a goal of maximizing customer participation in order to have meaningful
peak demand reductions as a result of the TOU tariff.
Interruptible tariffs are contractual arrangements set up between the utility and large non-residential
customers. Customers agree to reduce their electrical consumption to a pre-specified level, or by a prespecified amount, during system reliability problems in return for an incentive payment or a similar rate
19
discount. Customers are given the incentive regardless of whether reliability events are called. In the
past, these programs were developed mostly for customer retention as the utilities assured customers
that reliability events were so rare and would never be called. However, as reliability problems are
becoming more acute, utilities are calling more interruptible events. As a result, many customers are
opting to negotiate an exit to their contractual obligations for these programs as they cannot tolerate
the volume interruptions to their businesses.
3.2.2. Cost and RisksHow Load Aggregators have Removed Traditional Barriers to DR
Participation
Complicated tariff structures and insufficient incentives are just a few of the challenges utilities face
when trying to garner customer interest in traditional, non-aggregator-based DR programs. Equally
important are the costs and risks customers must bear in order to participate.
While the costs for metering and load control equipment may not always be borne by the customer in
these situations, the exposure to performance penalties remains essentially a constant. Without an
aggregator to guarantee the load response, utilities have no choice but to penalize customers if they
dont fully comply with a dispatch in order to ensure proper response. However, C&I loads are
inherently volatile and customers may not always be able to participate and consequently customers
may need to be willing to face a strong likelihood of penalties if they seek to participate.
Using load aggregators is one proven approach to removing many of these traditional barriers to DR
participation. It is typical that the load aggregator pays all costs for the installation of metering and load
control equipment, making participation for the customer a no-cost proposition. More importantly,
because load aggregators are measured on the total load reduction their entire portfolio of sites
provides, and not on a site-by-site basis, they are able to pool resources in a way that ensures that
contract performance requirements can be met. In the event that performance penalties are assessed
on the aggregator, many will still refrain from passing these onto the customer. Figure 5 illustrates this
concept.
20
Load
Aggregator
Utility/TSO
Figure 5: Aggregated Performance and Risk-Shielding
3.2.3. Avoid Energy Costs vs. Resource Payments

As is evident from the relative lack of uptake in energy-based demand response opportunities in
wholesale markets (where prices are higher and more volatile than what customers face at a retail level),
the economic benefit of avoided energy costs alone is likely to be an insufficient driver of customer
participation. While dynamic pricing may impact this trend in some ways (as discussed in the next
section), currently it is the ability to receive resource payments from DR participation that are driving
customer involvement. In both wholesale market and bilateral programs, aggregators or very large
customers that qualify for direct participation receive a payment from the entity purchasing the DR
resources, either the system operator or the utility.
Whether determined through market pressures or a utility decision, these payments are almost always
based on the avoided costs of providing the same functional service through a traditional supply-side
resource. Aggregators then use a portion of this payment stream to cover their costs of customer
acquisition, site enablement, dispatch and settlement; the remainder is used to pay the customer an
incentive payment for their participation. These payments tend to exist in the same form as those the
aggregator receives, namely energy and capacity. In wholesale markets where very large customers can
participate directly, the customer would individually receive the full payment stream, but would be
responsible for adhering to technical requirements and managing performance risk. For these reasons,
many large customers continue to work with aggregators even when the market requirements dont
make it a necessity.
3.2.4. Emerging Trends: Dynamic Pricing

Dynamic pricing refers to a category of rates that offer customers time-varying electricity prices on a
day-ahead or real-time basis. Prices are higher during peak periods to reflect higher-than-average cost
21
of providing electricity during those times, and lower during off-peak periods, when it is cheaper to
provide electricity. Dynamic pricing incentivizes customers to lower their usage during peak times,
particularly during the most critical hours of the year when peak demands spike and the cost of
acquiring electricity tends to be the highest. Dynamic pricing can take many forms. The most
sophisticated form of dynamic pricing is real-time pricing (RTP). RTP programs are where prices are set
by the utility in near real-time to match the market conditions for available power. Customers must be
able to accommodate whatever price is given, which means that they take a significant risk that if prices
spike they will either accept the higher price or be capable to rapidly reduce their consumption levels to
avoid the high prices. Because of the complexities of RTP programs, most of the examples are in the
pilot stages. Once sophisticated metering infrastructures are put into place and customers have the
necessary building automation systems, it is likely that there will be more RTP programs coming on line
in the future.
Critical peak pricing (CPP) is a less complex form of dynamic pricing. CPP programs are designed such
that the prices for the top 60 to 100 hours are defined ahead of time, but the actual times in which
these prices are in effect is not known until the day before the DR event or sometimes on the same day
as the DR event. The price differentials are intended to be quite steep (oftentimes set at three to fivetimes the peak price) to encourage the customer to reduce or shift their loads during the critical peak
times. CPP programs are offered to all customer types from residential to large commercial and
industrial. A variant of CPP is peak time rebates (PTR). In PTR programs, a standard rate is applied
during all hours but customers can earn a rebate if they reduce their consumption during the critical
peak hours. PTR programs are most applicable to residential customers.
3.3. Summary/Comparative Analysis of Policy and Regulatory Frameworks

The global survey of demand response programs in this report illustrates a variety of regulatory
constructs under which DR can thrive. Fundamentally, all of these regulations and policies in one way or
another attempt to change the traditional paradigm that has historically lead to investments in
additional supply-side infrastructure rather than load management.
Clearly, one method that has been incredibly successful in this regard is the wholesale capacity market.
By removing the type of resource from the decision-making equation altogether and rather basing
procurement decision on price alone, any resource that can meet the necessary market requirements
can be purchased. With more 8-10%, or more, of system capacity met by DR in the PJM Interconnection,
ISO New England, and the Western Australia Independent Market Operator, these markets have shown
a clear ability to drive significant penetration of demand response.
Outside of the established liberalized markets where DR is present, there tend to be more fragmented
regulatory efforts to mitigate but not eliminate the disparity in incentives between supply-side and
demand-side investments by utilities. In fact, one could argue that these multitude of policies and
initiatives are required because in most areas, the underlying financial drivers that encourage a supply-
22
side-focused perspective have not been modified: utility revenue is still tied to the amount of kWh sold,
and the amount of capital they invest in generation and/or network infrastructure.
In many regions, utilities are only allowed to recover their DSM expenditures, but cannot earn a rate of
return in the same manner as they would for supply-side investments. Because of this unequal
treatment, some jurisdictions require their utilities to first pursue DSM programs before they can build
generation assets to ensure solutions that may be cost-effective, but not financially beneficial, are
considered. In other areas, utilities are mandated to reduce the peak demands (and energy
consumption) or face penalties such as in Pennsylvania where there is no financial driver for the
utility to do anything other than build more and more infrastructure.
It is within this environment that the UKs equalisation incentive, is significant as it demonstrates a
way to create true parity of treatment outside of a wholesale market context. While wholesale
generation is competitive in the UK, distribution network operation is not they are regulated
monopolies in the same manner as vertically-integrated utilities in traditionally-regulated markets.
Moreover, in traditionally regulated areas, such a mechanism could be applied to all investments so that
generation (or alternatives to it) were also covered. In many ways, it is the concept of the equalisation
incentive that is most important, and not its exact methodology. A multitude of regulatory mechanisms
could likely be developed that would result in equal financial treatment between supply-side and
demand-side investments, and it is important to not prescribe specific methodologies that may be
better suited for one system than another.
This global survey demonstrates that good program designs are crucial to the success of demand
response, perhaps more so than the existence of a formal market structures. Regardless of how DR
programs or opportunities are engendered, programs must have the essential elements outlined in this
paper in order to be sustainable, whether they are in liberalized markets or operated by verticallyintegrated utilities.
In the wholesale capacity markets profiled in this paper, the programs found in the investor-owned
utilities of California, as well as the program for the public utility TVA, clear similarities are evident. All
such programs and markets are capacity-based, in which demand response resources are paid an
ongoing payment for being available to provide capacity. In addition, all these examples are mainly
targeted at the infrequent, yet expensive, top peak hours of the year. While there is indeed the ability
for DR to provide more frequent response, such as in ancillary service markets, these general peakshaving or emergency-prevention programs are suitable for the widest number of participants and can
therefore lead to the highest levels of customer penetration.
Lastly, the inclusion of demand response load aggregators is another key recipe for success. In wholesale
markets, often only the largest industrial customers can participate directly and aggregators are a
mechanism for small and medium sized C&I customers to participate as well. Yet, even in such
conditions, it is common for customers that could otherwise directly access the market do so instead
through aggregators for the risk-mitigation benefits discussed in this paper. And in both the wholesale
markets and among the regulated utility environments that are indeed more similar to the landscape in
23
China, we see aggregators play two other key roles that contribute to the success of DR. From the utility
or system operator perspective is the ability to provide guaranteed capacity. Once reliability can be
ensured, system planners and operators are subsequently able to depend on the DR resource and
reduce the usage of, or construction of, supply-side infrastructure. Put another way, without these
guarantees, there would be limited ability for investments in demand response that lead to
opportunities for participation among end-users. Equally if not more important is the behind-the-meter
expertise that aggregators offer. With specialized staff and technology able to implement repeatable
curtailment strategies that do not negatively impact commercial business operations, aggregators can
both identify and leverage more capacity, and achieve higher levels of customer participation.
24
Enabling Technology Solutions for Demand Response
4.
Demand Response enabling technology solutions are dependent on the level of automation a particular
facility participating in DR program is capable of. Understanding the functional capabilities of building
control systems, including the underlying technologies and software capabilities as installed, is essential
to identify and quantify a specific facilitys potential to participate in Automated Demand Response
(Auto-DR) and to maximize load reduction savings without affecting day-to-day business or operations.
The three key ways a DR program can be implemented are:
1)
2)
3)
Manual DR: This involves manually turning off or changing comfort set points, lights, or
processes or each equipment, switch, or controller.
Semi-Automated DR: This involves automation of HVAC or one or several processes or systems
within a facility using Energy Management Control Systems (EMCS) or centralized control
system, with the remainder of the facility under manual operations.
Fully Automated DR: This involves automation of an entire facility, with integration of end use
loads into an EMCS and centrally managed with no human intervention.
Regardless of the type, technology plays an important role in the reliable operation of demand response.
4.1. Metering and Control Solutions

Metering
Granular meter data is essential to the successful operation of a demand response program. First and
foremost, it is the foundation of accurate measurement and verification (M&V), which is necessary for
both proper measurement of the performance of the DR resource as well as financial settlement.
Ensuring that DR performs as expected requires real-time data, so that the actual consumption of
participating facilities can be compared to accurate forecasts of what their consumption would have
been should a dispatch not have occurred. Furthermore, real-time metering and data presentment
allows for performance monitoring during a dispatch. For aggregators, this enables them to ensure their
entire portfolio is cumulatively delivering the load reduction required, and if not, allows them to utilize
other resources to provide the proper level of curtailment. From an end-user perspective, particularly
among larger sites responding with some level of manual action, real-time data also allows for them to
ensure they have taken the proper steps necessary to comply with their intended response.
That said, it is important to differentiate between real-time meter data for DR and typically advanced
metering infrastructure (AMI). First, while AMI can facilitate DR it is by no means a prerequisite for
successful deployments. In fact, because AMI deployments are in their early stages, and often focused
on the residential customer classes, most of the technology-enabled DR present today utilizes real-time
meter data by the installation of additional technology. This typically includes directly accessing a utility
meter through analog pulse or digital serial outputs, as well as metering/sub-metering specific loads
such as a generator, and then transferring this information back to the DR aggregator using existing
broadband and wireless infrastructure.
Even when and where AMI is present, it may be insufficient. Most smart meters and their supporting
infrastructure are designed primarily with automated meter reading, and not DR in mind. As such, it is
25
common for these new smart meters to read data every half-hour or hour, and then backhaul the
consumption data once a day. Such infrequent and delayed measurements, while appropriate for AMR
purposes, do not provide the needed functionality for DR aggregators whom need to ensure delivery
standards are met in real time. In this manner, the installation of additional or specialized metering
equipment is likely required even where AMI is present.
Load Control
Load control hardware is another essential component of modern-day, technology-enabled DR
deployments and is often part of the same advanced metering kit that is installed on customer premises.
Many customer types require some level of automation in order to be able to respond to a dispatch
signal. A grocery store, for example, will typically not have an energy or facilities manager on staff able
to initiate curtailment measures. Even if personnel was present, without automation, they would likely
be unable to manually enact common strategies for this customer segment, including HVAC cycling,
partial lighting curtailment, and anti-sweat heater (condensation) control. In other situations, it is the
program requirements that require load control in order to comply with the response time. Ancillary
service programs, and some bilateral utility programs, can have response times of ten minutes, or less.
In fact, frequency responsive DR programs can have even shorter response times. For example, the
Alberta Energy System Operator (AESO) just launched a DR program with a 200-millisecond response
time. With such requirements, automation and load control is an absolute necessity. Yet even in
traditional peak management programs, remote load control is increasingly being utilized for customer
convenience and enhanced resource reliability.
The aforementioned metering/gateway devices installed are often the foundation for initiating load
control as they feature two-way communication. Such devices may toggle relays attached to specific
circuits, send scripts to Building Energy Management Systems (BEMS) to begin pre-defined curtailment
actions, or attach directly to industrial control equipment.
Dispatch, Monitoring and Management
In order to successfully leverage the metering and load control hardware described above, DR providers
commonly deploy Network Operation Centers (NOCs) to utilize the aforementioned foundation
technologies. It is from these NOCs that load aggregators can initiate automatic dispatch notifications to
participating customers, remotely control customer loads and generation, monitor performance in order
to ensure performance compliance, and coordinate technicians in the field.
Centralized control centers also allow DR to comply with telemetry requirements in a cost-effective way.
Some grid operators require resource in some of their markets (e.g. PJM Synchronized Reserves,
National Grid STOR) to be directly integrated into their respective control rooms with remote terminal
units, or other similar equipment. Such generation-grade hardware is expensive, and would be costprohibitive to deploy at individual customer sites.
26
4.2. Auto-DR and OpenADR (with the AMI linkage)

Increasingly, Auto-DR activities in California and in pilots across the U.S. are carried out through Open
communication technologies, namely the Open ADR technology developed by LBNL. Since 2010,
OpenADR is being formally standardized within standard organizations and it is selected by the U.S.
national Smart Grid activity coordinated by the National Institute of Standards and Technology (NIST) as
the only standard to communicate price and reliability-based information.23
In the Open Automated Demand Response Communications Specification (Version 1.0),24 OpenADR is
defined as a communications data model designed to facilitate sending and receiving DR signals from a
utility or independent system operator to electric customers. The intention of the data model is to
interact with building and industrial control systems that are pre-programmed to take action based on a
DR signal, enabling a demand response event to be fully automated, with no manual intervention. The
OpenADR specification is a highly flexible infrastructure design to facilitate common information
exchange between a utility or regional transmission organization (RTO)/Independent System Operator
(ISO) and their end-use participants. The concept of an open specification is intended to allow anyone
to implement the signaling systems, providing the automation server or the automation clients.25
The specification also describes the scope of the OpenADR standard: The Open Automated Demand
Response Communications Specification defines the interface to the functions and features of a Demand
Response Automation Server (DRAS) that is used to facilitate the automation of customer response to
various Demand Response programs and dynamic pricing through a communicating client. This
specification, referred to as OpenADR, also addresses how third parties such as utilities, ISOs, energy
and facility managers, aggregators, and hardware and software manufacturers will interface to and
utilize the functions of the DRAS in order to automate various aspects of demand response (DR)
programs and dynamic pricing. The OpenADR structure is illustrated in Figure 6, with the key features
defined in Box 1.
23
http://collaborate.nist.gov/twiki-sggrid/bin/view/SmartGrid/OpenADR.
Piette, M.A., G. Ghatikar, S. Kiliccote, E. Koch, D. Hennage, P. Palensky, and C. McParland. 2009. Open Automated Demand
Response Communications Specification (Version 1.0). California Energy Commission, PIER Program. CEC-500-2009-063 and
LBNL-1779E.
25
The OpenADR Primer, White paper by the OpenADR Alliance (http://www.openadr.org/).
24
27
Figure 6: OpenADR Structure

Box 1: OpenADR Features
Continuous, Secure and Reliable Provides continuous, secure, and reliable two-way communications
infrastructures where the clients at the end-use site receive and acknowledge to the DR automation sever
upon receiving the DR event signals.
Translation Translates DR event information to continuous Internet signals to facilitate DR automation.
These signals are designed to interoperate with Energy Management and Control Systems, lighting, or other
end-use controls.
Automation Receipt of the external signal is designed to initiate automation through the use of preprogrammed demand response strategies determined and controlled by the end-use participant.
Opt-Out Provides opt-out or override function to participants for a DR event if the event comes at a time
when reduction in end-use services is not desirable.
Complete Data Model Describes a rich data model and architecture to communicate price, reliability, and
other DR activation signals.
Scalable Architecture Provides scalable communications architecture to different forms of DR programs,
end-use buildings, and dynamic pricing.
Open Standards Open standards-based technology such as Simple Object Access Protocol (SOAP) and Web
services form the basis of the communications model.
During a Demand Response event, the utility or RTO/ISO provides information to the DRAS about what
has changed and on what schedule, such as start and stop times. A typical change would specify one or
more of the following:
Price signals: This would include a price multipler, a price relative, or an absoulte price
Reliability signals: This would include the load amount to be shed (difference, load level, or setpoint that a load should go to).
Levels: These are simple representations of the price and reliability signals such as NORMAL,
MODERATE, and HIGH.
28
The standard also specifies considerable additional information that can be exchanged related to DR and
Distributed Energy Resources (DER) events, including event name and identification, event status,
operating mode, various enumerations (a fixed set of values characterizing the event), reliability and
emergency signals, renewable generation status, market participation.
Widespread adoption of OpenADR will accelerate the successful implementation of DR programs

andDER, thereby providing the following four major benefits for all stakeholders:
Lower Costs Standardization lowers development and support costs for vendors and,
ultimately, their utility customers. Standardization also fosters technology innovation and
competition, which expands product choices for both utilities and end users.
Assured Interoperability Electricity providers and consumers alike benefit from being able to
choose from among a wide range of different products and services without concern for any
incompatibility or inevitable obsolescence.
Greater Reliability Products based on robust standards function dependably under normal
circumstances and are able to recover from any anticipated error conditions to deliver
dependable operation.
Enhanced Flexibility OpenADR has been designed to work with existing DR equipment (socalled backwards compatibility), as well as with newer, more sophisticated systems offering
advanced feature sets.
Commercial, industrial and residential customers, and energy aggregators, will all be able to reduce
costs, time and risk in the selection and deployment of products and systems based on the OpenADR
standard. Work being performed by the OpenADR Alliance26will educate these stakeholders about the
benefits of DR, and will increase their confidence in the available solutions with rigorous testing and
certification programs.
As a result, equipment vendors and systems integrators will be able to accelerate the time-to-market for,
and lower the development costs of, innovative products and services, while electric utilities, ISOs and
RTOs will gain faster access to the market, experience lower capital and operational expenditures, and
achieve greater success with DR programs. Even regulatory agencies will benefit from knowing that the
introduction of new pricing policies will not be undermined by incompatibilities or other end-to-end
impediments in the marketplace.
4.3. Smart Meter and Advanced Metering Infrastructure (AMI) and OpenADR
As the use of OpenADR for commercial and industrial facilities has gained significant traction in
California and other parts of the U.S., the Advanced Metering Infrastructure (AMI) and smart home
technologies are currently being implemented on a large-scale basis in residences. The AMI system wide
implementation in California residences by the utilities together with development of the supporting
26
http://www.openadr.org/.
29
technologies has provided opportunity for wide range of system operation and customer management
applications, including communicating DR information through the AMI communication channels. The
AMI communication is not open and accessible outside the utility network. AMI infrastructure can
include smart meter, which is a revenue-qualified device from which charges can be derived. Other
means of measuring power may be used, but they would generally not be qualified for revenue use from
the residence point-of-view, the advanced meter contains valuable information about current and past
power usage. This advanced infrastructure is however, not needed in most DR programs. While the
traditional electrical meters only measure total consumption and as such provide no information of
when the energy is consumed, an interval meter can usually record consumption of electricity in
intervals of an hour or less and communicate that information at least daily back to the utility for
monitoring and billing purposes. In some DR programs, an interval meter is all that is needed for a
customer to be qualified to participate.
LBNL is working with the utilities and other stakeholders to provide an external non-AMI based
OpenADR interface to the residential technologies and home automation networks (HAN). These
interfaces coexist with the AMI infrastructure that the utilities plan to use for their metering and billing
purposes. Figure 7 shows these interfaces where OpenADR can be used as a means of communication
directly with the residential gateway or the end-use devices such as the appliances:27
Figure 7: AMI-HAN Interface

Further details on the home automation technologies and its use within the DR context are available
from previous LBNL studies.28
27
28
Figure courtesy: Ron Hoffman, California Energy Commission.

McParland, Charles. Home Network Technologies and Automating Demand Response. LBNL, 2008. LBNL-3093E.
30
Development And Integration

Of Renewable Energy:
Lessons Learned From Germany
Hans Poser
Jeffrey Altman
Felix ab Egg
Andreas Granata
Ross Board
July 2014
DEVELOPMENT AND INTEGRATION

OF RENEWABLE ENERGY: LESSONS
LEARNED FROM GERMANY
July 2014
Hans Poser
Jeffrey Altman
Felix ab Egg
Andreas Granata
Ross Board
2014 by FAA Financial Advisory AG (Finadvice).

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or
transmitted in any form or by any means, electronic, mechanical, photocopying, recording or any
information storage or retrieval system or method, now known or hereinafter invented or adopted, without
the express prior written permission of the FAA Financial Advisory AG.
This work was prepared by FAA Financial Advisory AG (Finadvice) for the Edison Electric Institute
(EEI) and Finadvices European clients. When used as a reference, attribution to Finadvice is
requested. Although every reasonable effort has been made to ensure the accuracy of this
publication, Finadvice and any person acting on its behalf (a) does not make any warranty, express or
implied, with respect to the accuracy, completeness or usefulness of the information, advice or
recommendations contained in this work, and (b) does not assume and expressly disclaims any liability
with respect to the use of, or for loss and/or damages resulting from the use of any information, advice or
recommendations contained in this work.
The views and opinions expressed in this work do not necessarily reflect those of Finadvice or any
person(s) acting on behalf of Finadvice. This material and its production, reproduction and distribution by
Finadvice does not imply endorsement of the material.
Published by:
Finadvice
FAA Financial Advisory AG
Soodstrasse 55
CH-8134 Adliswil
Switzerland
Office: +41 43 377 1000
Fax: +41 43 377 1005
Website: www.finadvice.ch
Contents
1.
EXECUTIVE SUMMARY ......................................................................................................... 1
2.
INTRODUCTION .................................................................................................................... 8
3.
4.
2.1.
Why Germany? ............................................................................................................ 8
2.2.
Germanys renewable policies and support mechanisms ........................................... 10
GERMANYS RENEWABLE SUCCESS STORY ..................................................................... 16

3.1.
Renewable energy deployment and diversification of the power portfolio ............... 16
3.2.
Emission reductions ................................................................................................... 18
3.3.
Energy independence ................................................................................................. 20
3.4.
Lower wholesale prices .............................................................................................. 20
3.5.
Job creation and expansion of Germanys manufacturing industry ........................... 21
UNINTENDED CONSEQUENCES OF GERMANYS RENEWABLE POLICIES ............................... 26

4.1.
Enormous governmental subsidies for renewables .................................................... 26
4.2.
Ever increasing power prices to residential customers .............................................. 30
4.3.
Impact on national competitiveness ........................................................................... 34
4.4.
Financial impact to thermal generators and reliability ............................................... 36
4.5.
Impact of renewables variability on market operations and thermal plants ............. 42
4.6.
Expansion and additional investment in the power grid ............................................ 47
4.7.
Repeated redesigns and boom and bust cycles........................................................... 50
5. CONCLUSION: TAKEAWAYS OF THE GERMAN AND EUROPEAN EXPERIENCE WITH

RENEWABLES ............................................................................................................................. 58
APPENDIX A: INFLUENCE OF HIGHLY FLEXIBLE GRID DEMANDS ON AGING AND LONG TERM
RELIABILITY OF LARGE TURBINE GENERATOR: AN INSIGHT FROM SIEMENS ............................. 60
APPENDIX B: A PERSPECTIVE FROM THE INSURANCE INDUSTRY ON CHANGES TO THE POWER
INDUSTRY: INSIGHT FROM MARSH ............................................................................................ 65
APPENDIX C: REGULATORY INTERVENTIONS ON VARIOUS SUBSIDIES SCHEMES ACROSS
SEVERAL EUROPEAN COUNTRIES............................................................................................... 69
BIBLIOGRAPHY .......................................................................................................................... 72
References to the Finadvice and the Authors ........................................................................... 78
1. EXECUTIVE SUMMARY
Over the last decade, well-intentioned policymakers in Germany and other European countries
created renewable energy policies with generous subsidies that have slowly revealed themselves
to be unsustainable, resulting in profound, unintended consequences for all industry stakeholders.
While these policies have created an impressive roll-out of renewable energy resources, they
have also clearly generated disequilibrium in the power markets, resulting in significant
increases in energy prices to most users, as well as value destruction for all stakeholders:
consumers, renewable companies, electric utilities, financial institutions, and investors.
Accordingly, the United States and other countries should carefully assess the lessons learned in
Germany, with respect to generous subsidy programs and relatively rapid, large-scale
deployment and integration of renewable energy into the power system. This white paper is
meant to provide further insight into the German market, present an objective analysis of its
renewable policies, and identify lessons learned from Germany, and to a lesser degree, other
European countries.1
The rapid growth of renewable energy in Germany and other European countries during the
2000s was due to proactive European and national policies aimed at directly increasing the share
of renewable production in their energy mixes through a variety of generous subsidy programs.
Two main types of subsidy programs for renewable power developed in Europe include feed-in
tariffs (FITs), which very quickly became the policy of choice for Germany and many other
European countries, and quota obligation systems.
FITs are incentives to increase production of renewable energy. This type of subsidy guarantees
long-term (usually for 20 years) fixed tariffs per unit of renewable power produced. These fixed
tariffs normally are independent of market prices and are usually set by the government, but can
be structured to be reduced periodically to account for technology cost decreases. The level of
1
The authors of this white paper would like to state that they fully support renewables as a part of the overall power
portfolio. All the authors have worked with both electric utilities and purely renewable companies. Some of them
have 20+ years of experience in the power sector, and a couple have direct equity interests in renewable projects.
the tariffs normally depends on the technology used and the size of the production facility.
Because of their generosity, FITs proved capable of quickly increasing the share of renewable
power, but since the FITs are set administratively, it is difficult to meet renewable energy goals
in the most cost-effective way possible.
The quota system is the European equivalent to the Renewable Portfolio Standard used in the
United States. Whereas FIT programs set the price for the resources and let the market achieve
whatever level it can at that price, the quota system is a market based system that sets the desired
amount of renewable resources and lets the market determine its price. Under the quota system,
compliance is proven through renewable certificates that can usually be traded.
Germany used FITs to help finance its energy policy, Energiewende (the energy
transformation), that calls for a nuclear-free and carbon-reduced economy through a vast
deployment of renewable technologies.
Because FITs levels were administratively driven and slow to adapt to the evolution of the solar
market, the incentive became excessively generous, which initiated an uncontrolled development
of renewables, which, in turn, created unsustainable growth with a myriad of unintended
consequences and lessons learned. Accordingly, this analysis will focus on Germany, whose FIT
policies allowed it to realize the highest production of non-hydro renewable electricity (wind and
solar) in Europe.
The most important lessons learned include:
1.
Policymakers underestimated the cost of renewable subsidies and the strain they
would have on national economies. As an example, Germanys FIT program has cost
more than $412 billion to date (including granted and guaranteed, but not yet paid FIT).
Former German Minister of the Environment Peter Altmaier recently estimated that the
program costs would reach $884 billion (680 billion2) by 2022. He added that this figure
could increase further if the market price of electricity fell, or if the rules and subsidy
Amounts in dollars are translated from euros at 1:1.3 exchange rate.
levels were not changed.3 Moreover, it is estimated that Germany will pay $31.1 billion in
subsidies for 2014 alone.4 A recent analysis5 found that from 2008 to 2013, Germany
incurred $67.6 billion (52 billion) in net export losses because of its high energy costs,
compared to its five leading trade partners. Losses in energy intensive industries
accounted for 60 percent of the total losses. This was further highlighted by a recent
International Energy Agency report, which stated that the European Union (EU) is
expected to lose one-third of its global market share of energy intensive exports over the
next two decades due to high energy prices,6 expensive energy imports of gas and oil, as
well as costly domestic subsidies for renewable energy.
2.
Retail prices to many electricity consumers have increased significantly, as subsidies

in Germany and the rest of Europe are generally paid by the end users through a costsharing procedure. Household electricity prices in Germany have more than doubled,
increasing from 0.14/kilowatt hour (kWh) ($0.18) in 2000 to more than 0.29/kWh
($0.38) in 2013. In Spain, prices also doubled from 0.09/kWh in 2004 to 0.18/kWh in
2013 ($0.12 to $0.23) while Greeces prices climbed from 0.06/kWh in 2004 to
0.12/kWh in 2013 ($0.08 to $0.16)7. Comparatively, household electricity prices in the
United States average $0.13/kWh, and have remained relatively stable over the last
decade.
3.
The rapid growth of renewable energy has reduced wholesale prices in Germany,
with adverse consequences on markets and companies. Large subsidies and guaranteed
interconnection to the grid for renewable energy led to unexpected growth over the last 10
years in Germany and elsewhere. The merit order in Germanys wholesale markets
switched as renewables, with a zero variable cost of production, take precedence over
Frankfurter Allgemeine, Energiewende knnte bis zu einer Billion Euro kosten, 19th February 2013;
http://www.faz.net/aktuell/politik/energiepolitik/umweltminister-altmaier-energiewende-koennte-bis-zu-einerbillion-euro-kosten-12086525.htm
4
German Federal Ministry for the Environment, Nature Conservation, Building and Nuclear Safety: Development
of renewable energy sources in Germany in 2012
5
Financial Times, Germans told of billions lost to trade due to energy policy, 26th February 2014,
http://on.ft.com/1cRFiKb
6
Financial Times, Energy price gap with the US to hurt Europe for at least 20 years; 29th January 2014;
http://www.ft.com/cms/s/0/80950dfe-8901-11e3-9f48-00144feab7de.html#axzz2thyHzZc8
7
European Commission, Eurostat,
http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&plugin=1&language=en&pcode=ten00115
thermal plants. As a result, wholesale prices in Germany for base load have fallen
dramatically from 90-95/megawatt hour (MWh) in 2008 to 37/MWh in 2013. This has
created a large amount of load and margin destruction for utilities that built and financed
thermal plants. Many new gas-fired power plants have been rendered uneconomical,
leaving owners to shore up their balance sheets by undertaking large divestitures of some
of their holdings, as well as by reducing their operational costs. The impact to utilities
shareholder value has been dramatic and has come on top of the impact of the global
financial crises, and, in the case of Germany, the decommissioning of nuclear power. The
German utilities have seen their stock plunge by nearly 45 percent since 2010. Some
power plant operators in Germany and other countries, like the United Kingdom, are now
calling for capacity payments to ensure that reliability is maintained and not threatened by
the shutdown of various thermal power stations.
4.
The wholesale pricing model has changed as a result of the large renewable energy
penetration. In the past, wholesale prices followed the demand curve, but in Europe they
now react to the weather; going down when the sun shines and the wind blows, and up
whenat times of high demandthe sun does not shine and the wind does not blow.
Price forecasts and power trading require more skill sets and different know-how,
including weather forecasting.
5.
Fossil and nuclear plants are now facing stresses to their operational systems as these
plants are now operating under less stable conditions and are required to cycle more often
to help balance renewables variability. Investments in retrofits will be required for these
plants in order to allow them to run to these new operational requirements. Moreover,
renewable resources are dramatically changing thermal plants resource planning and
margins. As a result, many of these plants are now being retired or are required to receive
capacity payments in order to economically be kept online.
6.
Large scale deployment of renewable capacity does not translate into a substantial
displacement of thermal capacity. Because of the variability of wind and solar, there are
many hours in the year during which most generation comes from thermal power plants,
which are required to provide almost complete redundant capacity to ensure the reliability
of the system. In turn, grid interventions have increased significantly as operators have to
intervene and switch off or start plants that are not programmed to run following marketbased dispatching. For instance, one German transmission operator saw interventions
grow from two in 2002 to 1,213 in 2013. It is higher amounts of renewables with low full
load hours relative to the total portfolio of power production that creates greater variability
and strains on the grid. In the case of Germany, it is the large-scale deployment of both
wind and solar that has impacted the entire system.
7.
Large-scale investments in the grid are being required to expand transmission grids so
they can connect offshore and onshore wind projects in the north of Germany to
consumers in the south of the country. The total investment cost for the build-out of
German onshore and offshore transmission systems is estimated to be around $52 billion
(40 billion) over the next 10 years. Moreover, the grids are now being challenged to meet
the dynamic flows of variable renewables and require significant additional investment to
accommodate increased penetration of renewables. All of these costs will ultimately be
passed on to electricity consumers. This has not gone unnoticed in Germany or in the EU.
A report was released in late February 2014 by an independent expert commission
mandated by the German government, which concluded that Germanys current program
of incenting renewables is an uneconomic and inefficient means to reduce emissions and
therefore should be stopped 8 . Moreover, the European Commission released new
guidelines on April 9, 2014, with effect starting in 2017 that will correct market
distortions. It will essentially ban all FIT subsidies and introduce technology agnostic
auctions as the only incentives for renewables.
8.
Overgenerous and unsustainable subsidy programs resulted in numerous redesigns

of the renewable support schemes, which increased regulatory uncertainty and
financial risk for all stakeholders in the renewable energy industry. As the lessons
above show, some European renewable energy regulatory regimes were inappropriately
structured, gamed by market players, or made obsolete by market conditions. As a result,
governments and regulators corrected unsustainable regulatory regimes by reducing the
Frankfurter Allgemeine. http://www.faz.net/aktuell/wirtschaft/wirtschaftspolitik/oekostrom-regierungsberaterwollen-eeg-abschaffen-12820227.html
level of subsidies, sometimes retroactively, and modifying the rules of the programs.
These changes often resulted in significant value destruction to various renewable players
and their respective investors. This continued regulatory uncertainty across Europe is
increasing the cost of capital to European renewable companies, which the rating agency
Fitch just recently highlighted as the most likely sector in the European energy market to
receive a downgrade in 2014.
These lessons learned are important and provide factual analyses to assist other countries
electric industry stakeholders in creating more technically-efficient, cost-effective and
sustainable ways to integrate renewable energy.
U.S. stakeholders should take into consideration the lessons learned from Germany and Europe:
Utilities should incorporate those lessons into their strategic planning, load forecasting, financial
planning, trading, and regulatory affairs organizations. Decisions about current and future
investments should then be made with this new analysis in mind.
Renewable companies should calculate appropriately the true costs of grid enhancements,
capacity, and other important measures when submitting their plans to commissioners, investors,
and other stakeholders.
Legislators and regulators should use the lessons learned from large scale integration of
renewables in Germany and elsewhere in Europe to ensure a stable transition of renewables as
part of the overall power portfolio while ensuring high reliability of power, stability of pricing to
all users, as well as minimal value destruction to both utilities and renewable companies.
Finally, consumers must be made aware of the tradeoffs to a large portfolio of renewables and
the necessary requirement for a smooth transition as part of the overall power portfolio.
In conclusion, the lessons learned in Europe prove that the large-scale integration of renewable
power does not provide net savings to consumers, but rather a net increase in costs to consumers
and other stakeholders. Moreover, when not properly assessed in advance, the rapid, large scale
integration of renewables into the power system will ultimately lead to disequilibrium in power
markets, as well as value destruction to renewable companies, utilities, and their respective
investors. The U.S. has the opportunity to incorporate these lessons learned to ensure the
sustainable growth of renewable energy over the long-term, for the benefit of all customers.
2. INTRODUCTION
Over the last decade, well-intentioned policymakers in Germany and other European countries
have created renewable energy policies that have slowly revealed themselves to be
unsustainable, resulting in profound, unintended consequences for all industry stakeholders.
While these policies have created an impressive roll-out of renewable energy resources, they
have also clearly generated disequilibrium in the power markets, resulting in significant
increases in energy prices to most users, as well as value destruction for all stakeholders:
consumers, renewable companies, electric utilities, financial institutions, and investors.
Accordingly, the United States and other countries should carefully assess the lessons learned in
Germany, with respect to generous subsidy programs and relatively rapid, large-scale
deployment and integration of renewable energy into the power system. This white paper is
meant to provide further insight into the German market, present an objective analysis of its
renewable support policies, and identify lessons learned from Germany, and to a lesser degree,
other European countries.9
2.1. Why Germany?

More than any other region in the world, Europe has taken a proactive stance on an extensive
roll-out of renewable forms of energy. Further, Germany has been one of the most aggressive
supporters of renewable power in the world, and, accordingly provides an appropriate case study
of the law of unintended consequences.
As a result of aggressive policies during the last decade, the European Union (EU or Europe) has
increased its gross renewable electricity generation by 50 percent, climbing from 13.6 percent in
2000 to 23.5 percent in 2012. As of 2011, the EU was the worlds second largest renewable
generator (following China with 18.6 percent of total production), providing 16.5 percent of the
worlds total renewable electricity generation (including hydropower). More interestingly, in
2010, the EU produced 70 percent of the worlds electricity net generation from solar
9
The authors of this white paper would like to state that they fully support renewables as a part of the overall power
portfolio. All the authors have worked with both electric utilities and purely renewable companies. Some of them
have 20+ years of experience in the power sector, and a couple have a direct equity interests in renewable projects.
photovoltaics (PV) and 44 percent of the worlds wind generation.10 However, it must be noted,
this market share is decreasing as the United States and China expand both their wind and solar
PV portfolios.
Figure 1. EU 27 Member States: Trends in the share of renewable generation in gross final
energy consumption (EC, 2010)11
60%
50%
40%
30%
20%
10%
0%
2005 RES Share
2010 RES Share
2020 RES Target
Although Germany is not the European country with the highest renewable energy penetration, it
has become the most widely cited case study because of its status as the largest European
producer of non-hydro renewable electricity, its economic importance in Europe, and its muchobserved and replicated support mechanism for renewables, the feed-in tariff (FIT) program.
After decades of experience with policies promoting renewable energy, Germany has become the
focus of global attention with respect to its aggressive renewable policies and their unintended
consequences.
Germany is Europes largest economy, the fourth largest country in the world based on GDP,
and the third largest exporting country in the world. Additionally, Germany also has the single
10
EU Commission Staff Working Document, Energy Economic Developments in Europe, Brussels 22.1.2014.
http://ec.europa.eu/energy/renewables/index_en.htm
11
Eurostat European Commission
largest energy market in Europe, with a total net installed generation capacity of 168 gigawatts
(GW) in 2011 and, with its interconnection to nine surrounding countries through a large
interconnection network, Germany is the second largest European exporter of energy after
France.
2.2. Germanys renewable policies and support mechanisms

The rapid growth of renewable energy in Germany and other European countries is due to
proactive European and national policies aimed at directly increasing the share of renewable
production in their energy mixes through a variety of generous subsidy programs.
2.2.1. Government support for renewable energy
The European Commission (EC) has historically concluded that more renewable energy will
enable the EU to cut greenhouse gas (GHG) emissions and reduce its dependency on energy
imports. It also has created mechanisms to ensure that a strong renewables industry will
encourage technological innovation and job creation.12 To achieve those goals, the EC developed
the first European Directive on renewable energy in 2001, which was amended by a second
directive in 2009 that established the Europe-wide goal of obtaining 20 percent of its total energy
consumption, including all sectors, from renewable sources by 2020.13 The directive also set
differentiated goals for each country, but left it up to them to decide how to achieve their national
target. The EC asked each member state to develop a National Renewable Energy Action Plan
(NREAP) outlining the countrys overall strategy and to submit periodic progress reports.
In 2014, the EU extended climate and energy targets to 2030, requiring an aggregate 27 percent
renewable energy within total energy consumption, and a 40 percent reduction of GHG
emissions (from 1990 levels). This package is not prescriptive and does not require NREAPs.
Instead, it offers states the opportunity to determine policy at a national level.
12
European Commission's Directorate-General for Energy, Online Information platform about strategies for
renewable energy
13
European Commission, Directive 2009/28/EC, 23 April 2009; http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32009L0028:EN:NOT
10
According to the differentiated goals set by the renewables directive, Germanys share of energy
from renewable sources in gross final consumption of energy by 2020 was set at 18 percent. In
its NREAP from 2010,14 the country estimated that renewable energy would account for 19.6
percent of final energy consumption by 2020, with 38.6 percent of renewables in the electricity
sector, 15.5 percent in the heating/cooling sector, and 13.2 percent in the transportation sector.
At the end of 2012, Germanys total renewable generation, including hydropower, represented
23.5 percent of total electric output.15
In addition to European goals, Germany has, for many years, had its own energy policy
promoting renewable energy. The so-called Energiewende, or the energy transformation, calls
for a nuclear-free and carbon-reduced economy through a vast deployment of renewable
technologies. Germanys goal is to reduce carbon dioxide (CO2) emissions by 90 percent from
1990 levels and to provide 80 percent of its electricity generation with renewables by 2050. The
government has also planned the complete phase out of nuclear power by 2022.
2.2.2. Different subsidy schemes around Europe16
As a result of the European renewable directives, all European countries chose their preferred
policies and support mechanisms and later implemented NREAPs to deploy renewable energy.
Two main types of subsidy programs for renewable power developed in Europe include FITs,
which very quickly became the policy of choice, and quota obligation systems.
FITs
FITs are incentives to increase production of renewable energy. This type of subsidy guarantees
long-term (usually for 20 years) fixed tariffs per unit of renewable power produced. These fixed
tariffs normally are independent of market prices and are usually set by the government. The
level of the tariffs normally depends on the technology used and the size of the production
14
European Commission, Action Plans and Forecasts; http://ec.europa.eu/energy/renewables/action_plan_en.htm

of renewable energy sources in Germany
16
Sources: IZES (Instituts fr ZunkunftsEnergieSysteme); Das Erneuerbare-Energien-Gesetz Erfahrungen und
Ausblick Institut der deutschen Wirtschaft Kln, 2012 - Frankfurter Allgemeine Zeitung 21.10.2013 Wirtschaft.
http://blog.insm.de/4770-quotenmodell-versus-einspeisevergutung-aus-der-praxis-lernen/;
http://www.greenpeace.de/themen/energie/nachrichten/artikel/warum_das_eeg_besser_ist_als_ein_quotenmodell/
15
11
facility. Additionally, in some cases, the tariff is scheduled to be lowered periodically by a

defined percentage to account for the assumed technology cost decrease.
The advantage (and also disadvantage) of FITs is that it is independent of the market price. This
mechanism allows fostering a technology that has not yet reached commercial viability, but is
considered an important addition to the production portfolio. In 2004, the FIT for PV power was
457/megawatt hour (MWh), but in 2014, it was only 94.7/MWh.17 This reduction followed a
decrease in the cost of technologies, as well as program redesigns that lowered the subsidy rate.
Because of their generosity, FITs proved capable of quickly increasing the share of renewable
power. Since FITs set the price for resources and not volume, it is difficult to set the height of the
FIT such that the renewable goals are reached as economically as possible. A large FIT target
results in uncontrollable development of qualifying projects, irrespective of the demand for this
power. FITs remove the price risk from project developers and gives policymakers the ability to
decide on the optimal allocation of resources (as opposed to the market). This ultimately leaves
consumers paying for the outcome, and causes value destruction to investors in renewables and
utilities who made investment decisions based upon representations of stable regulatory regimes
as well as the interaction of dynamic market forces.
Like many other European countries, Germany chose FITs as the main support mechanism to
support the renewables goals of the EU, and later developed a more comprehensive plan for the
reduction of carbon emissions known as the Energiewende. Germany introduced the first FIT
law in 1990, aimed at fostering the development of renewable energy and designed to promote
rural economic development and domestic manufacturing. This law was later revised several
times, including in 2000, when the German Renewable Energy Act (Erneuerbare Energien
Gesetz or EEG) created the FIT program that became famous throughout the world and that still
remains today. The German legislation guarantees renewable developers interconnection to the
grid, priority scheduling and dispatch, and a technology differentiated FIT for 20 years. The FITs
applicable to new projects decrease each year by a legal percentage (or by law amendments).
17
Erneuerbare-Energien-Gesetz (EEG) am 1. August 2004 in Kraft getreten 11,

http://www.bgbl.de/banzxaver/bgbl/start.xav?startbk=Bundesanzeiger_BGBl&bk=Bundesanzeiger_BGBl&start=//
*%255B@attr_id=%2527bgbl104s1918.pdf%2527%255D#__bgbl__%2F%2F*[%40attr_id%3D%27bgbl104s191
8.pdf%27]__1400074679965
12
This was meant to ensure price certainty while encouraging technology innovation and costefficiency. This subsidy is socialized and financed mainly by residential consumers, since many
exporting industrial customers are exempt from paying any costs associated with the subsidy in
an effort to maintain global industrial competitiveness. It was the starting block for rapid
increases in renewable energy.
German Renewable Energy Act Erneuerbare Energien Gesetz (EEG)

The German Renewable Energy Act (Erneuerbare-Energien-Gesetz, EEG) is a law that came into
force in 2000 and introduced FITs as the main mechanism to incent and finance renewable energy
projects. The EEG can be seen as the starting point of a tremendous boost of renewable energy in
Germany. The purpose of the EEG is to promote electricity generated from renewables
(hydropower, landfill gas, mine gas, sewage gas, biomass, geothermal, wind, and solar). Due to
changes in market conditions as well as the state of renewable energy in Germany, this law was
reformed several times (EEG 2004, 2009, and 2012) and ongoing modifications are needed to keep
the development of renewable energy up to date and improve the efficiency of its impact.
The main four provisions of the EEG are:
1.
Investment protection through guaranteed feed-in tariffs (FITs). Owners of new plants
receive a fixed rate, the FIT, for every kWh of renewable energy they generate. The FIT
depends on the specific year a plant goes online, its size and technology, and is guaranteed
for 20 years.
2.
Guaranteed interconnection to the grid for renewable energy resources. Every new plant
which generates renewable energy gets a preferential treatment over conventional sources
by the network operator for feeding green electricity into the grid.
3. Decreasing FITs/degressive rates: Every year, the FIT rate decreases for new plants by a
fixed percentage (degression rate). Initially, the degression intended to give renewable
owners an incentive to lower the costs.
4.
Socialized and financed by customers, not the government. The FIT is not paid with
governmental funding, but instead is completely financed by markets and consumers.
Renewable generation is sold into wholesale markets and receives the market price. The
difference between the market price and the government set, predetermined FIT, is paid for
by consumers as part of their electricity bills. This portion is called the EEG levy or
renewable energy levy (or surcharge). The levy is not applied equally to all consumer
types. Industrial consumers pay only a fraction or, in the case of energy intensive
industries, are completely exempted.
13
Quota obligation
The quota system is the European equivalent to the Renewable Portfolio Standard used in the
United States. All players, such as energy producers, retailers, and end-use consumers, have to
produce and/or consume a specific amount of renewable power, which is set by the government.
The price paid for the renewables is set by the market and the actual production or usage of
renewable energy is proven through certificates, which are given out once power is produced
from renewable energy. Since these certificates are tradable, at least within the specific country,
it is possible either to produce renewable energy on ones own or to buy certificates from other
producers. There are government sanctions in place in case market participants dont fulfill the
quota. The quota system is used by various European countries, such as Sweden, Belgium, the
UK, and the Netherlands, but the regulations and details (number of certificates per kilowatt hour
(kWh), limit of quotas, etc.) vary among the nations.
Figure 2. Incentive schemes in Europe18
The quota system is a market-based system. It aims at lowering costs during the roll-out of
renewable energy. It exploits the cheapest possibilities of renewable energy production available
18
Frankfurter Allgemeine Zeitung 21.10.2013
14
given a certain demand. This system displays much price competition between different
renewable energy technologies. Sometimes, it is argued, quotas do not give sufficient investment
security to producers of renewable power, which in turn increases the need for a subsidy.
Yet another subsidy mechanism is feed-in premiums, which offer a premium for the ecological
value added in addition to the market price of electricity. As they are not very common in Europe
they are not explained in detail in this document.
15
3. GERMANYS RENEWABLE SUCCESS STORY

Germanys experience with renewables has often been portrayed as a success story. It
undoubtedly met one of the objectives set by the EEG: the promotion of renewable generation. It
remains unclear, however, how successful Germany has been in meeting the other stated goals of
its renewable energy policy: mainly climate change mitigation, energy independence, reduction
of fuel costs, conservation of fossil fuels, local economic development, and expansion of the
domestic manufacturing base.
3.1. Renewable energy deployment and diversification of the power portfolio

Germany experienced rapid growth of renewable energy. In 2012, renewable energy generation,
including hydropower, accounted for 23.5 percent of total power consumption in Germany, up
from 11 percent in 2005.19 Renewable generation grew from 4.3 percent (19.000 GWh) of total
power consumption in 1990 to 23.5 percent (140000 GWh) in 2012. As the potential for
additional hydropower is limited due to topographic preconditions, Germany had to resort to
wind and solar, as well as biomass. All of these resources showed impressive growth rates in the
last decade.
It is worth noting the difference between resources with high capacity factors, like biomass and
hydropower, and those with lower capacity factors, like solar PV. Electricity from biomass, for
example, has grown proportionately more than its installed capacity, whereas solar PV has
required a lot more investment for a much lesser impact on the electricity mix.
19
of renewable energy sources in Germany. http://www.erneuerbare-energien.de/die-themen/datenservice/zeitreihenentwicklung-ab-1990
16
Figure 3. Germany - Installed renewable energy capacity (MW), 1990-2012

90,000
80,000
Geothermal
70,000
Biomass
Solar PV
Onshore Wind
Oshore Wind
Hydro
MW
60,000
50,000
40,000
30,000
20,000
2008
2009
2010
2011
2012
2008
2009
2010
2011
2012
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
10,000
Figure 4. German renewable energy generation20

140,000
Geothermal
Onshore Wind
120,000
Biomass
Oshore Wind
Solar PV
Hydro
GWh
100,000
80,000
60,000
40,000
20
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
20,000
of renewable energy sources in Germany. http://www.erneuerbare-energien.de/die-themen/datenservice/zeitreihenentwicklung-ab-1990/
17
3.2. Emission reductions

According to the European Renewable Energy Council, in 2009 alone, through the use of
renewable energy sources in the EU, carbon dioxide (CO2) emissions were reduced by about 340
million metric tons, or 7 percent, against 1990 levels (calculations are based on the GEMISmodel [Global Emission Model for Integrated Systems]). Given a carbon price of about 15/t in
2009, this emission reduction benefit equals around 51 billion.21
Figure 5. CO2 emissions worldwide (million metric tons)22
China
India
Russia
France
Japan
Canada
United Kingdom
Germany
Europe
United States
-1,000
1,000
2,000
3,000
Net Change 2005-2011
4,000
5,000
2011
6,000
7,000
8,000
9,000
2005
Without a doubt, renewables have helped achieve the CO2 goals, thereby taking some of the
burden from other emission sources and keeping the CO2 certificate prices lower than they would
have otherwise been. From 2005 to 2011, Germanys CO2 emissions declined by 99 million
metric tons, or 12 percent.
21
22
European Renewable Energy Council. http://www.erec.org/statistics/co2.html

US Department of Energy, Energy Information Administration, International Energy Statistics,
http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=90&pid=44&aid=8&cid=regions,&syid=2005&eyid=20
11&unit=MMTCD
18
Yet, since 2009, a number of factors have led to an increase in German emissions: low prices for
CO2 certificates, low coal prices in comparison to natural gas prices, larger power generation
needs due to the increase in electricity consumption in response to the economic recovery, the
decommissioning of nuclear plants, and the increase in power exports. It is interesting to note
that the United States is the country that has achieved the greatest reductions in CO2 emissions,
helped by significant fuel switching to natural gas.
Figure 6. CO2 emissions from the power sectors generation in Germany23
450
400
350
Million tons
300
250
200
150
100
50
0
While in most circumstances renewable energy contributes to reducing GHG emissions, there
have been voices that have contested the suitability of FITs as a tool to reduce emissions. A 2009
report24 estimated that while carbon allowances were at the time trading at around $20/metric ton
CO2e, PV had an estimated abatement cost of $1,050 per metric ton CO2e, and wind had an
abatement cost of around $80 per metric ton CO2e. These results suggest that FITs have
produced unnecessarily expensive outcomes.
23
24
Eionet, Central Data Repository; http://cdr.eionet.europa.eu/de/eu/ghgmm/envutt6ka/index_html?&page=2

RWI (2009) Economic impacts from the promotion of renewable energies: The German experience, Essen,
Germany.
19
3.3. Energy independence

Energy independence is desirable for every country, and certainly for Europe. Unlike the United
States, which has a long-term estimated supply of 2,400 trillion cubic feet of recoverable natural
gas reserves,25 and 29 billion barrels of oil reserves,26 the EU is the worlds largest energy
importer. Fifty five percent of the EUs total energy supply comes from imports. In 2012, the
region imported 84 percent of its oil consumption and 64 percent of its natural gas consumption.
The EU is keenly aware of its dependence on fuel sources, as was exemplified in January 2009,
when 18 European countries suffered major disruptions of natural gas supplies, or in some cases,
complete cutoff, during the dispute between Russia's Gazprom and Ukraine's Naftohaz Ukrayiny
over prior debts, gas supplies, and prices. European countries that import gas from Russia
received severe drops in pressure in their pipelines that affected countries as far as the United
Kingdom. Needless to say, at the time of this writing, the EU is acutely aware of these issues,
given the disputes between Russia and Ukraine with respect to Crimea, whereby the EU is
considering sanctions against Russia, with the expectation that supply of natural gas from Russia
may be possibly withheld.
As will be discussed later, competitiveness and energy independence are intimately related. A
recent International Energy Agency report released on January 29, 2014, stated that the EU is
expected to lose one-third of its global market share of energy intensive exports during the next
two decades due to high energy prices, the majority of which is due to the high cost of energy
imports, such as gas and oil.27 Renewables help reduce the dependency on imported fossil fuels,
thereby reducing the risk of possible price shocks.
3.4. Lower wholesale prices

European wholesale power prices have declined in recent years. The reasons for this include
increased participation of renewables in the market (especially PV during the day, reducing high
25
Speech of Gregg Kantor Chairman of American Gas Association, NARUC Winter Committee Meetings, February
11, 2014
26
The Wall Street Journal, U.S. Oil Reserves Continue to Bulge, August 1, 2013.
http://online.wsj.com/news/articles/SB10001424127887323681904578641871449942246
27
Financial Times, Energy price gap with the US to hurt Europe for at least 20 years, 29th January 2014.
20
mid-day prices), abundant and cheaper coal from the United States as a result of the impact of
increased development of shale gas resources on American fuel markets that make exporting
coal more economical, and the global financial crisis. While lower wholesale prices are
problematic for power producers who struggle to obtain adequate compensation in the market for
their costs, reduced wholesale prices have helped to keep retail market prices from rising as
much as they otherwise would have by providing some savings that help to offset a portion of the
cost of the renewable subsidy. Given the ever-increasing large amount of subsidies, retail rates
would have increased even more if wholesale prices had not declined. However, as will be
explained later, sharp decreases in wholesale prices are unsustainable, as owners of generating
units will be unable to keep uneconomical plants in service. In turn, many of these plants will
ultimately be required to receive capacity payments in order to be online to provide back-up
power for periods of power variability.
3.5. Job creation and expansion of Germanys manufacturing industry

The rapid growth of renewable energy created new jobs in the industry. In 2012, the German
renewables industry employed 378,000 people,28 which accounted for four times the amount of
jobs in 2000. During the time of greatest growth, 2004-2010, renewable energy jobs grew around
129 percent. Although biomass is the sector that has traditionally employed the most Germans,
most of the growth occurred in the solar energy sector, which went from about 25,000 jobs in
2004 to nearly 120,000 in 2010. During this timeframe, the other technologies remained
relatively stable. Wind energy jobs, however, increased to 100,000 in 2009, but decreased
slightly in 2010 and beyond.
28
Agentur fr Erneuerbare Energie - Agency of Renewable Energy Data and Figures about employment in
renewable energy. http://www.unendlich-viel-energie.de/themen/wirtschaft/arbeitsplaetze/artikel367
21
Figure 7. Jobs attributable to renewable energy in Germany: 2004-201029

140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
Wind Energy
2004
Biomass
2007
Solar Energy
Hydropower
Geothermal
2009
2010
After rapid growth, 2012 saw a slight decrease in the number of renewable jobs, due, for the
most part, to a reduction of employment in the solar industry. German officials, however, expect
that growth in the wind and biomass industries will continue to grow strongly.30
In 2012, biomass, wind, and solar shared almost equal parts of renewable energy jobs. Biomass
accounted for 34 percent of the total, followed by wind (31 percent) and solar (27 percent).
Geothermal, hydro, and other renewables rounded out the total. These figures are converse with
respect to the overall deployment of renewables themselves, which is likely due to the capital
intensity, stage of development of technologies, and economies of scale and scope.
29
30
OSullivan, et al, 2011

renewable energy. http://www.unendlich-viel-energie.de/themen/wirtschaft/arbeitsplaetze/artikel367
22
Figure 8. Renewable energy employment in 201231

Geothermal, 4%
Hydro, 2%
Other, 2%
Solar, 27%
Biomass, 34%
Wind, 31%
The development of renewable energy in Germany and other countries fostered growth in the
German manufacturing industry. Germany is Europes leading PV manufacturer and is the
largest manufacturer of inverters in the world.32 The growth of renewable energy throughout the
world has allowed Germany to expand its wind and solar manufacturing base. However, other
countries have also expanded their capabilities, thereby hurting German domestic manufacturers,
which have tended to be more costly than their foreign counterparts. Historically, a considerable
share of PV modules installed in Germany has come from China and Japan. In 2006 and 2007,
for instance, about half of PV module demand was covered by imports. Also, the boom and bust
cycle that FITs created in the solar market has left some German manufacturers in a precarious
situation, while Asian manufacturers have been the greatest beneficiaries of German and other
European countries programs.
Despite recent difficulties in the solar market, it is expected that new renewable energy jobs will
reach 500,000 in 2020.
31
renewable energy. http://www.unendlich-viel-energie.de/themen/wirtschaft/arbeitsplaetze
32
Id.
23
Figure 9. Job creation in renewable energy in Germany 33

600,000
500,000
400,000
300,000
200,000
100,000
-
1998
2000
2002
2004
2006
2008
2010
2012
2020
Yet, there is some controversy around this issue.34 While there is no doubt that the growth of the
renewable market led to new jobs, like in the case of emissions reductions, it is less clear if it
happened in an efficient way. For example, if 380,000 jobs were created in 2012, and 14 billion
were disbursed in payments to renewables that same year (total amount of EEG levy per year.),
then it can be calculated that each job received a 35,000 subsidy per year.
Moreover, the total net employment is called into question when assessing the total macroeconomic impact. A recently published study by the Institute on the Future of Labor states that
the increasing trend of electricity prices affects jobs in other sectors. This study calculates that
the increase of the EEG levy from 5.28 eurocents/kWh in 2013 to 6.24 eurocents/kWh in 2014,
will lead to the loss of around 86,000 jobs, or 1.4 percent.
33
renewable energy. http://www.unendlich-viel-energie.de/themen/wirtschaft/arbeitsplaetze
34
EEG- Jobmotor oder Jobkiller? www.energie-fakten.de/pdf/eeg-job-motor.pdf
24
On the other hand, as Germanys industrial sector is exempt from EEGs surcharge, a reversal of
this support and its direct impact to industrial jobs could translate into a significant loss of jobs.35
With respect to the renewable manufacturing sector, the PV industry provides a good example of
what could happen to other industries when Germany reduces the subsidy. There have been
several recent bankruptcies of various solar and wind manufacturers, as well as service
providers. For example, in the last two years, the total number of solar cell and module
production employees has fallen from 10,196 to 5,973.36 The same trend applies to conventional
power plants. Due to the transition to renewable energy and the need of conventional plants only
as backup, many of these plants have been turned down or closed definitely. It is estimated that
these actions will impact around 200,000 thermal power plant employees. 37
In sum, several industries in Germany have benefited from the development of renewable energy
sources and, as a result, a large number of additional jobs have been created. Nevertheless, it has
to be pointed out that generous subsidies are having adverse macroeconomic effects in other
areas of the economy. Also, due to an increasing level of global competition in the solar market,
especially due to the extraordinary cost efficiency of Chinese companies, German manufacturing
companies are suffering and, as a consequence, job creation is struggling.
35
Die Welt: Ende der EEG-Privilegien gefhrdet eine Million Jobs 07th November 2013; Handelsblatt Online:
Altmaier reist mit radikalem kostrom-Plan zur EU 07th November 2013
36
Die Welt: Deutschlands Solarbranche lst sich auf 20th April 2013.
http://www.welt.de/wirtschaft/energie/article121621919/Ende-der-EEG-Privilegien-gefaehrdet-eine-MillionJobs.html; http://www.handelsblatt.com/politik/international/foerderung-metallindustrie-eine-million-jobsbedroht/9039578-2.htm
37
Wirtschaftswoche: Reservekraftwerke werden Milliarden verschlingen 05th February 2014
25
4. UNINTENDED CONSEQUENCES OF GERMANYS RENEWABLE

POLICIES
While there have been some positive impacts from increased development of renewables in
Germany, with respect to emissions reductions, diversification of the power portfolio, and energy
independence, there have also been challenges and problems associated with this evolution.
Large subsidies brought about rapid deployment of renewable energy that resulted in increased
costs for most types of consumers, additional investment needs for transmission lines and other
integration capabilities, disequilibrium in wholesale markets with the potential of seriously
affecting reliability, and unsustainable costs to the economy, resulting in repeated redesigns and
realignments of renewable policies and support schemes that led to boom and bust cycles
detrimental to the renewables and power industries.
4.1. Enormous governmental subsidies for renewables

Germanys FIT program has cost more than $412 billion to date (including granted and
guaranteed, but not yet paid FIT). Former German Minister of the Environment Peter Altmaier
recently estimated that the program costs could reach $884 billion (680 billion) by 2022. He
added that this figure could increase further if the market price of electricity falls, or if the rules
and subsidy levels are not changed.38 It is estimated that Germany will pay $31.1 billion in
subsidies in 2014 alone.
Enormous, guaranteed FITs for PV led to very rapid, unexpected growth of PV installations
during the last few years in Germany. As technology improved, costs decreased and generous
subsidies made installing PV a lucrative business. While the installation of wind turbines was
relatively stable at around 2 GW since 1999, the growth of PV exploded in 2009. Between 2010
and 2012, Germany built 21 GW of PV, around 7 GW a year.
38
Frankfurter Allgemeine Zeitung: Energiewende knnte bis zu einer Billion Euro kosten 19th February 2013.
http://www.faz.net/aktuell/politik/energiepolitik/umweltminister-altmaier-energiewende-koennte-bis-zu-einerbillion-euro-kosten-12086525.html
26
Figure 10. Annual renewable energy capacity additions in Germany, 1990-2021

8,000
7,000
6,000
MW
5,000
4,000
3,000
2,000
1,000
0
Wind
Solar PV
Biomass
Given the long planning and construction periods of traditional power plants, (for example, the
new nuclear plant in Olkiluoto, Finland, with 1.7 GW, is in the tenth year of construction) this
rapid deployment of renewables can only be described as a macroeconomic shock. The
development of 21 GW of PV in only three years blindsided the energy market. The speed of
capacity additions made it impossible for the market and the generation fleet to adjust
appropriately.
The fast growth in PV was unexpected. The system and respective market players were unable to
plan the amount of capacity that was coming online. In 2012, Peter Terium, CEO of RWE,
Germanys largest power generator, said that the prices for PV modules had decreased to an
extent that RWE did not consider possible. The impact has been material to RWE and other
German energy companies. As an example, RWE recently reported a net loss in 2013 accounts
for 2.8 billion accompanied from write-downs of approximately 4.8 billion which was
attributed to the huge increase in solar and wind capacity. This is RWEs first full year loss since
the foundation of the Federal Republic of Germany in 1949.39 Moreover, it was not just the
39
RWE, RWE posts first net loss in 60 years. http://www.rwe.com/web/cms/en/113648/rwe/press-news/pressrelease/?pmid=4010679
27
utilities, but also research institutions that underestimated the growth of the renewables. For an
industry that has long-term technical and investment lifetimes, this created system disruptions
that led to value destruction.
Because of the large amount of renewable plants coming online, the EEG levy increased steadily
from 0.19 eurocents/kWh in 2000 to 6.24 eurocents/kWh in 2014. Future development is unclear
and experts expect a value between 5.8 and 6.8 eurocents/kWh40 for 2015. The main drivers of
the increase in the EEG levy over the years have been the rapid increase in renewable energy
(especially in expensive PV), the levy exemptions for industry, and the decreasing price of
renewable energy in the wholesale market.
Figure 11. Development of EEG subsidy and EEG levy41
6.24
5.28
20
5
15
4
24
10
20
2.05
13 14
0.65
0.19
3
2
EEG levy (Euroct/kWh)
EEG Cost per year (billion )
25
1
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
EEG cost per year (Billion )
EEG levy (Euroct/kWh)
In absolute terms, the EEG subsidy for renewable energy has increased dramatically. While in
the years between 2000 and 2003 the total amount of the levy for renewable energy was around
40
Netztransparenz: German transmission system operators. http://www.netztransparenz.de/de/JahresMittelfristprognosen.htm

41
Federal Ministry for the Environment, Nature Conservation and Nuclear Safety: Development of renewable
energy sources in Germany. http://www.erneuerbare-energien.de/die-themen/datenservice/zeitreihen-entwicklungab-1990/ (updated 15.10.2013)
28
1 billion per year, it surpassed the 20 billion mark in 2013, and is estimated to approach 25
billion in 2014.
Taking a closer look at the EEG and the distribution of average FITs for existing renewable
projects among the different technologies, figure 12 illustrates the huge differences that persist
between technology types, both in the rate and its trend over the last years. The highest support is
dedicated to PV, although the numbers in 2012 are only two-thirds of what they were in 2006. In
total, the average FIT to plants without direct marketing increased from 89/MWh to
approximately 230/MWh, as the share of high, albeit decreasing, PV FITs increased.
Figure 12. Development of average FIT rates paid out to all existing EEG plants divided
per technology in Germany (/MWh)42
600
500
/MWh
400
300
200
100
0
Hydropower
2002
2003
Biomass
2004
Geothermal Wind onshore Wind oshore

2005
2006
2007
2008
2009
PV
2010
Average
2011
2012
In 2014, payments to solar PV will account for almost half of the total EEG levy, followed by
biomass and onshore wind.
42
Netztransparenz: Information platform run by the 4 German transmission system operators. http://www.eegkwk.net/de/EEG-Umlage.htm
29
Figure 13. Share of renewable technologies to the EEG levy, 201443

Other!
2%!
Offshore wind!
6%!
PV!
47%!
Onshore wind!
20%!
Biomass!
25%!
4.2. Ever increasing power prices to residential customers

Retail electricity prices have increased in Germany due in part to the generous subsidies for
renewable energy. The two figures below show an increase in household electricity prices from
0.14/kWh in 2000 to 0.21 /kWh in 2007 to 0.29 /kWh in 2013. There are diverse reasons
behind the increase in retail electricity rates, including the considerable growth of taxes and
charges. While taxes and charges accounted for 25 percent of the total price in 1998, they were
responsible for around 40 percent of the total price in 2012. Also, the price of electricity
(including procurement, transmission, and distribution) has increased slightly, as a result, in part,
of additional grid costs and balancing needs associated with increased renewable penetration.
Finally, while the EEG levy only contributed slightly to the price of electricity in the first years
of its introduction (1.4 percent in 2000), it is now one of the main factors contributing to the rise
of retail electricity rates (18 percent in 2013). The EEG levy grew from 0.013/kWh in 2009 to
43
PV Magazine, Germany: EEG levy increases in 2014, http://www.pvmagazine.com/news/details/beitrag/germany--eeg-levy-increases-in-2014_100013038/#axzz2vf5eJZkV
30
0.053/kWh in 2013, or 240 per year per citizen, and is expected to grow to 0.062/kWh in
2014.
Figure 14. Evolution of residential power prices44
35
30
euroct/kWh
25
20
15
10
5
0
2007
2008
EEG levy
2009
2010
2011
2012
2013
Power costs, taxes and other charges
Electricity price increases went mostly uncontested in Germany because of two main factors.
First, electricity expenses are only a small part, about 2.5 percent, of the overall expenditures of a
regular German household. Second, there was initial strong support for the Energiewende and
the readiness to bear additional costs. However, there are signs indicating that further unchecked
price increases risk diminishing the popular support for the Energiewende, which is the main
reason why Germany is currently working on a complete change of the existing EEG system.
Other European countries have had similar experiences with rapidly rising electricity prices. In
the EU-28 area, the household electricity price rose by 11.7 percent between 2011 and 2013,
while the industrial price rose by 9 percent. It is worth noting that the countries with the highest
electricity prices, Denmark (0.30/ kWh) and Germany (0.29/kWh), also have significant levels
of renewable energy; whereas the countries with the lowest prices, Bulgaria (0.09/kWh),
44
Agentur fr Erneuerbare Energie Agency of Renewable Energy
31
Romania (0.13/ kWh), and Estonia (0.14/kWh), have more traditional electric-generating
resources.
Figure 15. Breakdown of household prices in Germany, 201345
Distribu`on costs,
10.70%
Grid charges, 20.60%
EEG levy, 6.40%
Concession levy,
13.80%
Taxes, 24.40%
Energy costs, 24.10%
A further analysis confirms that a correlation exists between the amount of variable renewable
energy capacity that a country has (PV and wind) and its household electricity prices including
taxes, levies, and value added tax. The figure below measures the capacity of PV and wind plants
in watts (W) per capita. A trend can be detected which shows that higher W per capita will result
in higher electricity prices. While the majority of European countries have a low/medium level
of capacity, with a level under 300 W per capita, other countries show a higher level of capacity
and, accordingly, increased electricity prices. Leading countries in this analysis are Denmark and
Germany, followed by Spain, Italy, and Belgium.
45
Bundesnetzagentur: Federal Network Agency.

http://www.bundesnetzagentur.de/SharedDocs/Downloads/DE/Sachgebiete/Energie/Verbraucher/PreiseUndRechn
ungen/WieSetztSichDerStrompreisZusammen.pdf;jsessionid=0B318530B0B7F0F3325CB5CA631C83F7?__blob
=publicationFile&v=2
32
Figure 16. Comparison of the amount of wind and solar capacity and electricity prices,
selected countries, 201246
PV+wind capacity in Wacs per capita
900
Denmark
Germany
800
700
600
Spain
500
Italy
400
Greece
300
Bulgaria
200
US
Estonia
100
Czech Republic
UK
10
Belgium
Austria
Netherlands
France
Finland
Romania
Sweden
15
20
25
30
35
Electricity price (euroct/kWh)
The rise in electricity prices has spurred a new debate in Europe about a new energy poverty. A
recent front cover of the popular German magazine Der Spiegel titled Luxury Electricity: Why
energy will always be more expensive and what politicians have to do against it and showing
gold-plated and diamond-encrusted power cables, succinctly summarized the mood of the
German public toward high energy prices. The article discussed Germany's aggressive and
reckless expansion of wind and solar power (that) has come with a hefty price tag for consumers
and the costs often fall disproportionately on the poor.47
According to the EU Fuel Poverty Network,48 a portal established with the aim of bringing
together energy researchers and practitioners from across the EU, energy poverty occurs when a
household is unable to afford the most basic levels of energy for adequate heating, cooking,
46
Wikipedia, Solar energy in the European Union,

http://en.wikipedia.org/wiki/Solar_energy_in_the_European_Union; US Department of Energy, Energy
Information Administration
47
Germanys Energy Poverty: How Electricity Became a Luxury Good, Der Spiegel, 4 Sept. 2013
48
The EU Fuel Poverty Network has become the leading online portal for information about EU fuel poverty and
aims to bring together researchers and practitioners from across the European Union who are working in the field
of fuel poverty in order to facilitate discussion, further the dialogue on across the EU and provide a platform for
researchers and practitioners
33
lighting, and use of appliances in the home. While this phenomenon was initially only British49,
it is now expanding to the whole EU as electricity and natural gas prices increase throughout the
continent.
In November 2013, after many years of promoting FITs as an effective mechanism to support
renewable energy development, the EC hinted at the need to reform or end renewable subsidies,
and the need to support fossil generation that backs up renewables. The EC stated that (i)n some
cases, state intervention in energy markets may be necessary in order to ensure security of supply
and to achieve climate objectives and that (a)s technologies mature, renewables should
gradually be exposed to market prices and eventually support must be fully removed.50 As will
be described later, the EC will ultimately remove all FIT schemes starting in 2017.
4.3. Impact on national competitiveness

Concerns about the impact of high energy prices on national competitiveness are growing. In
January 2014, the EC released a communication on a policy framework for climate and energy51
that warned of the particularly high risk for industries that have high share of energy costs and
which are exposed to international competition (p.10). At the World Economic Forum Annual
Meeting in early 2014, energy prices and competitiveness was one of the biggest themes.
Participants observed the growing competitiveness gap between Europe and the United States,
contrasting the United States shale revolution and abundant domestic natural gas supplies
with Europe, where industrial electricity prices are much higher than in other parts of the world
because of a pell-mell push toward high-cost renewable electricity (wind and solar), which is
imposing heavy costs on consumers and generating large fiscal burdens for governments. 52
The rise in German power prices does not only apply to residential consumers, but also to
industry consumers. In this case the main factors contributing to the end price are represented by
the procurement costs. For medium-sized enterprises, the additional part is denoted by taxes and
49
Fuel Poverty: a Framework for Future Action, Department of Energy and Climate Change, July 2013
EC Communication, Guidance to Member States on state intervention in electricity markets; November 2013;
http://ec.europa.eu/energy/gas_electricity/internal_market_en.htm
51
EC Communication, A policy framework for climate and energy in the period from 2020 to 2030, 22nd January
2014. http://ec.europa.eu/energy/doc/2030/com_2014_15_en.pdf
52
Daniel Yergin, US vs. Europe: Energy battle heats up, CNBC, http://www.cnbc.com/id/101365772
50
34
charges, which has gained a higher portion over the last few years, reaching about one-third of
the final price in 2012.
For energy-intensive industrial consumers, such as paper, aluminum (non-iron metals), steel, and
cement, electricity prices are a critical factor in economic competitiveness. These consumers
represent an important part of the German economy and are therefore exempt from paying the
EEG levy. 53 The aforementioned industries account for around 40 percent of the power
consumption, although they represent only a small portion of the total number of privileged
companies (10 percent).
As the next table shows, a huge number of companies benefit from privileged treatment
regarding power prices, and that number is steadily increasing.
Figure 17. Exempted companies and power consumption in power-intensive industries
(2012/2013)54
Exempted companies
Consumption (GWh)
Ratio consumption/
companies (GWh)
Paper
107
14,062
132
Aluminum
40
10,699
267
Steel
37
11,945
323
Cement
25
3,738
150
Total: power intensive

industries
209
40,464
194
Total: ALL industries
2,057
107,477
52
The share of total production costs attributable to electricity expenses varies between 7 percent in
the paper industry and 40 percent in the aluminum industry, meaning electricity price increases
have a great impact on total production costs.
53
54
Forum kologisch-soziale Marktwirtschaft by order of Greenpeace e.V.: Strom- und Energiekosten der Industrie
of renewable energy sources in Germany. www.erneuerbare-energien.de/.../ee.../hintergrundpapier_besar_bf.pdf
35
Figure 18. Share of total production costs for power-intensive industries55

100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Paper
Other costs
Aluminum
Sta
Steel
Raw material
Fuel
Natural Gas
Cement
Electricity
For power-intensive industry companies, this special treatment is without a doubt an important
benefit and enables them to stay competitive. Current calculations state that the exemptions
given to German industrial companies will account for a total of 5 billion in 2014.56
Because of the advantage that this exemption brings to large German exporting industries, these
exemptions are now being challenged by the EC, which is planning to examine the special
treatment that the above mentioned German companies are enjoying, and determine whether this
situation violates the principle of fair competition.
4.4. Financial impact to thermal generators and reliability

Large penetration of renewable energy has not only translated into higher costs for the economy,
it is also having profound effects on wholesale electricity markets that could ultimately result in
a deterioration of the countrys reliability. Subsidized renewables have dispatch priority over
55
Forum kologisch-soziale Marktwirtschaft by order of Greenpeace e.V.: Strom- und Energiekosten der Industrie.
http://www.greenpeace.de/fileadmin/gpd/user_upload/themen/energie/2012-FOES-IZES-VerguenstigungenIndustrie.pdf
56
Frankfurter Allgemeine Zeitung: EEG-Umlage: Welche Firmen mssen knftig zahlen? 19th February 2014.
http://www.faz.net/aktuell/wirtschaft/wirtschaftspolitik/oekostrom-eeg-umlage-welche-firmen-muessen-kuenftigzahlen-12808022.html
36
thermal generators and come first in the markets merit order, thus depressing wholesale prices
to levels that are making thermal plants uneconomical. At the same time, increasing amounts of
renewables require increasing amounts of back-up and balancing power that only thermal plants
can provide. The implications of these developments for reliability are evident.
4.4.1. Impact on wholesale markets: Subsidized renewables first in merit order and low
wholesale prices
While it is the total costs that determine investment decisions for power plants, it is the variable
costs that determine if an existing power plant runs at any given time. Therefore the offer curve
of a power market is determined by the marginal costs in ascending order of the available power
sources. This is the so-called merit order. If there is an increase in demand, then plants are turned
on, starting with the cheapest, until the demand is satisfied. The last plant that is turned on
determines the market price for all market participants. Focusing on the difference between the
long-term investment decisions and the short-term merit order is key to understanding power
markets.
Renewable energy resources, like wind and solar, have very low marginal costs because they
have no fuel costs. Accordingly, renewable resources are bid into the market at very low prices,
thereby becoming first in the merit order. In an undistorted market, generators may offer their
power at prices below their total costs. As long as the market is in equilibrium, the use of power
plants with higher marginal costs ensures that other plants cover their total costs. However, the
power markets today are distorted by subsidies. Renewable generation will continue to be built
since it depends only on subsidies and does not react to the markets excess power signals.
The change of the merit order and the increasing amounts of low-bid renewable energy in
electricity wholesale markets have been steadily depressing wholesale prices of electricity in
Germany and other European nations over the last couple of years. From values around
90/MWh in July 2008, the power price fell on the European Energy Exchange (EEX) to levels
under 40/MWh at the end of 2013.
37
Figure 19. Wholesale price Germany - Non-peak futures prices, EEX57
100
90
/MW
80
2011
2015
2012
2016
2013
2017
2014
2018
70
60
50
40
30
Although lower prices sound like a positive development, wholesale prices have not translated
into lower prices to consumers, but instead have had a number of perverse effects.
4.4.2. Cost recovery and financial impact to utilities
Lower prices and changes in the structure of wholesale markets have had several implications for
thermal generators.
The first implication is that, at current price levels, coal and gas-fired power plants cannot cover
their full costs. There are fewer hours in which the conventional power plants earn more than the
marginal cost since they run fewer hours than originally planned and, in many cases, provide
back-up power only.
Also, the market peak price has been reduced, further reducing the revenues of traditional
thermal power plants. Given the large percentage of PV deployment, PV was able to reshape the
power market. In the past, wholesale prices followed the demand curve and peak load plants
earned most of their margin in the middle of the day, when high load led to high power prices.
57
European Energy Exchange. www.eex.de
38
The growth in PV eroded the midday peak, which took away the high mid-day margins of the
peak plants.
Figure 20. Yearly Performance of PV and Electricity Tariff (standardized)58
12,000
1.80
1.60
10,000
MWh/h
8,000
1.20
1.00
6,000
0.80
4,000
0.60
Hour Price/Base Price
1.40
0.40
2,000
0.20
0.00
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
2006 performance PV
2013 performance PV
2006 price
2013 price
This situation is making cost recovery even more difficult. This means that the owners of the
plants have to write-off the money they originally invested. As discussed earlier, RWE recently
announced a write down of 4.8 billion on assets, mainly power stations, and a net loss of 2.76
billion ($3.8 billion) on total sales of 54.1 billion, its first full-year loss since 1949. 59 This
situation is not unique to Germany. One of Australias largest utilities, Energy Australia, also
announced a significant write down due, in part, to gas-fired generators becoming uneconomic
because of the rapid growth of solar power and the rapid increase of electricity prices for
customers.60
Generators financial difficulties have already translated into lower stock prices and credit
ratings. In terms of the magnitude of share price reductions, power utilities have fared worse than
58
European Energy Exchange. www.eex.de

Bloomberg: RWE Suffers First Loss Since Founding of German Republic 4th March 2014.
http://www.bloomberg.com/news/2014-03-04/rwe-reports-first-loss-in-more-than-60-years.html
60
Renew Economy, Massive losses hit EnergyAustralia as demand falls, solar soars, 28 February 2014.
http://reneweconomy.com.au/2014/massive-losses-hit-energyaustralia-as-demand-falls-solar-soars-67443
59
39
the renewable space. According to the MSCI (Morgan Stanley) European utilities share price
index, the top 20 energy utilities have lost more than half a trillion dollars since their peak in
September 2008. 61
This is not only attributed to the large subsidies, but also to deregulation, the impact of the global
financial crises, failed acquisitions, emissions controls, and investment in new efficient plants
(that ultimately were closed due to renewable subsidies and permanent demand destruction), and,
in the case of Germany, nuclear decommissioning. Since 2010, the European Stoxx Utilities
Index is down 31 percent, while German utilities, like Eon, have seen their shares plunge 45
percent.
62
Development
of Ratings
of European
major European
tilities
since
2010
Figure 21. Development
of ratings
of major
utilities u
since
2010
EDF
GSZ
E-on
EnBW
RWE
Enel
positive
AA-/Aa3
negative
positive
A+/A1
negative
positive
A/A2
negative
positive
A-/A3
negative
positive
BBB+/Baa1
negative
positive
BBB/Baa2
negative
Rating as per Jan 1. 2010
Rating as per Jan 1. 2010
current rating
current rating
source: E.ON ; own research on Bloomberg Terminal

61
62
The Economist October 12th, 2013. http://www.economist.com/node/21587782/print

Source: E.ON and own research on Bloomberg
40
Iberdrola
The impact to credit ratings of these institutions has also been significant. Back in 2008, the top
10 European electric companies had credit ratings of A or higher. At the time of this writing, less
than half still maintain this rating.
Collectively, both renewable companies and utilities are having their costs of capital increased
by both regulation and the uncertainty that is being created in the capital markets. There is no
doubt that these increased costs will ultimately be passed on to consumers.
4.4.3. Evolution of the fleet and impact on reliability
A second major implication of low wholesale prices is that fewer new plants are planned. This
can present reliability problems, especially as nuclear plants shut down. It can also present a
challenge to integrate large amounts of renewable energy, as thermal power plants still provide
back-up and balancing services.
Figure 22. German-wide commissioning and decommissioning of non-intermitting power
plants; National planning data 2013 - 201863
MW
3,383
Waste
Pump storage
63
3,183
957
Lignite
Bituminous coal
Natural gas
Mineral oil
-2,488
2013-2018
indenite year
-1,924
2018
-950
2017
-247
2016
2015
2014
0
2013
11,000
10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
0
-1,000
-2,000
-3,000
-4,000
-5,000
-6,000
-7,000
-8,000
-9,000
-10,000
Several energy sources

Nuclear
Federal Network Agency; 08th January 2014.

http://www.bundesnetzagentur.de/DE/Sachgebiete/ElektrizitaetundGas/Unternehmen_Institutionen/Versorgungssi
cherheit/Erzeugungskapazitaeten/Kraftwerksliste/kraftwerksliste-node.html; 08.01.2014
41
The effects on reliability can be seen in an agreement reached by a German grid operator and a
gas-fired power plant that had threatened to close because of economic problems. In 2013, the
owners of the CCGT Irsching 5 threatened to mothball the power plant for two years,64 even
though Irsching 5 had only been online since 2010, and, with an efficiency factor of 60 percent,
was one of the most modern CCGT plants in Europe. The plant was kept online per decree due to
its role in maintaining system stability. By agreement, the power plant committed to continued
operations and, in exchange, TenneT, the grid operator, compensates Irschings fixed costs
proportionally to the number of usages on demand of TenneT (Redispatch).
Figure 23. Electricity generation at E.ON's Irsching Gas power plant (2011 vs. 2012)65
4.5. Impact of renewables variability on market operations and thermal

plants
Ironically, the fast growth in renewables in general, and especially PV, is contributing to drive
out of the market the very same generators that can help them grow. Because of their variability,
renewables require other generators to help them integrate their power into the grid. In most
cases in Germany, it is the thermal generators that used to provide baseload power that are now
providing back-up and balancing services for intermittent renewables at a significant loss of
technical efficiency and increased costs.
64
TAM-News 14th. March 2013 and 29th April .2013

. 01st November 2013: Speech of Thomas Barth, CEO and Chairman of the Managing Board, E.ON Energie AG:
The German Energiewende: Shining or Warning Example for Europe? 5th Conference ELECPOR.
http://www.elecpor.pt/pdf/Thomas%20Barth_ELECPOR_Nov2013.pdf.
65
42
4.5.1. Large thermal as back-up grid interventions

The more variable renewables there are, the more the thermal power plants will serve as back-up
and balancing for renewables.
Figure 24 shows the daily production of solar, wind, and conventional generation in Germany.
The maximum daily solar and wind-combined production in 2012 was 530 GWh on January 5,
2012, while the minimum was only 30 GWh on December 19, 2012.
Figure 24. Daily production of Solar, Wind and Conventional in Germany 201266
Given the average daily power consumption of around 1,643 GWh in Germany, this means that
in spite of the 13.2 percent67 share of wind and solar power in total power generation, there must
be almost complete redundant capacity of thermal plants or storage.
Wind and solar energy, by their very nature, are highly variable, with fluctuations in weather
conditions causing significant variance over multiple timescales: seconds (gusts of wind and
passing cloud cover), minutes (wind speed variations, briefly overcast skies), days (diurnal
cycles, creating peaks of solar condition), months/quarters (seasonal cycles), and years (annual
variation in environmental conditions).
At yearly and seasonal levels, both wind and solar generation can be forecasted with relative
certainty. It is when considering diurnal (daily) generation profiles that variability occurs and
66
FRAUNHOFER INSTITUTE FOR SOLAR ENERGY SYSTEMS ISE; Electricity production from solar and
wind in Germany in 2012; February 08th , 2013
67
of renewable energy sources in Germany
43
requires system operators to intervene and make sure that supply and demand of electricity are
equal at all times.
In Germany, as the percentage of renewable power increased, so did the number of times that
grid operators had to intervene to rebalance the market. In 2012, there were 1,213 such
interventions.
Figure 25. Grid interventions to stabilize the grid by grid operator Tennet, 2003-201268
For new thermal power plants to replace the currently uneconomical power plants once they
reach their technical lifetime, current prices will have to rise. The effect of fewer operational
hours needs to be compensated by higher prices in these hours. As a consequence, it is likely that
markets will experience lower prices in times when there is sufficient renewable power and
much higher prices at other times.
Renewables generate higher direct costs than traditional power production. Traditional base load
wholesale power can be generated in Germany at around 65/MWh, but wind power and solar
PV in Germany receive a FIT of around 90 /MWh.
68
Tennet
44
Because renewables, like wind and solar, do not produce at certain times, available back-up
power to the system is required. The back-up capacity must be financed even if it is used only
occasionally as back-up. Therefore the little power that is produced in the back-up plants will
become expensive. Data drawn from business models of Finadvice show that a CCGT can
produce 3000 GWh per year at fixed costs of 11/MWh, in a power system without renewables.
If renewables reduce the production of the CCGT to for example 1500 GWh, the price needed to
recover fixed costs will double to 22/MWh. In a nutshell, this could mean that the cost of power
in the hours with renewable power is the subsidized 90/MWh instead of conventional 65
MWh, and when there is no renewable power, the (back-up) power price will be 76/MWh (65 +
11).
How difficult it is to integrate renewable energy depends on the overall system and the specific
characteristics of each national electric system. Norway, for instance, has 95 percent of
hydropower, which has essentially no variable cost but acts as a nice storage/buffering
mechanism for other renewables, allowing the country to integrate renewables with less impact
on the overall system.
4.5.2. Impact to thermal plants operating under new conditions of high variability
Baseload thermal plants were designed to operate on a continuous base. Although some were
designed to perform efficient ramping, they were all built to operate at their highest efficiencies
when running 24 hours a day, seven days a week. The rapid deployment of renewable energy has
meant that those same thermal plants are providing back-up and balancing services to renewables
at suboptimal efficiencies.69 The potential operational impact to owners of thermal plants for
material damage and consequential business interruption could be significant and accordingly is
now being closely analyzed by one of the worlds top insurers.70
Renewable energy sources have a significant influence on the daily operations of conventional
power plants since they have guaranteed access to the grid and are variable in nature. The
fluctuating distribution of all kinds of power generation plants is shown in figure 26 for a one-
69
70
See Appendix A for an analysis from Siemens which provides further technical related impacts,
See Appendix B for an analysis from Marsh Ltd.
45
week time span in June 2013, in Germany. Hard coal and gas-fired units are following load and
balancing renewables during peak load conditions. Typical baseload lignite coal, and even
nuclear units, has to follow load during minimum load periods because of priority dispatch of
renewables.
Figure 26. SIEMENS: Weather-related fluctuation of renewable energy (solar and wind
power) with significant influence on operation regime of conventional power plants
The change from providing baseload power to increased cycling, load following, and providing
peak load power has had profound effects on thermal generators, particularly the older, less
efficient generators.
Depending on the type of generator, the new peak and medium load operation conditions with
steep load ramps of up to 50 MW/min for new gas-fired units will stress a number of generator
components in different ways. For example, when large, old coal-fired generators, which were
designed for baseload operation, are running in peak load operation, the frequent thermal
expansion and contraction of stator and rotor windings will result in accelerated wear and aging
of the unit.
Adding to the costs associated with increased renewables, a condition-based maintenance,
refurbishment, and replacement strategy will be needed to reduce the sudden outage risk for
these older generators.
46
4.6. Expansion and additional investment in the power grid

The German power grid was originally designed for centralized, thermal baseload power
production, but the growth of renewable energy (both centralized and distributed) in Germany
requires new investments and the extension and transformation of both the transmission and
distribution grids. Renewables, like offshore wind in Germany, are usually located far from
power demand. Thus, adding renewables to electric systems usually requires a substantial
extension of the transmission system. Resources that are close to consumption, like rooftop PV,
require grid connection and grid services to back up their power when there is no sun and to
ensure power quality through balancing services that control frequency and voltage.
Figure 27. New investments and operational expenditures of transmission and distribution
grid operators71
Transmission
8,000
7,000
6,000
O&M
Investments
8000
Distribu4on
7000
6000
5,000
5000
4,000
4000
3,000
3000
2,000
2000
1,000
1000
2007 2008 2009 2010 2011 2012 2013
2007 2008 2009 2010 2011 2012 2013
While analyzing the amounts of investments related to the grid system, it is important to
distinguish between investments undertaken by the transmission system operators and those by
distribution system operators. While the transmission system operators are mainly concerned
with connecting new power generation plants to the existing system, it is the task of distribution
system operators to work on regional and local bases and to serve private households with
electricity. The investments expenditures undertaken by distribution system operators are mainly
due to maintenance of the existing grid, like metering or communication systems. Since 2007,
71
Federal Network Agency
47
investments and operational expenditures by distribution system operators rose significantly and
reached their peak in 2011 (6,930 million), while the level of investments and operational
expenditures in the transmission system remained proportionally low and quite stable with only a
small rise in 2012 and 2013.
As a result of these additional investments in grid expansion and improvement, grid usage fees
(fees that recover costs associated with transmission and distribution) increased in 2011, 72 and
are expected to continue to increase in the future as a result of Germanys plan to further expand
the grid to accommodate increasingly large amounts of renewable resources.
Figure 28. Development of the average grid usage fees 2006-201373
Euroct/kWh!
8
7
6
5
4
3
2
1
0
2006
2007
2009
Household
2010
2011
Commerce
72
2012
2013
2014
Industry
Federal Network Agency Monitoring report 2013.

http://www.bundesnetzagentur.de/SharedDocs/Downloads/DE/Allgemeines/Bundesnetzagentur/Publikationen/Ber
ichte/2013/131217_Monitoringbericht2013.pdf?__blob=publicationFile&v=9
73
Federal Network Agency Monitoring report 2013.
http://www.bundesnetzagentur.de/SharedDocs/Downloads/DE/Allgemeines/Bundesnetzagentur/Publikationen/Ber
ichte/2013/131217_Monitoringbericht2013.pdf?__blob=publicationFile&v=9
48
The Grid Development Plan

The Grid Development Plan is an effort begun in 2012 by the four German grid operators
(Tennet, 50Hertz, Amprion, and TransnetBW) to develop expansion plans of the current grid,
including the Offshore-Grid Development Plan, which is meant to strengthen the north-south
high voltage connections in order to bring power from the newly built offshore plants in the
North and the Baltic Sea to the populated areas of Southern Germany. 74 The total investment in
the expansion of the onshore and offshore transmission grid in the next 10 years was initially
estimated at around 40 billion, 75 but was recently revised downward as the plans focus
changed from building new lines to improving existing ones.76 The costs will be recovered by
additional grid usage fees paid by all electricity consumers.77
Unfortunately for transmission operators and regulators, government officials of the State of
Bayern lodged a protest against the build-out of the SUEDLINK on February 6, 2014, calling
into question one of the cornerstones of the Energiewende.78 The State of Bayern is not the only
state to create protest, other states and municipalities are questioning the build-out of the grid
mainly based upon a not in my backyard syndrome, as well as the high cost to be paid.
Also, critics among the scientific community have questioned the magnitude of the grid
development plan and believe the plan is overdesigned, which would result in higher than
necessary costs that will have to be covered by end consumers through higher grid usage fees.79
74
Transmission system operators: Grid development plan: second draft 17th July 2013.
http://www.netzentwicklungsplan.de/sites/default/files/pressematerial/Presse%20release_GDP_2013_second%20d
raft.pdf
75
Transmission system operators_ Grid development plan.
http://www.netzentwicklungsplan.de/sites/default/files/pressematerial/Presse%20release_OGDP_2013_second%20draft.pdf
76
Umweltdienstleister Netzentwicklungsplan besttigt 16 January 2014 ; German Network Agency.
http://umweltdienstleister.de/2014/01/16/netzentwicklungsplan-bestaetigt/;
http://www.netzausbau.de/SharedDocs/Downloads/DE/II/NEP/ZFStromnetzausbau2013.pdf?__blob=publicationF
ile
77
Transmission system operators: grid development plan. http://www.netzentwicklungsplan.de/content/fragen-zurfinanzierung
78
Frankfurter Allgemeine Zeitung: Die Energiewende kommt die Armen teuer
79
Solarify Netzausbauplan bertrieben: Akzeptanz der Energiewende bedroht 06th April 2013.
http://www.solarify.eu/2013/04/06/netzausbauplan-ubertrieben-akzeptanz-der-energiewende-bedroht/
49
Figure 29. Target grid network
Unequivocally, large scale deployment of renewables in Germany has increased the need to
expand the grid, which will therefore lead to higher grid investments and, in turn, to higher grid
usage fees for customers. The effect on the grid usage fees will be even more evident when
interest rates return to pre-crisis levels.
4.7. Repeated redesigns and boom and bust cycles

European subsidy programs for renewables increased prices for European consumers, and, in
many instances, became such a burden on the national economies that they resulted in numerous
redesigns. Some European renewable energy regulatory regimes were inappropriately structured,
gamed by market players, or made obsolete by market conditions. As a result, governments and
regulators corrected unsustainable regulatory regimes by reducing the level of subsidies,
sometimes retroactively, and modifying the rules of the programs. The numerous changes in the
rules increased regulatory uncertainty and financial risk for the renewable industry that
experienced significant value destruction.
50
4.7.1. Redesigning unsustainable programs

Germany set the subsidy level in /MWh and left it to the market to react with an according
quantity in installed capacity. The original FIT law had no limit to the quantity of renewables to
be built, but the FIT rate was to be reduced year-by-year. This system was meant to lead to a
sustainable growth of renewables. However, neither the wind nor the PV market reacted as
expected by politicians. Rather, they were taken by surprise by the pace of deployment. In the
solar PV industry, for example, as the cost rapidly decreased, the profitability of PV improved
much faster than the FIT was reduced. This led to a boom in PV installations. The everincreasing demand led to very high margins for producers, project developers, and installers who
had an incentive to keep installing new PV systems. More systems meant more subsidy
payments, but also higher costs to consumers.
By 2010, the debate over the cost of the FIT program had gained momentum in Germany as the
economic crisis brought cost and industrial competitiveness back to the forefront of policy
concerns, while at the same time solar PV enjoyed a rapid decline in costs. More than 100
electricity service providers announced significant price increases for 2010 (as high as 16 percent
for households) claiming increased costs associated with renewable energy. In 2010, Germanys
new government introduced significant changes to the FIT scheme for solar and announced its
desire to undertake a major revision of its renewable energy policy in 2012. That year, further
encouraged by the international economic and financial crises to attempt to restrain costs, the
government modified the FIT law again. To make sure that PV installations followed a
sustainable path, a growth corridor for solar power was established that linked the subsidy paid
to PVs to the new PV capacity installed. If the yearly installed capacity exceeds 2.53.5 GW, the
FIT decreases accordingly.80 The FIT for solar installations above 10 MW was abandoned and
the self-consumption premium (premium paid above the retail electricity price for all energy that
is self-consumed and not fed into the grid) was cancelled. The new revision also announced the
phase-out of the program by placing a cap on the overall FIT program of 52GW of installed solar
capacity, which the government thinks will be achieved by 2020. At the end of 2013, Germany
80
Bundesministerium fr Umwelt, Naturschutz und Reaktorsicherheit (BMU): Die wichtigsten nderungen der
EEG-Novelle zur Photovoltaik 2012 (PDF; 14 kB) Berlin Juni 2012, abgerufen am 29. September 2012
51
had almost 33 GW of installed solar PV capacity, which brings some to anticipate that the cap
will be reached as early as 2016.
Other countries in Europe and around the world also had to modify, and eventually phase out,
their program because of the very high costs of their renewables support mechanisms. A more
detailed explanation of these regulatory interventions and redesigns can be found in Appendix C.
Spain offers the best example of a poorly designed, overgenerous subsidy program for solar PV
that became so costly for the national economy that the government had to modify it several
times and even take the very unpopular road of introducing retroactive cuts of the tariff, before
ending the program in 2013. These changes had adverse consequences for investors in Spain,
but, because of the size of the Spanish solar market, it also had the effect of contributing to the
collapse of the much overheated international solar market.
In the mid-2000s, Spain was among the leading European countries in overall installed capacity
of wind, solar PV, and concentrated solar power, as well as in share of renewable energy sources
of total power demand, which it fueled through very generous premiums for renewable energy
PVs in particularand a poorly designed system without caps or tariff degressions. Spains
program, at a time of rapidly decreasing solar costs, created rapid demand for PVs which helped
drive a boom cycle in the solar industry. However, by 2008 these subsidies could no longer be
continued due to the impact of the global financial crisis and its impact on Spanish finances,
which were further worsened by the increasing tariff deficit that subsidy payments were
imposing on the Spanish budget.81 Accordingly, the government introduced changes to the PV
FIT, which ultimately included several revisions that contributed to burst the solar market
worldwide and destroyed large holdings of equity and debt investments. The FIT program ended
in 2013, but the government policy changes were not able to avoid leaving the country holding
26 billion in debt that tax payers will have to honor, as well as ever-increasing electricity prices.
Almost all European nations also modified, reduced, and/or phased out their FITs programs for
solar including the Czech Republic, Bulgaria, Belgium, France, Greece, Italy, and the United
81
In Spain, the cost of the FIT program is shared between rate payers and tax payers.
52
Kingdom. This trend was also followed outside of Europe. Canada (Ontario) and Australia
(Victoria, Queensland, and New South Wales) also had to cut back their renewable energy rates.
In all cases, the introduction of such sweeping changes damaged investor confidence, increased
the cost of capital to renewable companies and projects, and consequently further reduced
investments in renewable energy. 82
All of those changes tried to moderate cost increases by limiting the growth of renewable
demand. However, since the PV factories where already built, and with production orders
booked, the changes led to reduced prices in PV modules and reduced margins for the producers,
which provoked several manufacturers bankruptcies. Between January 2012 and January 2013,
companies producing PV modules with more than 50 employees decreased from 33 to 22.83 The
reduction in the level of subsidies around the globe drove some industry leaders, including the
Chinese firm SunTech and American companies First Solar and SunPower, to move into the
German market creating greater competition for German manufacturers who are more dependent
on their domestic market and also suffer the most from the FIT revisions. Q-Cells, Soltecture,
and Sovello all went bankrupt in 2012.
Ultimately, the EC recognized that European policies were leading to unintended consequences,
including various market distortions across Europe. On April 9, 2014, the EC approved the new
guidelines84 for state aid on energy that included the removal of all FIT support mechanisms for
renewables to apply from 2017 onwards, which, depending on the category, included some
transitional measures. Effectively, all prior support mechanisms will be replaced by technology
agnostic auctions (with the exception of emerging technologies and smaller scale plants) and
prices will be directly linked to the wholesale market. Renewable companies will no longer
receive any state support that allows them to exceed their respective market determined cost of
capital. This will require renewable companies to focus on their costs and appropriate profit
creating projects, whereby it is expected that these new incentive mechanisms will instill market
82
European Commission: Delivering the internal electricity market and making the most of public intervention
November 5th 2013. http://ec.europa.eu/energy/gas_electricity/doc/com_2013_public_intervention_en.pdf
83
Die Welt: Deutschlands Solarbranche lst sich auf 20 April 2013.
http://www.welt.de/wirtschaft/article115455341/Deutschlands-Solarbranche-loest-sich-auf.html
84
http://ec.europa.eu/competition/sectors/energy/legislation_en.html
53
competitiveness throughout the renewable sector that will essentially require them to perform as
market competitive generators. It should be noted that these actions are not retroactive, however,
the implications will unequivocally change the European renewable sector and hopefully assist in
creating a level playing field for all energy producers.
4.7.2. Trying to make things right
Germany and other governments around the world have not only reduced the tariffs paid to
renewable developers and modified program rules in an effort to achieve long term sustainable
deployment of renewable energy, but they have also begun to introduce self-generation fees to
ensure that the costs of maintaining and expanding the electric grid are paid for by all electric
consumers, not only those without rooftop PVs.
Spain, Australia, and Germany are the first countries to have proposed changing their pricing
structures and imposing a fixed fee, or back-up rate, on distributed solar installations to help pay for
the electric grid.
The largest element in Germanys average electricity bill is the grid fee, the fixed portion of
costs associated with delivering power to consumers (transmission and distribution).
Figure 30. Retail power price and its components in Germany, euroct/kWh85
Cost of power
12.20
Charges
16.91
Grid fee
7.00
Concession fee
1.80
EEG levy
5.30
Offshore liability levy
0.25
KWK levy
0.13
19 power levy
0.33
Electricity tax
2.10
Total retail power price
85
29.11
ET ENERGIE: Zur vermeintlichen Grid Parity von Photovoltaik-Anlagen
54
In 2012, the FIT for PV in Germany was reduced and, for the first time, fell below the retail price
of electricity, which created an incentive for owners of new PV systems to consume their PV
generation directly instead of feeding it into the grid in exchange for the FIT payment. The EEG
allows for the FIT to be applied on the net generation (total generation minus simultaneous
consumption). Consumers generating and consuming their own electricity avoid paying for all
fees and charges that are normally charged via power from the grid. On every kWh self-produced
and consumed onsite, self-generators save 0.07 on grid fees and 0.053 on the EEG levy.
It is problematic that in the case of the grid fee, only the fee is spared but not the cost, as the
owner of the PV plant still relies on the grid and grid costs arise mostly from the grid installation,
irrespective of how little the grid is used. In that way, self-consumption reduces the owners
electricity bills, while increasing the electricity bills of grid users who do not have the chance for
their own consumption. The savings on the EEG levy is also problematic. Why should the owner
of a PV system contribute less to the Energiewende? It is not only PV owners that resort to this
circumvention. This is also a common method within the German industry, using, for example,
gas-fired generation for self-consumption. 86
In response to the growing trend towards self-production and consumption, and in an attempt to
contain rising electricity prices, in early 2014, the German government proposed a new fee
charging new owners of relatively larger PV installations (above 10 kW) for their own
consumption of self-produced electricity. If approved, the new fee could enter into effect in the
summer of 2014.87 This fee would prevent companies trying to avoid the EEG levy from not
contributing to the other charges. According to recent reports, 27 percent of German industry
companies are building their own power plants, while another 21 percent are planning to. 88
86
Handelsblatt Online: Der Trend zum eigenen Kraftwerk 06th . January 2014; Frankfurter Allgemeine Zeitung: Die
Industrie macht ihren Strom selbst 15th October 2013; Markt und Mittelstand Nachrichten: Schutz vor EEG:
Unternehmen produzieren Strom selbst 26th August 2013; Wirtschaftswoche EEG-Umlage: Gefhrden IndustrieAusnahmen die Energiewende? 12th July 2013. http://www.handelsblatt.com/technologie/das-technologieupdate/energie/industrie-der-trend-zum-eigenen-kraftwerk/9291960.html;
http://www.faz.net/aktuell/politik/energiepolitik/steigende-eeg-umlage-die-industrie-macht-ihren-strom-selbst12618930.html; http://www.marktundmittelstand.de/nachrichten/finanzierung/schutz-vor-eeg-unternehmenproduzieren-strom-selbst/; http://green.wiwo.de/eeg-umlage-gefahrden-industrie-ausnahmen-die-energiewende/
87
Bloomberg, Germany Tax on Own Use of Renewables Is First in Europe, 24th January 2014.
http://www.bloomberg.com/news/2014-01-24/germany-tax-on-own-use-of-renewables-is-first-in-europe.html
88
Handelsblatt Online: Der Trend zum eigenen Kraftwerk 06th January 2014
55
4.7.3. Financial impact on the renewable industry: Renewable Investment Funds

The financial impact of renewable policies on renewable investment funds is becoming
increasingly negative as various European governments and regulators continue to decrease their
generous subsidy programs in order to meet their fiscal requirements, or to correct the
appropriate incentive mechanisms due to new innovations and/or economies of scale and scope.
It is difficult to measure the total impact of these interventions across Europe due to the number
of private transactions. However, while many renewable projects were bankrupted by these
regulatory interventions, many other renewable players made good profits by selling early, or by
not selling, and earning a respectable cash yield with a structure that had little or no debt.
A recent article in the Financial Times, titled Private equity retreats from renewables fad,
highlighted a recent survey from Prequin that identified just 22 percent of all renewable funds
earned an internal rate of return higher than 3 percent. Joseph Dear, chief investment officer of
Calpers, the worlds sixth-largest pension fund, last year described clean-tech investment as a
noble way to lose money. Calpers suffered annualized losses of 9.7 percent in the sector. We
are all familiar with the J-curve in private equity. Well, for Calpers, clean-tech investing has got
an L-curve for lose added Dear. If it takes 12 years to get the money out, the internal rate of
return is not going to be very good, even if the investment is reasonably successful. 89
The outlook for European renewables for 2014 and going forward is negative. According to a
December 2013 Fitch report: 90
The outlook for the overall renewables sector is negative. This reflects increased
political risk and the expectation that the industry will need to adapt to less favorable
operating requirements and economic incentives. This is true across most jurisdictions
and it results from the greater focus on the sustainability of incremental renewable
capacity additions, in terms of the effect on the power industry in general and cost to
consumers who ultimately foot the bill.
Fitch rated the renewables sector as having the highest downgrade risk potential for its EMEA
project finance ratings. Budgetary constraints, oversupply and distortion of power prices,
89
Financial Times, Private equity retreats from renewables fad 16th February 2014.
http://www.ft.com/cms/s/0/ef1b2248-94bb-11e3-9146-00144feab7de.html
90
Fitch Report: 2014 Outlook: Energy Infrastructure EMEA - Stable Except for Renewables. December 11, 2013
www.fitchratings.com
56
transaction-specific operational performance, market economics (i.e. Germany proposing to cut

all support for biogas), debt structures, and backlash of consumers paying higher prices were all
factors contributing to regulatory intervention. Projecting past 2014, these factors are expected to
continue over the next several years.
57
BIBLIOGRAPHY
Newspapers and other media
Frankfurter Allgemeine Zeitung (FAZ)
24.02.2014: Regierungsberater wollen EEG abschaffen
http://www.faz.net/aktuell/wirtschaft/wirtschaftspolitik/oekostrom-regierungsberater-wollen-eegabschaffen-12820227.html
19.02.2013: Energiewende knnte bis zu einer Billion Euro kosten
http://www.faz.net/aktuell/politik/energiepolitik/umweltminister-altmaier-energiewende-koennte-biszu-einer-billion-euro-kosten-12086525.html
15.10.2013 Steigende EEG-Umlage Die Industrie macht ihren Strom selbst
http://www.faz.net/aktuell/politik/energiepolitik/steigende-eeg-umlage-die-industrie-macht-ihrenstrom-selbst-12618930.html
05.02.2014 Bayern zieht Stromnetzausbau in Zweifel
http://www.faz.net/aktuell/wirtschaft/fruehaufsteher/exklusiv-in-der-f-a-z-bayern-ziehtstromnetzausbau-in-zweifel-12590891.html
19.02.2014 kostrom EEG-Umlage: Welche Firmen mssen knftig zahlen?
http://www.faz.net/aktuell/wirtschaft/wirtschaftspolitik/oekostrom-eeg-umlage-welche-firmenmuessen-kuenftig-zahlen-12808022.html
Handelsblatt
07.11.2013: Altmaier reist mit radikalem kostrom-Plan zur EU
http://www.handelsblatt.com/politik/international/foerderung-metallindustrie-eine-million-jobsbedroht/9039578-2.html
06.01.2014 Der Trend zum eigenen Kraftwerk http://www.handelsblatt.com/technologie/dastechnologie-update/energie/industrie-der-trend-zum-eigenen-kraftwerk/9291960.html
24.02.2014 Industrie bangt um Stromrabatte http://www.handelsblatt.com/technologie/dastechnologie-update/energie/grossverbraucher-industrie-bangt-um-stromrabatte/9528744.html
Wirtschaftswoche
12.07.2013 EEG-Umlage: Gefhrden Industrie-Ausnahmen die-Energiewende?
http://green.wiwo.de/eeg-umlage-gefahrden-industrie-ausnahmen-die-energiewende/
05.02.2014 Reservekraftwerke werden Milliarden verschlingen
http://www.wiwo.de/politik/deutschland/energiewende-reservekraftwerke-werden-milliardenverschlingen/9412340.html
Der Spiegel
18.12.2013 kostrom-Rabatte: EU leitet Verfahren gegen Deutschland ein Der Spiegel Online
http://www.spiegel.de/wirtschaft/soziales/eu-kommission-greift-deutsche-industrie-an-a-939795.html
Die Welt:
07.11.2013 Ende der EEG-Privilegien gefhrdet eine Million Jobs
http://www.welt.de/wirtschaft/energie/article121621919/Ende-der-EEG-Privilegien-gefaehrdet-eineMillion-Jobs.html
72
14.12.2013 Hhere kostrom-Umlage kostet 86.000 Jobs

http://www.welt.de/wirtschaft/article122930122/Hoehere-Oekostrom-Umlage-kostet-86-000Jobs.html
Tagesschau
19.01.2014 Gabriel im Bericht aus Berlin "Strompreise werden nicht sinken"
http://www.tagesschau.de/inland/bab-gabriel100.html
Wall Street Journal

01.08.2013 U.S. Oil Reserves Continue to Bulge
http://online.wsj.com/news/articles/SB10001424127887323681904578641871449942246
Financial Times
29.01.2014 Energy price gap with the US to hurt Europe for at least 20 years
16.02.2014: Private equity retreats from renewables fad http://www.ft.com/cms/s/0/ef1b2248-94bb11e3-9146-00144feab7de.html
Reuters
26.08.2013 EU's Oettinger warns against Germany cutting renewable subsidies
http://uk.reuters.com/article/2013/08/26/uk-renewables-eu-idUKBRE97P0FS20130826
Renewables International
01.08.2013 Spanish solar FITs revisited http://www.renewablesinternational.net/spanish-solar-fitsrevisited/150/510/71701/
22.08.2013 Prague to implement retroactive solar tax (again)
http://www.renewablesinternational.net/prague-to-implement-retroactive-solar-taxagain/150/452/72232/
PV Magazine
16.12.2010 Czech President approves controversial solar tax http://www.pvmagazine.com/news/details/beitrag/czech-president-approves-controversial-solartax_100001824/#axzz2pp6Ajpms
19.09.2012 Bulgaria: Up to 39% retroactive grid fee for PV operators http://www.pvmagazine.com/news/details/beitrag/bulgaria--up-to-39-retroactive-grid-fee-for-pv-operators_100008536/#ixzz2uRTtu9GB
19.12.2012 EU solar industry calls for action against retroactive subsidy changes http://www.pvmagazine.com/news/details/beitrag/eu-solar-industry-calls-for-action-against-retroactive-subsidychanges_100009663/#axzz2pp6Ajpms
14.02.2013: Greece prepares for more retroactive PV cuts http://www.pvmagazine.com/news/details/beitrag/greece-prepares-for-more-retroactive-pvcuts_100010212/#axzz2tI1WNo7u
26.03.2013 Bulgaria: Photovoltaic grid access fee revoked; appeals underway http://www.pvmagazine.com/news/details/beitrag/bulgaria--photovoltaic-grid-access-fee-revoked-appealsunderway_100010684/
PV Tech
26.11.2012 France retroactively cuts FiT by 20% http://www.pvtech.org/news/france_retroactively_cuts_fit_by_20
73
Cleantechnica
17.02.2013 Why German Solar Is So Much Cheaper Than U.S. Solar Updated Study
http://cleantechnica.com/2013/02/17/why-german-solar-is-so-much-cheaper-than-u-s-solar-updatedstudy/
ET Energiewirtschaftliche Tagesfragen
07/2013 Zur vermeintlichen Grid Parity von Photovoltaik-Anlagen http://et-energieonline.de/AktuellesHeft/Topthema/tabid/70/Year/2013/Month/7/NewsModule/423/NewsId/633/Zurvermeintlichen-Grid-Parity-von-PhotovoltaikAnlagen.aspx#fn:7
Markt und Mittelstand Nachrichten

26.08.2013 Schutz vor EEG: Unternehmen produzieren Strom selbst
http://www.marktundmittelstand.de/nachrichten/finanzierung/schutz-vor-eeg-unternehmenproduzieren-strom-selbst/
Umweltdienstleister
16.01.2014 Netzentwicklungsplan besttigt
http://umweltdienstleister.de/2014/01/16/netzentwicklungsplan-bestaetigt/
Solarify
06.04.2013 Netzausbauplan bertrieben: Akzeptanz der Energiewende bedroht
http://www.solarify.eu/2013/04/06/netzausbauplan-ubertrieben-akzeptanz-der-energiewende-bedroht/
TAM-News 14.03.2013 and 29.04.2013

Instituts zur Zukunft der Arbeit (IZA)
16.12.2013 Moderater Beschftigungsrckgang durch steigende Strompreise
http://newsroom.iza.org/de/2013/12/16/moderater-beschaeftigungsrueckgang-durch-steigendestrompreise
The Ministry for Climate Protection, Environment, Agriculture, Nature Conservation and
Consumer Protection of the German State of North Rhine-Westphalia
17.01.2014 Fachministerinnen und Fachminister aus sieben Bundeslndern fordern
Gemeinschaftswerk in der Energie- und Klimapolitik
http://www.umwelt.nrw.de/ministerium/presse/presse_aktuell/presse140117.php
Renewable Energy World

26.08.2013 Norway Approves $3 Billion for Wind Power Plants to Triple Capacity
http://www.renewableenergyworld.com/rea/news/article/2013/08/norway-approves-3-billion-forwind-power-plants-to-triple-capacity
Research papers and studies

IZES (Instituts fr ZunkunftsEnergieSysteme)
2012 Das Erneuerbare-Energien-Gesetz Erfahrungen und Ausblick Institut der deutschen
Wirtschaft Kln, - http://blog.insm.de/4770-quotenmodell-versus-einspeisevergutung-aus-der-praxislernen/)
http://www.greenpeace.de/themen/energie/nachrichten/artikel/warum_das_eeg_besser_ist_als_ein_qu
otenmodell/)
Forum kologisch-soziale Marktwirtschaft

Strom- und Energiekosten der Industrie
http://www.greenpeace.de/fileadmin/gpd/user_upload/themen/energie/2012-FOES-IZESVerguenstigungen-Industrie.pdf
74
EEG- Jobmotor oder Jobkiller? www.energie-fakten.de/pdf/eeg-job-motor.pdf

Ecofys Group
28.08.2013 Renewable energy deployment possible even with delays in transmission grid expansion
Impacts of restricted transmission grid expansion
Congressional Research Service

Europes Energy Security: Options and Challenges to Natural Gas Supply Diversification
http://www.fas.org/sgp/crs/row/R42405.pdf
Federal Ministry for the Environment, Nature Conservation and Nuclear Safety
14.03.2012 Gross employment from renewable energy in Germany in 2011
http://m.germany.info/contentblob/3146650/Daten/1312974/BMU_GrosEmploymentRE2010_DD.pdf
Public Institutions
German Federal Ministry for the Environment, Nature Conservation, Building and
Nuclear Safety
development of renewable energy sources in Germany:http://www.erneuerbare-energien.de/diethemen/datenservice/zeitreihen-entwicklung-ab-1990
Hintergrundinformationen zur besonderen Ausgleichsregelung 2012/2013: www.erneuerbareenergien.de/.../ee.../hintergrundpapier_besar_bf.pdf
German Federal Network Agency

How will the power price calculated?
http://www.bundesnetzagentur.de/SharedDocs/Downloads/DE/Sachgebiete/Energie/Verbraucher/Preis
eUndRechnungen/WieSetztSichDerStrompreisZusammen.pdf;jsessionid=0B318530B0B7F0F3325CB
5CA631C83F7?__blob=publicationFile&v=2
List of power plants in Germany:
http://www.bundesnetzagentur.de/DE/Sachgebiete/ElektrizitaetundGas/Unternehmen_Institutionen/Ve
rsorgungssicherheit/Erzeugungskapazitaeten/Kraftwerksliste/kraftwerksliste-node.html
Monitoring report 2013
http://www.bundesnetzagentur.de/SharedDocs/Downloads/DE/Allgemeines/Bundesnetzagentur/Publik
ationen/Berichte/2013/131217_Monitoringbericht2013.pdf?__blob=publicationFile&v=9
Grid development 2013
http://www.netzausbau.de/SharedDocs/Downloads/DE/II/NEP/ZFStromnetzausbau2013.pdf?__blob=
publicationFile
Grid development plan

http://www.netzentwicklungsplan.de/content/wie-funktioniert-die-erstellung-desnetzentwicklungsplans
Press release: 2013 Grid Development Plan, second draft_17.07.2013:
http://www.netzentwicklungsplan.de/sites/default/files/pressematerial/Presse%20release_GDP_2013_s
econd%20draft.pdf
http://www.netzentwicklungsplan.de/content/fragen-zur-finanzierung
Agency for renewable Energy

www.unendlich-viel-energie.de
http://www.unendlich-viel-energie.de/themen/wirtschaft/arbeitsplaetze
75
German Association of Energy and Water Industries (BDEW)

Power Price analysis May 2013
https://www.bdew.de/internet.nsf/id/05B6EBC2BF77350DC1257AD700582730/$file/130527_BDEW
_Strompreisanalyse_Mai%202013_presse.pdf
via KWH-Preis http://www.kwh-preis.de/strompreis-dossier-teil-3-vergleich-strompreise-industrieund-privathaushalt
Netztransparenz EEG-KWK Informationsplattform der deutschen

bertragungsnetzbetreiber
Prognosekonzepte und Berechnungen der bertragungsnetzbetreiber 2008-2014 http://www.eegkwk.net/de/EEG-Umlage.htm
FRAUNHOFER INSTITUTE FOR SOLAR ENERGY SYSTEMS ISE

08.02.2013 Electricity production from solar and wind in Germany in 2012;
http://www.ise.fraunhofer.de/en/downloads-englisch/pdf-files-englisch/news/electricity-productionfrom-solar-and-wind-in-germany-in-2012.pdf
09.01.2014 Electricity production from solar and wind in Germany in 2013;
http://www.ise.fraunhofer.de/en/downloads-englisch/pdf-files-englisch/news/electricity-productionfrom-solar-and-wind-in-germany-in-2013.pdf
Office of Gas and Electricity Markets (OFGEM)

https://www.ofgem.gov.uk/publications-and-updates/understanding-energy-prices
https://www.ofgem.gov.uk/gas/retail-market/monitoring-data-and-statistics/electricity-and-gas-supplymarket-indicators
European Commission (incl. Eurostat)

Electricity and natural gas price statistics (updated November 2013):
http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Electricity_and_natural_gas_price_stati
stics
Delivering the internal electricity market and making the most of public intervention November 5th
2013 http://ec.europa.eu/energy/gas_electricity/doc/com_2013_public_intervention_en.pdf
The future role of gas. Presentation to the European Commission Directorate-General for Energy,
Madrid Forum, April 18-19, 2013. http://ec.europa.eu/energy/gas_electricity/gas/doc23/02.01_mf23_presentation_by_ec_-_future_role_of_gas_-_kitti_nyitrai.pdf
Share of renewables in electricity production (2012):
http://epp.eurostat.ec.europa.eu/statistics_explained/index.php?title=File:Share_of_renewables_in_ele
ctricity_production,_2012_%28in_%25%29.png&filetimestamp=20130429062902
Legal sources on renewable energy: http://www.res-legal.eu/search-by-country/norway/toolslist/c/norway/s/res-e/t/promotion/sum/378/lpid/379/
European Renewable Energy Council

http://www.erec.org/statistics/co2.html
REN21: Renewable Energy and Policy Network for the 21st Century
About REN 21: http://www.ren21.net/AboutREN21.aspx
Renewables 2013 Global Status Report
http://www.ren21.net/Portals/0/documents/Resources/GSR/2013/GSR2013_lowres.pdf
EU Fuel Poverty Network

http://fuelpoverty.eu/about/
76
Fuel Poverty: a Framework for Future Action, Department of Energy and Climate Change, July 2013
Statuette - Norways national main grid owner and operator

grid development plan 2013 http://www.statnett.no/Global/Dokumenter/Prosjekter/Nettutviklingsplan%202013/StatnettNettutviklingsplan2013-engelsk_03korr.pdf
Norwegian Ministry of Petroleum and Energy

Facts 2013: Energy and water resources in Norway
http://www.regjeringen.no/upload/OED/Faktaheftet/FACTS_energy_water.pdf
Transmission and Distribution grid http://www.regjeringen.no/en/dep/oed/Subject/energy-innorway/The-transmission-and-distribution-grid.html?id=444385
Norwegian Renewable Energy http://www.intpow.no/?categoryid=47

Statistics Norway Statistisk sentralbyr www.ssb.no
Nord pool Spot http://www.nordpoolspot.com/Market-data1/Elspot/Area-Prices/ALL1/Hourly/
The Swedish-Norwegian Electricity Certificate Market Annual Report 2012 http://www.nve.no/Global/Elsertifikater/Elcertifikat2013_Eng_TA%20(2).pdf
Other
European Energy Exchange www.eex.de
E.ON http://www.eon-schafft-transparenz.de/
Fitch Ratings: 2014 Outlook: Energy Infrastructure EMEA - Stable Except for Renewables.
December 11, 2013 www.fitchratings.com
Tennet. www.tennet.eu
Speech of Gregg Kantor Chairman of American Gas Association, NARUC Winter
Committee Meetings, February 11, 2014
Wikipedia
http://de.wikipedia.org/wiki/Erneuerbare-Energien-Gesetz#Photovoltaik
01.11.2013: Speech of Thomas Barth, CEO and Chairman of the Managing Board, E.ON
Energie AG: The German Energiewende:Shining or Warning Example for Europe? 5th
Conference ELECPOR http://www.elecpor.pt/pdf/Thomas%20Barth_ELECPOR_Nov2013.pdf
77
Authors:
Hans Poser, Managing Director, FAA Financial Advisory AG
Hans Poser is one of the founders of Finadvice. He has extensive experience in Germany, France, and
Switzerland. Hans specialist sector experience is utilities in continental Europe. Before Finadvice, Hans
was Vice President of the European Utilities Team of UBS Investment Bank Zurich and provided M&A
and strategic advice. Prior to that, he was a project leader in the Energy and Utilities Practice Group of
BCG Frankfurt. Hans holds a Master of Engineering from the Technical University of Berlin and a
DESCAF (similar to MBA) from Toulouse Business School.
Jeffrey Altman, Senior Advisor, Finadvice GmbH

Jeffrey Altman has more than 20 years of infrastructure and energy experience. Most recently, Jeffrey
was Director of Investment Management at First State Investments' European Diversified Infrastructure
Fund and was a member of the holding company board of Electricity North West, the electric distribution
company for the City of Manchester, UK. He served 10 years in both the United States and Europe with
Southern Company/Mirant Corporation. During this time, he spent five years successfully privatizing and
restructuring Berlin's electric and gas utilities. While in the United States, Jeffrey initiated, negotiated,
structured, and closed value-creating transactions for Southern Company, as well as developed several
strategic plans, including a recommendation not to enter into the California retail energy market. Jeffrey
has a Masters of Business Administration (Executive MBA Program) from the University of Southern
California and a Bachelor of Science in the School of Foreign Service from Georgetown University. He is
the editor of the book Best Practice in Infrastructure Asset Management, and has authored several
articles.
Felix ab Egg, Managing Director, FAA Financial Advisory AG

Since 2005, Felix ab Egg has advised on more than 90 M&A projects (27 successful transactions) with
respect to every step of the utility value chain, on behalf of Swiss and German utilities. His current
primary focus is renewable energy transactions, where he has advised on more than 40 projects (11
successful transactions). Additionally, Felix advises on risk management, financings, and strategic
analyses, and is also involved with Finadvice's in-house wind park development in Poland. He also
worked as an author for the publisher Neue Zrcher Zeitung. Felix studied at the Universities of Lausanne
and Basel and graduated with a lic. rer. pol. (MBA equivalent).
Andreas Granata, Intern, FAA Financial Advisory AG

Andreas Granata is an intern at the Finadvice Office in Zurich. He is trying to consolidate his
competences and gain additional experience in the renewable energy sector, as well as corporate finance
area. He is currently enrolled in the Master of Science in Management program at the Universit
Commerciale Luigi Bocconi in Milan, as well as the CEMS Master in Management, issued by a global
alliance of 29 leading international universities.
Ross Board, Renewable Energy Investment Executive, Downing LLP

Ross Board, a Renewable Energy Investment Executive at Downing LLP, is responsible for deploying
private-equity capital into utility-scale UK energy projects. Prior to joining Downing, Ross served within
one of the UKs largest solar developers, working on numerous sell-side M&A transactions. Ross is
currently enrolled in Warwick Business Schools Global Energy MBA, focusing on financing of energy
assets and international energy policy.
79
Project Finance Primer for

Renewable Energy and Clean Tech Projects
Authors: Chris Groobey, John Pierce, Michael Faber, and Greg Broome
Executive Summary
Investments in the clean technology sector often combine capital intensity with new technologies. Securing project
finance can prove to be a critical step in the path to commercialization. Project finance succeeds best when you have
long-term off-take agreements with quality-credit counterparties (such as power purchase agreements) but commoditybased projects that sell into open markets (such as biofuels) can also benefit from the project finance model.
This primer provides an overview of project finance for renewable energy investors, with a focus on the pros and cons,
as well as a survey of key concepts and requirements, including tax incentives and monetization strategies in the
renewable energy sector, and other key structuring considerations in determining whether to project finance.
Key Points
Project finance has emerged as a leading way to finance large infrastructure projects that might otherwise be
too expensive or speculative to be carried on a corporate balance sheet.
The basic premise of project finance is that lenders loan money for the development of a project solely based
on the specific projects risks and future cash flows. As such, project finance is a method of financing in which
the lenders to a project have either no recourse or only limited recourse to the parent company that develops
or sponsors the project.
For equity investors, the appeal of project finance is that it can maximize equity returns, move significant
liabilities off balance sheet, protect key assets and monetize tax financing opportunities. A wide range of
commercial and legal issues must be addressed to secure adequate returns. Tight credit markets exacerbate
competition for long-term financing, so even small differences in deals can impact the availability of financing
or reduce leverage.
Project financing became particularly important to project development in emerging markets, with participants
often relying on guarantees, long-term off-take or purchase agreements, or other contractual relationships with
the host sovereign or its commercial appendages to ensure the long-term viability of individual projects. These
were typically backstopped by multilateral lending agencies that mitigated some of the political risks to which
the project lenders were exposed. Analogies to alternative energy projects help investors de-risk higher-risk
new technologies.
Austin
New York
Palo Alto
San Diego
San Francisco
Seattle
Shanghai
Washington, D.C.
Part I of the primer introduces project finance to those that may be less familiar with the concept, and asks questions
that will assist investors and developers in determining whether project finance is appropriate for their renewable
energy projects. Part II sets out the legal and contractual structure that will facilitate project financing. Part III
describes the process of obtaining equity investment and some of the important options and considerations that
companies may have in that process. Part IV provides a more in-depth look at what a typical renewable energy project
financing looks like, including fundamental structural components that characterize any project finance transaction.
Finally, Part V outlines key tax incentives currently available in the renewable energy industry, as well as monetization
strategies that may be useful for earlier-stage energy companies unable to directly utilize such tax incentives.
Given the breadth of the current renewable energy landscape, this primer focuses on a hypothetical solar generation
facility (Solar Project) as the primary case study with discussions of other renewable energy projects (wind power
and biofuel projects in particular) as appropriate. In general, once the contracts related to a project are negotiated
(which is described in Part II), the mechanical aspects of raising equity and project financing are likely to be similar
across various renewable technologies, although investor enthusiasm and financing prices and terms are likely to vary
significantly across technologies at any given time.
I. Introduction to Project Finance

A.
What Is Project Finance?
The basic premise of project finance is that lenders loan money for the development of a project solely based on the
specific projects risks and future cash flows. As such, project finance is a method of financing in which the lenders to
a project have either no recourse or only limited recourse to the parent company that develops or sponsors the
project (the Sponsor). Non-recourse refers to the lenders inability to access the capital or assets of the Sponsor to
repay the debt incurred by the special purpose entity that owns the project (the Project Company). In cases where
project financings are limited recourse as opposed to truly non-recourse, the Sponsors capital may be at risk only for
specific purposes and in specific (limited) amounts set forth in the project financing documentation.
Project financing has been used in various ways for many years, but in the 1970s and 1980s it emerged as a leading
way of financing large infrastructure projects that might otherwise be too expensive or speculative for any one
individual investor to carry on its corporate balance sheet. Project financing has been particularly important to project
development in emerging markets, with participants often relying on guarantees, long-term off-take or purchase
agreements, or other contractual relationships with the host sovereign or its commercial appendages to ensure the
long-term viability of individual projects. These were typically backstopped by multilateral lending agencies that
mitigated some of the political risks to which the project lenders (and, sometimes, equity investors) were exposed.
B.
What Underpins Project Finance?
As a general (if not universal) rule, lenders will not forgo recourse to a projects Sponsor unless there is a projected
revenue stream from the project that can be secured for purposes of ensuring repayment of the loans. In the case of
large wind and solar power projects, this revenue is typically generated from a power purchase agreement (PPA)
with the local utility, under which the project may be able to utilize the creditworthiness of the utility to reduce its
borrowing costs. While the wind power market has matured significantly in the past five years, leading to the
successful project financing of merchant projects in the absence of long-term PPAs, Solar Projects are generally not
yet able to be project financed in such a manner. In merchant power projects, lenders are able to receive assurance of
the projects ability to repay its debt by focusing on commodity hedging, collateral values, and the income to be
produced based on historical and forward-looking power price curves and fully developed markets. In non-power
generation contexts, the projects revenue stream may be a long-term operating agreement (e.g., in the case of toll
roads), a capacity purchase agreement (e.g., in the case of transmission lines), a production sharing agreement (e.g.,
in the case of oil field development), or a series of short-term and spot sales into commodity markets (e.g., in the case
of biofuels projects).
While project finance lenders clearly prefer a long-term contract that ensures a relatively consistent and guaranteed
revenue stream (including assured margins over the cost of inputs), in the context of some industries, lenders have
determined that sufficient revenues to support the projects debt are of a high enough probability that they will provide
debt financing without a long-term off-take agreement. Solar Projects, due to their peak period production, high marginal
costs, and lack of demonstrated merchant capabilities, are not at this time viewed as project financeable without PPAs
that cover all or substantially all of their output. Solar Projects lack of merchant viability is exacerbated by the fact that
the southwest United States (the region most appropriate for utility-scale solar power development) does not have a
www.wsgr.com
mature merchant power market that functions in the absence of long-term bilateral sales agreements. The dependence
of large-scale solar projects on the PPA model is not expected to change in the short to intermediate term.
C.
When to Project Finance?
One of the primary benefits of project financing is that the debt is held at the level of the Project Company and not on
the corporate books of the Sponsor. When modeling projects and projected income, the internal rate of return of
Sponsors and other project-level equity investors can increase dramatically once a project is fully leveraged. Sponsors
are frequently able to recover development costs at the closing of the project financing and put their money into other
projects. Another benefit of project financing is the protection of key Sponsor assets, such as intellectual property, key
personnel, and investments in other projects and other assets, in the case of the Project Companys bankruptcy, debt
default, or foreclosure. Moreover, project financing allows for a wide variety of tax structuring opportunities, particularly
in the context of monetizing tax incentives (discussed further in Part V). On the other hand, project financing is
document-intensive, time-consuming, and expensive to consummate. It is not atypical that administrative and closing
costs, when factoring in lenders, consultants, and attorneys fees for all parties, equal several percentage points of the
amount of the loan commitment. Moreover, project financing imposes significant operating restrictions on each Project
Company, including its ability to make equity distributions to the Sponsor prior to the payment of operating expenses,
debt service, and a percentage sweep of additional cash flow (discussed further in Part IV). The result is that the
decision of whether to reinvest cash flow in the project does not rest solely with the Sponsor.
Given the pros and cons of project finance, the most relevant initial inquiry for an investor or developer may be when is
project financing possible or most appropriate? The following questions should be useful in determining if project
financing is a realistic opportunity for any given company:
-
Is there an individual project or group of projects of a sufficient size to make either a standalone or
portfolio project financing worthwhile? Typically lenders will be reluctant to provide project financing if the
total amount of debt is less than US$50 million and, preferably, US$100 million.
Will there be a revenue stream from the project large enough to support a highly leveraged debt financing?
This is a prerequisite for project financing.
Will the receipt of revenue be enforceable under contractual rights against a creditworthy party? This is
not necessarily a prerequisite for all project financings, but the absence of a contract, or questionable
creditworthiness of the purchaser, will prompt lender skepticism and necessitate thorough due diligence
regarding future revenue projections.
Will there be physical assets sufficient to ensure lender repayment in case of foreclosure? Lenders will
want to know that even if the Project Companys projected revenue stream does not materialize, they will
be able to foreclose on the projects assets sufficient in value to make themselves whole, either by selling
the project outright or operating it until the debt is repaid.
Is there a significant level of technology risk? While in many project financings, technology may be
relatively new or cutting edge, project finance lenders almost never want to be the first to finance an
untested technology. Demonstrated successful use in some context will often be necessary to secure
project financing.
Does the project have contractual relationships with reputable companies for services key to the success
of the project or the technology it employs? Lenders will be less likely to lend to a project the success of
which depends solely on a few talented individuals who may depart, leaving the project unable to meet its
potential.
Is the Sponsor ultimately willing to risk the project? In other words, once project financing is completed,
the Sponsor loses the ability to determine how the vast majority of the projects revenue is spent. In the
event a project becomes uneconomic and unable to service its debt, the only option besides refinancing
the debt may be to turn over the project to the lenders (voluntarily or involuntarily), with the corresponding
loss of the Sponsors investment in the project.
Is the Sponsor looking for a quick exit? Once project-financed, divestiture opportunities are complicated
by the requirement of lender consent, and potential purchasers will be thoroughly examined by lenders for
development and operational expertise as well as creditworthiness.
www.wsgr.com
Are Sponsors willing to grant rights of high-level oversight regarding the projects development and
operation to project finance lenders? In many cases the interests of the Sponsor and the lenders will be
aligned, and lenders will tend to defer to the Sponsors developmental expertise. On the other hand,
lenders must be viewed as additional project partners, with veto rights over many significant decisions.
Assuming project financing is a viable option, Part II provides a roadmap to structuring a project financing transaction.
II. Establishing a Project Structure and Negotiating Project Agreements

A.
Project Structure
The project finance structure revolves around the creation of the Project Company that holds all of the projects assets,
including all of its contractual rights and obligations. The Project Company is usually a single-member limited liability
company, although in some cases it may be a limited partnership.
In most cases, the equity interest in the Project Company will be held by at least one intermediate holding company,
usually a limited liability company (the Holdco), created for the purpose of pledging the Project Companys equity to the
lenders in the eventual project financing. While the Holdco will have a separate legal identity, typically it will not have any
business apart from holding the equity of the Project Company. This structure allows for most liability to be contained at
the bankruptcy-remote Project Company level, and thus insulates the Sponsor (including equity investors in the Sponsor)
and the Holdco from liability to either the Project Companys contractual counterparties (Counterparties) or to the
Holdcos lenders. In order to ensure that the Project Company is treated as a separate legal entity, it will be necessary to
have governance mechanisms at the Project Company level that are independent, including designated officers, at least
one independent director, and internal controls and procedures designed to preserve a legal entity distinct from the
Sponsor and the Holdco.
B.
Project Agreements Overview
As a general matter, all contracts related to the development, construction, ownership, and operation of the project will
be entered into by the Project Company (Project Agreements). If development-stage contracts have been executed
by the Sponsor or one of its affiliates, it is important that the contracts allow for their assignment to the Project
Company once the Project Company has been established for the purposes of pursuing project financing.
In addition to the external Project Agreements, there may be several intercompany agreements between the Project
Company and the Sponsor or its affiliates. These may include an Operation and Maintenance Agreement (O&M), an
Administrative Services Agreement (ASA), and a Technology License Agreement (TLA), often with affiliates of the
Sponsor created specifically for the purpose of providing administrative support, operation, and maintenance services
and holding the intellectual property for the benefit of one or more of the Sponsors projects. In other cases, unrelated
third parties may provide these services to the Project Company. If intercompany agreements are used, they should
be structured in such a manner as to track the material commercial terms that the Sponsor could obtain with an
unrelated third party providing the same services.
Intercompany agreements can also have a significant impact on the total return of a project to its investors, so their
economic terms must be carefully crafted. Assuming the O&M, ASA, and TLA are entered into with Sponsor affiliates,
they permit the affiliates to extract arms length fees for the provision of key services and technology to the Project
Company on a monthly or quarterly basis; these fees are frequently paid prior to repayment of debt. The
intercompany-agreement structure also allows the Sponsor, if the project fails following the project financing, to retain
all of its employees that provide services to the Project Company, thereby ensuring that key employees (and knowhow) will not be lost to lenders or a subsequent purchaser out of foreclosure. In such a scenario, the TLA will also
allow the Sponsor to retain ownership of its technology subject only to a license right on the part of the Project
Company which may no longer be affiliated with the Sponsor. These are especially critical points where the Sponsor
has multiple projects that may utilize the same technology, support equipment, and personnel. In addition, the O&M,
ASA, and TLA provide the Project Company's lenders contractual certainty (through the agreements themselves as
well as the corresponding consents to collateral assignment (discussed further in Part IV below)) that key services will
continue if the Project Company defaults, thereby increasing the likelihood of the efficient development, construction,
and operation of the project and the preservation of the value of the lenders' collateral.
There are many other Project Agreements that are typically executed during the course of developing and constructing
a renewable energy project. The Project Agreements may include one or more PPAs, which may have an income
www.wsgr.com
stream payable from an off-taker for energy payments, capacity payments, or both; an Engineering, Procurement, and
Construction Agreement (EPC Agreement); a Site Lease Agreement (if the projects land is not owned by the Project
Company itself); a Renewable Energy Credit Agreement (in states where applicable); an Interconnection Agreement
(for projects tied to the electricity grid); agreements for the provision of utility services; agreements for the provision of
feedstock commodities (in the case of biofuels) and the necessary price and supply hedging; agreements including
equity flip structures to take advantage of the federal tax incentives discussed in Part V below; and other Project
Agreements necessary or desirable to develop, construct, own, or operate the project. In some cases certain
byproducts of production may be sold in addition to the primary product (for example, steam as a byproduct of cogeneration power projects, high protein distillers grains as a byproduct of ethanol production, or carbon dioxide where
markets exist).
Typical Project Finance Structure

Equity Investors
Equity
Contribution $
Operating or Shareholders
Agreement
Sponsor
Equity
Contribution $
Project-Level Equity Investors
Operating or Limited
Partnership
Agreement
Equity
Contribution $
Lenders
Operating or Limited
Partnership
Agreement
Loans $
Loan
Documentation
Project Company
aka The Borrower
Interconnection
Agreement
Interconnecting
Utility
Consent
Lenders
C.
PPA
Purchasing
Utility/
Offtaker
Consent
Lenders
EPC or
EPCM
Agreement
Contractor
Consent
Lenders
Supply
Contracts
REC
Purchase
Agreement
Equipment
Suppliers
Consent
REC
Purchaser
Consent
Lenders
Lenders
O&M
Agreement
O&M
Service
Provider
Consent
Lenders
Admin
Services
Agreement
Technology
License
Agreement
Admin
Services
Provider
Consent
Lenders
Technology
Provider
Consent
Lenders
Key Project Agreement Terms
In the process of negotiating the Project Agreements it will be necessary to consider key project finance principles to
prevent having to revisit contractual terms at the lenders behest in the course of financing the project. One overriding
concept is that lenders will own (and likely seek to immediately transfer) the Project Company in the case of
foreclosure, thus will insist on contractual rights and terms that ensure a seamless transition to the lender or
subsequent owner. To this end, the project lenders will require consents to collateral assignment (Consents) for their
benefit with some if not all of the Counterparties. Therefore, provisions that prevent assignment without Counterparty
consent should be omitted from Project Agreements. Inclusion of contractual language that obligates the Counterparty
to cooperate with the Project Company and its lenders in the course of the financing process will not only expedite the
process of negotiating the Consents but will also reduce the scope for Counterparty intransigence in the context of the
project financing.
The commercial terms of the PPA and the EPC Agreement, together with the market and technology risks, will largely
determine whether lenders view the project as financeable. Foremost among considerations related to the PPA will
be whether or not there is a guaranteed revenue stream (usually energy payments from the actual production of
power) from a creditworthy purchaser that will be sufficient to support the economics of the project, thereby ensuring
www.wsgr.com
prompt repayment of debt and mitigating the risk of default. The PPA term should also be sufficient in length to fully
amortize the contemplated project debt. In contrast to most smaller distributed generation projects, where an off-taker
pays for only the power that is produced, utility scale solar generation facilities may have take or pay PPAs where the
utility is still required to pay the Project Company even if a certain level of power is not purchased. In the case of Solar
Projects, utilities are less likely to deliver capacity payments because power is generally produced only during daylight
hours. However, distributed generation projects may benefit from more certain payments because the distributed
project produces all of the power for a given host.
If a project does not have a PPA or other off-take contract, demonstrated merchant operating histories of similarly
situated plants (more relevant in the context of wind projects) will be necessary to convince lenders of the reliability of
forecast ratios. Even with long-term PPAs, lenders will still look for additional data to support viability such as
meteorological wind data for wind power sites over the course of one to two years, often at installed hub-heights, or
long-term temperature and sun data for Solar Projects. The trend in biofuels project financings is also moving toward
contracted off-take arrangements with a creditworthy purchaser for all of a plants production. At least in the short and
intermediate terms, most project-financed Solar Projects will have PPAs for a significant portion, if not all, of their
generated power. While PPAs for large-scale CSP projects will generally be far more complex than those for smaller
distributed PV projects, in either case, the core economic terms will determine the lenders view of whether a project or
a portfolio of projects is viable from a revenue perspective and, accordingly, financeable on favorable terms.
To the extent a project is not fully constructed by the time project financing is sought, EPC Agreements will be an
integral part of the financing analysis and pricing. While larger developers may be able to finance an entire project on
balance sheet, and subsequently refinance the development to free up invested capital, most developers seek to
leverage their equity and use project finance to construct and operate their projects. Where construction risk is
present, lenders will generally seek corporate parent guarantees, performance bonds, or other forms of performance
surety that ensure that the performance of the contractor is as close to budget and schedule as possible. Warranties
of appropriate substance and duration as well as subsequent maintenance coverage regarding the EPC work and the
equipment purchased will be necessary to convince lenders that significant unbudgeted expenses will not be incurred
by the Project Company. With respect to an EPC contractor, lenders prefer a full wrap EPC agreement because
such an agreement provides a single point of contact with regard to the various risks such an agreement might contain
(warranties and schedule and performance guarantees, among other things). This is particularly the case with newer
and untested technology even if operationally superior to previous generation technology. Liquidated damage
coverage (pre-agreed payments made by the contractor) for schedule and performance delays, inefficiency, or
equipment failures also reassure lenders that a project has the necessary protection against delays or performance
defects that are within the EPC contractors control. How much of the risk an EPC contractor accepts for cost overruns
and design or installation defects, when viewed with other contractual terms, will affect the lenders view of whether a
project is financeable and at what cost. For example, a project that is not financeable at 80% debt due to certain offtake or technology risks may be financeable with 40%60% debt because the lenders are taking less risk with a higher
level of capital pre-paid into the project. Dedicating sufficient resources at the negotiation stage of PPA and EPC
Agreements to achieve commercial and contractual terms as favorable as possible will usually pay dividends at the
financing stage by saving not only money but also costly renegotiation and valuable time toward project completion.
III. Raising Equity

Venture capital and private equity investors also serve as attractive sources for capital raising, as an increasing
number of funds are investing in renewable energy and clean technologies. The large sums of capital required to
initiate and complete renewable energy projects drive not only the selection of appropriate equity investors but also the
structure of such investments. Therefore, Sponsors and investors evaluating equity solar investments should consider
the following action items:
A.
Conduct an internal assessment of capital and budgeting strategies for the investment.
Sponsors and investors should conduct an internal evaluation of whether an equity investment would best serve their
respective strategic objectives. Salient considerations include:
-
Is the companys technology reliable enough to be considered financeable, and is there a realistic potential
pool of equity investors from which to draw?
Are there any gaps in the Sponsors existing organizational structure and operations that an equity
investor would want filled before engaging in substantive discussions and/or closing an equity round of
www.wsgr.com
financing? For example, given the complexity involved in successfully executing Solar Projects, equity
investors will look for experienced management with skill and connections within the industry, as well as
potentially requiring contractual commitments from relevant third parties in the supply chain and customer
base.
B.
How much capital investment is realistically required for the Solar Project? Has Sponsor management, on
the one hand, conducted a thorough analysis of the timing and amount of future capital needs and relevant
burn rates, and has the investor and its syndicate, on the other hand, assessed whether its proposed
financing will be sufficient to either execute the Solar Project or bridge the Sponsor towards its next round
of investment?
What type of investment is ideally suited for the particular Solar Project e.g., is the Sponsor seeking passive
investment, or an active strategic partner that will add value to the organization (as discussed in greater detail
below)?
How would an equity investment impact the Solar Projects existing grants, tax treatment, eligibility for
applicable federal and state incentive programs, and contractual obligations?
As equity investors become shareholders, and in many cases, directors of the Sponsor, how much control
is the Sponsor willing to give to the investor, and what level of control does the investor desire in order to
have an active voice within the organization?
Determine whether the investment will add value to the Solar Project.
Unless a Sponsor is seeking a purely passive equity investment, the Sponsor and its investor should conduct a
thorough assessment of the investors role in driving value to the enterprise by, among other things:
C.
Reviewing the investors existing portfolio companies to determine whether the investor has previously
invested in similar projects or has other relevant experience with alternative energy investments. It is
important to find investors who understand the longer time period required to execute and obtain a return
on investment from renewable energy projects;
Meeting with the investors key decision makers to assess how the investor will add value in addition to the
capital infusion e.g., through participation on the board of directors, introductions to potential customers,
assistance in financial forecasting and planning, and guidance in analyzing potential liquidity events; and
Assessing potential conflicts of interest that may arise to the extent that an investor has, for example, a
competitor as one of its portfolio companies.
Assess the appropriate structure for the equity investment.
Once an appropriate equity investor has been identified, the equity investment typically will proceed to the preparation
of a term sheet that identifies the key terms of the investment, as well as a diligence request and the execution of a
confidentiality agreement to facilitate the exchange of information to the investor for the investors due diligence
purposes. A term sheet is a helpful means of assessing whether the parties truly see eye-to-eye with each other on
the critical aspects of the investment before expending significant time and expense negotiating definitive documents,
and may include the following terms:
-
The identification of the relevant entity that will receive such funds (e.g., will the investment be made into a
special purpose vehicle solely created for the project (for example, a Project Company) or will the
investment be made into the Sponsor which may hold assets unrelated to the project);
The amount of the investment, as the Sponsor should ensure that it receives sufficient capital to minimize
future dilutive cram-down financings, but also not take in more capital than is needed as this also will
have dilutive effects to existing shareholders. Milestone-based investments may help serve to mitigate
Sponsor risk in terms of securing additional future financing, while helping investors stage their investment
to ensure that the Sponsor can meet specific financial and commercial targets before disbursing additional
funds; and
Whether the equity security will be common stock, which is typically issued to founders, optionees, and
angel investors, or preferred stock, which not only is senior to the common stock in preference but also
typically has additional terms and conditions that increase preferred stockholders return on investment
and control over the Sponsor such as:
www.wsgr.com
D.
The right to appoint one or more board members;
Dividend rights;
A liquidation preference, which is the right to receive a preferential return on investment in the event
of a liquidity event such as a merger, asset sale, or change of control;
A redemption right, which is the right to redeem the equity securities at an agreed-upon point in the
future;
Anti-dilution rights, which protect an investor from the dilutive effect of future equity issuances; and
Protective provisions, which allow the preferred holders certain veto rights over key corporate actions.
Have candid discussions to ensure that expectations are aligned on key business issues, including:
-
The market opportunity;
The companys ability to execute its business plan, and the investors commitment to both the initial and
subsequent capital needs during the companys life cycle;
A realistic commercialization timeline, use of proceeds, and the expected internal rate of return of the
Solar Project; and
The appropriate liquidity event, be it an acquisition or an initial public offering, and how the investor can
add value to facilitate a liquidity event (e.g., by assisting in pre-public corporate governance compliance
required by Sarbanes-Oxley, or introductions to key strategic partners, customers, and potential acquirers
in the future).
In summary, both Sponsors and investors analyzing an equity investment should conduct a realistic assessment of the
companys capital needs, structure an investment that can add value to the company and its projects, and seek to
create a mutually beneficial working relationship where expectations on key business issues between the Sponsor and
the investor are aligned.
IV. Time to Project Finance

Before beginning an examination of the project financing process, it is worth noting different options for raising debt in
the context of project development. The three most frequently utilized project financing structures are the syndicated
or club loan, the issuance of project bonds through a private placement, and the issuance of Term B loans.
A.
Syndicated and Club Loans and Project Bonds
Currently the majority of renewable energy projects are financed through the syndicated commercial loan market.
Syndicated loans are loans in which a group of banks each take a portion of a larger loan and thus minimize the risk
that any one individual lender making the same loan would otherwise have. A syndicated loan transaction is usually
coordinated by one or more arranger banks whereas in club deals a handfull of lenders take equal roles in leading
the transaction and lending to the project. An alternative to the syndicated loan market is the private placement of debt
through 144A offerings, which are exempt from registration with the SEC if the purchasers are Qualified Institutional
Buyers as defined in the Securities Exchange Act of 1933. The issuer of 144A bonds could be either the Project
Company or the Sponsor.
Syndicated loan structures are often preferred to accessing the capital markets through 144A offerings, because
capital markets investors are generally less likely to assume construction risk and the disclosure documentation for a
144A offering is generally more extensive than that prepared in connection with syndicating a commercial loan. In
addition, amounts raised through a 144A issuance are all disbursed at closing, which leads to negative carry
implications. Moreover, private placements or corporate level offerings tend to be fixed rate, which, while providing
certainty, removes the upside potential of floating rates that are available pursuant to commercial bank loans. On the
other hand, 144A bond offerings are generally completed more quickly and inexpensively than a syndicated project
loan, the covenants contained in the governing documentation may be less restrictive, and the repayment period of
www.wsgr.com
private placement debt offerings is generally longer. Bonds can also pay interest at tax-exempt rates (lowering the
borrowers borrowing cost), be issued in relatively small amounts (making them ideal for smaller project financings)
and carry implied or explicit credit support from government instrumentalities (again reducing borrowing costs).
B.
Term B Loans
Several years ago, Term B loans emerged as a subset of the project lending market and were characterized by shorter
tenors and lower or delayed amortization, often with bullet payments due at maturity. Correspondingly, Term B loans
carried higher risk profiles and usually were rated non-investment grade. In addition, the terms and conditions of Term
B loans tended to be less onerous than traditional project debt that amortized over a longer period. As a result of the
subprime lending crisis and the resulting credit crunch, the Term B loan market all but disappeared and has yet to reemerge. For purposes of the following discussion, due to the considerations set forth above and the lull in the Term B
market, we assume that a traditional bank syndication model of project financing will be most beneficial to the Sponsor.
Although the terminology may differ from transaction to transaction, the documentation for such a project financing is
governed by a credit or financing agreement (Credit Agreement) and at a minimum will include an asset security and
equity pledge agreement, a mortgage, and various Consents.
C.
Loan Types
Depending on the development stage of the project, and within the project finance framework, the Sponsor may on
behalf of the Project Company seek construction loans, term loans, working capital loans and/or a letter of credit
facility. Construction loans, as the name implies, are utilized only for the period that the project is under construction.
The interest rate can be higher vis-a-vis a term loan (reflecting increased risk to the lenders during the construction
period) but more frequent drawdowns of construction loans are permitted and at the end of the construction loan
availability period, the construction loan usually converts to a term loan. Term loans are characterized by a set and
limited commitment or drawdown period and an extended amortization period. Term loans can have a lower interest
rate than construction loans, and have scheduled (quarterly or otherwise) repayment dates or set amortization
schedules. The conversion from a construction loan to a term loan often coincides with the definition of Substantial
Completion or Final Completion under the EPC Agreement, and a failure to achieve such conversion by a certain
date will cause a default under the construction loan and accelerate the debt due thereunder.
Working capital loans, which are used primarily for ordinary course expenses such as inventory purchases, are
generally sized smaller than construction or term loans and are subject to a maximum available amount tied to the
value of a Project Companys inventory and cash (often 80%). Working capital loans are usually revolving in nature,
meaning that amounts borrowed can be reborrowed once they are repaid. Letters of credit are made available on the
Project Companys behalf usually for the benefit of third parties under the Project Agreements for example, if a letter
of credit is required as credit support under a PPA, an EPC Agreement or for the provision of utility services. Draws by
a third party on an outstanding letter of credit will operate to reduce the amount of working capital loan availability.
The term of a project finance loan will vary depending on the term of the principal off-take agreement. To minimize risk
profile and lower borrowing costs, loans will ideally amortize in full prior to the end of the term of the PPA. The
borrowing costs of a renewable energy project will invariably depend on the risk profile determined by the
characteristics of the project itself, in particular the lenders view of the likelihood that the project will default on its
loans. In addition, exposure to merchant markets or other off-take risk will increase borrowing costs relative to projects
that have a long-term PPA, particularly one that is fixed price with take-or-pay terms. The reduced risks that come with
long-term PPAs prevent Sponsors from taking full advantage of arbitrage opportunities that may become available in
the spot market if power prices rise, as price risk is avoided for the producer. Recent trends have seen a wide swing in
loan terms and it is difficult to provide standard pricing terms, although as a general rule rates are higher and fees
have increased, while internal credit reviews have become more stringent and less forgiving of unmitigated project
risks or even minor holes or errors in Project Agreements. Typical lending fees for a project financing include the
following: (i) two percent (2%) to six percent (6%) of the aggregate loan commitment as an arranging or structuring fee,
(ii) one percent (1%) of the aggregate loan commitment as a syndication fee, (iii) $75,000 administrative agency fee to
be paid annually, (iv) $50,000 collateral agency fee to be paid annually, and (v) facility fees to each lender in the
syndicate in an amount between three-quarters of one percent (.75%) and one and one-half percent (1.5%) of each
lenders commitment. In addition, the Project Company will be required to pay the professional fees and administrative
expenses of each of the lenders in evaluating the transaction, negotiating the loan documents, and providing the loans.
Despite the non-recourse nature of pure project financing, in some transactions lenders will seek guarantees for
certain obligations of the Sponsor or its affiliates, either to ensure construction of the project or to ensure that the
Project Company is sufficiently capitalized to meet its debt service requirements. While by no means a requirement in
www.wsgr.com
all transactions, under certain market conditions, a guaranteed (or limited recourse) project finance structure may be
the only way to finance one or more projects or to obtain reasonably priced project debt.
D.
Security Package
1. Overview
Project finance requires the pledge of a comprehensive collateral security package to the lenders in exchange for the
making of loans. The collateral security package, in the absence of recourse to the Sponsor, serves as the basis for
the lenders securing repayment in the case of default. Specifically, all assets of the Project Company owned at the
time of the loan closing, in addition to those acquired post-closing, will be pledged to the lenders until the loans are
fully repaid. Included in the assets to be pledged will be all of the Project Companys personal property, accounts
receivable, contractual rights, and intellectual property. The Project Companys real property is pledged to the lenders
pursuant to a mortgage. A pledge of the equity interests in the Project Company is executed by the Holdco or any
other entities that directly hold equity interests.
As part of the collateral security package, the lenders will require a Consent from some or all of the Counterparties.
The Consent negotiation process can be time consuming and even contentious, especially if the interests of the
Sponsor and the Project Company on the one hand, and the Counterparty on the other, are not aligned. To
complicate matters, lenders may use the process of Consent negotiation to incorporate amendments to the relevant
Project Agreement, which are likely to benefit the Project Company as well as the lenders, but at which the
Counterparty may balk as a renegotiation of the fundamental business agreement embodied in the Project Agreement.
Even fundamental Consent terms such as the extension of cure periods for defaults for the benefit of the lenders in the
event the Project Company does not cure may be viewed as an unfavorable renegotiation from the perspective of a
Counterparty. In addition, some Counterparties are hesitant to enter into a contractual relationship with a large
financial institution as a putative future partner. The prospect of perceived bargaining asymmetry often complicates
what may be tedious three-way negotiations between the Counterparty, the Project Company, and the lenders, with
the Project Company likely playing the role of honest broker in order to facilitate prompt agreement and closure of the
financing.
2. Distribution of Project Revenues
Almost all project financed loans have what is referred to as the project waterfall. All revenues received by the
Project Company are placed in a master project revenue account, which serves as the top of the metaphorical
waterfall. As the money flows down the waterfall it is siphoned off into segregated secured accounts at each different
level as described in an Accounts or Disbursement Agreement, with any funds remaining at the bottom of the waterfall
being paid, assuming there are no defaults and that certain financial tests are met, to the equity owners of the Project
Company. Typically, the project waterfall is structured (roughly) in a manner as described below, with most
withdrawals from the waterfall occurring on a monthly or quarterly basis as appropriate:
-
The first level of payment would be in an amount necessary to pay costs incurred by the Project
Company (i.e., construction and/or operation and maintenance expenses depending on the projects
stage of development), including pre-approved reasonable amounts paid to the Sponsors affiliates
under the O&M, the ASA, and the TLA;
The second level of payment would be to the lenders to pay (i) loan fees and expenses, (ii) interest
payments, and (iii) principal payments (in this order);
The third level of payment will be used to fill an account segregated for the purposes of paying future
debt service in times of lower project revenues, although once this account has been filled to the level
of the required amount no amounts will be taken out at this level;
The fourth level of payment is often referred to as a cash sweep in which the lenders are repaid
outstanding principal with a certain percentage of the excess cash (generally one-third or half, which
increases in a default scenario) remaining after the operation of the three waterfall levels above;
The fifth level of the waterfall may operate to fill one or more reserve accounts, often designated for
future major maintenance or other purposes, but once the reserve account is filled with the required
amount no amounts will be taken out at this level;
The sixth level of the waterfall may be used to repay the holders of subordinated debt or bondholders,
if applicable; and
10
www.wsgr.com
The seventh level of the waterfall allows for cash remaining after amounts have been removed at the
higher levels to be paid to the equity holders of the Project Company in the form of an equity
distribution, assuming there are no defaults and that financial tests are met.
While every project waterfall will operate somewhat differently and many will have features unique to specific project and
financing arrangements, the waterfall operation outlined above is generally standard in project financing arrangements.
Typical Project Finance Waterfall

Project Revenues Received
$
Project Revenues Account
Project Construction/Operating
Expenses
Construction / Operating Account
Fees, Interest & Scheduled Principal
Debt Payment Account
Maintain Required Debt Service

Reserve Level
Cash Sweep to Lenders
Debt Service Reserve Account
Maintain Required Major Maintenance

Reserve Level
Major Maintenance Reserve Account
Payment of Subordinated Debt

(if any)
Subordinated Debt Account
Remaining amount distributed to equity

holders (assuming no defaults and
financial tests are met)
Distribution Account
E.
Operating Restrictions
Project finance lenders place restrictions and affirmative obligations on the Project Company that significantly impact
its day-to-day operation. While many of the affirmative obligations in particular may seem like ordinary course of
business operations, and the affirmative obligations and restrictions taken individually may not seem particularly
onerous, on a collective basis compliance with these obligations and restrictions requires time and effort from the
Sponsors employees. It is worth noting in connection with the time consuming nature of complying with the covenants
set forth in project financing documentation that there may be certain economies of scale, particularly where the
individual projects are smaller, to arranging project financing on a portfolio basis.
More specifically, project finance lenders will require that the Project Company (i) comply with all laws and regulations,
including permits, (ii) construct and operate the project in accordance with prudent industry standards, (iii) pay its debts
and obligations as they become due, (iv) use proceeds received and cash flow as set forth in the financing
documentation (including operation of the waterfall), (v) maintain pre-determined (and generally quite comprehensive)
insurance coverage, (vi) maintain books and records in accordance with GAAP, (vii) adopt and update budgets,
(viii) permit independent verification by the lenders representatives of performance tests, (ix) maintain in effect all
Project Agreements, (x) preserve title to all assets, (xi) update the financial model, (xii) maintain the liens granted
under the security documentation, and (xiii) enter into pre-approved hedging arrangements both for commodity inputs
for example, natural gas in the case of a power project or feedstock in the case of a biofuel plant and for
purposes of interest rate protection. This list is far from comprehensive in scope or detail. In addition, comprehensive
11
www.wsgr.com
reporting requirements will be set out in the Credit Agreement that obligate the Project Company to provide the lenders
with copies of everything from construction status reports to auditors letters to notices of certain adverse events.
Prohibitions placed on the Project Company by the financing documentation will likely include (i) incurring
indebtedness subject to certain exceptions, (ii) incurring liens subject to certain exceptions, (iii) making investments
subject to certain exceptions, (iii) changing the nature of the business, (iv) issuing equity securities, (v) disposing of
assets outside of the ordinary course of business, (vi) consolidating or merging, (viii) transacting with affiliates subject
to certain exceptions, (ix) opening bank accounts other than those secured under the financing documentation,
(x) creating subsidiaries, partnerships, or joint ventures, (xi) making certain tax elections, (xii) making certain ERISA
elections, (xiii) amending Project Agreements (including EPC change orders) subject to certain exceptions, (xiv)
entering into additional Project Agreements, (xv) suspending or abandoning the project, (xvi) entering into hedging
arrangements not approved by the lenders, (xvii) budgeting changes subject to certain tolerance bands, and (xviii)
making equity distributions outside of the waterfall framework and unless certain criteria are met, including achieving
certain cash available to debt service ratios on a historical and prospective basis (usually between 1.25:1 and 1.5:1).
While this list is not comprehensive, it should again be stressed that lenders will generally tend to be sensitive to the
financial interests of the project and will to some degree tailor a covenant package to the projects expected
construction and operation characteristics. It should also be noted that project finance lenders will often entertain
requests for waivers of obligations set forth in the financing documentation after the closing of the loans, as they are
incentivized to keep the loans performing and out of default.
F.
Potential Defaults
Event of Default is the legal term for the circumstance that allows project finance lenders to exercise their remedies
under the financing documentation, including acceleration of the outstanding debt and foreclosure. Events of Default
may include: (i) nonpayment of fees, interest, or principal due under the financing documentation (usually with a very
short grace period with respect to fees and interest only), (ii) breach of representation or warranty made in the
financing documentation (usually with a grace period if capable of being cured), (iii) non-performance of certain
covenants or obligations under the financing documentation (usually with a grace period if capable of being cured),
(iv) cross-defaults to other debt instruments, (v) non-appealable legal judgments rendered against the Project
Company, (vi) certain events related to ERISA, (vii) bankruptcy or insolvency, (viii) default under or termination of
Project Agreements, (ix) significant delays in construction schedule, (x) failure to obtain or maintain a necessary permit
or government approval, (xi) unenforceability of financing documentation, (xii) certain material environmental matters,
(xiii) loss of or damage to collateral, (xiv) abandonment of the project, and (xv) a change of control. Many Events of
Default have cure periods, which allow the Sponsor or Project Company to take action over the course of a certain
period (usually 30 days but may be less or more) to remedy the non-compliance if the Event of Default is capable of
being cured; for example, a default under another debt instrument may be cured by paying the amount due but a
final, non-appealable legal judgment against the Project Company would be incurable. In addition, during the course
of negotiating the Credit Agreement it will be important for the Project Companys representatives to qualify as many of
the Event of Default provisions with materiality and Material Adverse Effect standards as possible, providing the
Project Company more leeway to avoid an Event of Default and the potential loss of the project.
G.
Conditions to Closing
Project financing lenders will require that a lengthy list of conditions be satisfied in order to close the financing and fund
the loan. While many of the precedent conditions and required documents are shared with other forms of financing, it is
worth mentioning certain of the conditions that constitute particularly long lead time items that must be commenced
months prior to the close of the financing. Specifically, project finance lenders will generally require the delivery of the
following as conditions to closing the loan: (i) a report of an independent engineer that confirms the technology employed
by the project is commercially viable, the reasonableness of budgetary assumptions, the absence of serious
environmental issues, compliance with all necessary permits or approvals, and that financial projections are realistic; (ii) a
power or biofuels market report (if the project will have significant uncontracted off-take) setting forth expected market
conditions over the course of the loan; (iii) an environmental site assessment (at least a Phase I report concluding that
no further environmental investigation is necessary); (iv) an insurance report from the lenders insurance consultant;
(v) land surveys and site descriptions; (vi) a commodity management plan (in the case of biofuels facilities and other
projects where appropriate); (vii) evidence that the required equity component of the project has been contributed or will
otherwise be available when required; and (viii) copies of all third-party and government approvals and permits.
As a final note, depending on the projects funding requirements and the size of the equity contribution and project
finance commitments, it may be possible to include subordinated debt in the financing package. In the case of certain
renewable energy projects (e.g., biofuels production facilities), tax-exempt state bond financing may be available to
12
www.wsgr.com
close any gap between the raised and required equity in a project finance scenario. As a general rule, subordinated
debt will be more expensive than senior debt due to the subordinated lenders higher risk of non-payment. In almost
all circumstances, the subordinated debt will need to be in place prior to finalization of the senior project debt to avoid
the substantial costs that would be incurred to re-document the senior loan. If subordinated debt is employed, an
intercreditor agreement will be negotiated between the agent for the senior lenders and the trustee or agent for the
subordinated debtholders, pursuant to which the senior lenders will obtain standard terms of subordination to ensure
their senior lien and payment positions vis-a-vis the subordinated lenders and any unsecured creditors in the case of
any Event of Default by the Project Company or its bankruptcy or insolvency.
V. Tax Implications
A.
Key Federal Income Tax Incentives for Renewable Energy Projects
The U.S. federal government provides several income tax subsidies to encourage the development of renewable
energy projects. These tax benefits are currently necessary to make renewable energy projects economically
competitive with projects that produce energy from conventional sources, and can finance as much as approximately
60 percent of the capital cost of a project. The following is a brief discussion of some of the key federal income tax
incentives available to developers of, and investors in, renewable energy projects.
1. Production Tax Credits
A production tax credit (PTC) is available for the production and sale of electricity from certain renewable sources.
Renewable sources of energy that qualify for the PTC include wind, biomass, geothermal, municipal solid waste (either
landfill gas or trash), hydropower (in the case of newly installed turbines), and marine and hydrokinetic energy. To
qualify for the PTC, electricity from these sources must be produced at a facility that is placed in service before
(i) January 1, 2013 for a wind facility and (ii) January 1, 2014 for other qualifying facilities. The facility must be located
in the United States.
The PTC is available for 10 years following the date the qualified facility is placed in service. The amount of the credit
for each year is generally determined by multiplying the credit rate by the number of kilowatt hours of electricity
produced by the taxpayer from a qualified facility and sold to an unrelated party. The credit rate is adjusted for inflation
each year and varies based on the type of renewable resource (for 2009, the credit rate for most qualifying facilities
was 2.1 cents per kilowatt hour). The amount of the PTC is reduced by as much as 50 percent to the extent the
project benefits from nontaxable grants, tax-exempt bonds, other subsidized energy financing, or other federal credits.
2. Investment Tax Credit
Most renewable energy projects can qualify for the investment tax credit (ITC), which is based on the cost of the
qualifying property (unlike the PTC, which is based on the amount of electricity generated and sold). The ITC is equal
to the product of the energy percentage and the taxpayers tax basis in its energy property that is placed in service
during the taxable year. Energy property includes, among other things, equipment that uses solar energy to generate
electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat. Certain fuel cell
power plants that are placed in service before January 1, 2017, also qualify for the ITC. The energy percentage is
30 percent for solar equipment and fuel cell equipment that is placed in service before January 1, 2017. For solar
equipment placed in service after 2016, the energy percentage is 10%, and the ITC is not available for fuel cell
property placed in service after 2016. To be placed in service, the property must be ready for use, which generally
requires that all tests have been completed, all licenses and permits have been obtained, and the project is
synchronized with the transmission system and is operational. Unlike the PTC, the ITC is not reduced by subsidized
energy financing received after 2008.
In 2009, Congress enacted legislation that allows a taxpayer to elect to claim either the ITC or the PTC for facilities
that qualify for the PTC. The ITC for these facilities is 30 percent of tax basis and the election is available for a facility
that is placed in service before the relevant PTC cutoff date: (i) January 1, 2013 for a wind facility, and (ii) January 1,
2014 for other qualifying facilities. In deciding which credit to claim for a renewable energy project that can qualify for
either credit, a Sponsor will consider a number of factors, including the estimated cost of the facility, the expected
power production from the facility over the 10-year PTC period and anticipated power prices (including prices under a
PPA that is in place).
13
www.wsgr.com
To qualify for the ITC, the energy property must satisfy several requirements. The property must be constructed or
acquired by the taxpayer and the original use of the property must commence with the taxpayer. In addition, the
property must be used within the United States and depreciation or amortization must be allowable with respect to the
property. The property must meet any performance and quality standards prescribed by the Internal Revenue Service
(IRS) after consultation with the Department of Energy (none have been proposed to date). The property must also
not be used (including under a lease) by a tax-exempt or governmental entity. Finally, the project must not include
property which is part of a facility the production from which is used to claim PTCs. The taxpayers depreciable basis
in the property is reduced by 50 percent of the amount of the ITC.
The ITC vests 20 percent per year over five years. If the property is disposed of or otherwise becomes ineligible for
the ITC prior to fully vesting, the unvested portion is recaptured.
3. Treasury Grants
A renewable energy project that qualifies for the ITC and that is placed in service in 2009 or 2010 can qualify for a
Department of the Treasury grant in lieu of the ITC (and the PTC). If construction on the project began in 2009 or
2010, the project can also qualify for a grant so long as it is placed in service by the relevant date on which the ITC
terminates. The amount of the grant is calculated in the same manner as the ITC for the qualifying property, but since
the grant is a cash payment from the Department of the Treasury (rather than a credit against federal income tax) a
taxpayer need not have a federal income tax liability to benefit from a grant. Property that is used (including under a
lease) by a tax-exempt or governmental entity may nevertheless qualify for a grant. The taxpayers depreciable basis
in the property is reduced by 50 percent of the amount of the grant.
Treasury grants are also subject to recapture, using the same schedule that is used for the ITC, but a sale or other
disposition of property with respect to which a grant was received is not a recapture event provided that (i) the sale is
to a person eligible to receive a grant and (ii) the buyer of the property agrees to be jointly liable with the seller of the
property for any recapture. An application must be filed for a grant not later than September 30, 2011.
4. Depreciation
Certain equipment used in renewable energy projects may qualify for accelerated depreciation. After the basis of the
property is reduced by 50 percent of the ITC (or Treasury grant), the remaining basis is generally depreciated over five
years following the date the project is placed in service. Bonus depreciation, which allowed a special 50 percent
depreciation deduction, expired for most property (including renewable energy projects) placed in service after 2009.
5. Qualifying Advanced Energy Project Credit
In 2009, Congress enacted a new credit equal to 30 percent of a taxpayer's qualified investment with respect to any
qualifying advanced energy project of the taxpayer. This credit is available only for manufacturing facilities, not for
renewables or energy efficiency installation projects. For the purposes of the credit, a "manufacturing facility" is a
facility that makes, or processes raw materials into, finished products (or accomplishes any intermediate state in that
process). A "qualifying advanced energy project" is a project that re-equips, expands, or establishes a manufacturing
facility to produce property that is designed to (i) be used to produce energy from solar, wind, geothermal, or other
renewable resources; (ii) manufacture fuel cells, microturbines, or an energy storage system for use with electric or
hybrid motor vehicles; (iii) manufacture electric grids to support transmission of intermittent sources of renewable
energy, including storage of such energy; (iv) manufacture carbon capture or sequestration equipment; (v) refine or
blend renewable fuels or produce energy-conservation technologies (including energy-conserving lighting technologies
and smart grid technologies); (vi) manufacture qualified plug-in electric drive motor vehicles, qualified plug-in electric
vehicles, or components designed specifically for such vehicles; or (vii) reduce greenhouse gas emissions (as
determined by the Treasury Department). The IRS must certify that the project is eligible for the credit and the project
cannot produce any property that is used in the refining or blending of any transportation fuel (other than renewable
fuels). A taxpayer's "qualified investment" is the basis of eligible property that the taxpayer places in service during the
taxable year and is part of a qualifying advanced energy project. Property is placed in service in the taxable year in
which it is placed in a condition or state of readiness and availability for its intended purpose. "Eligible property" means
any property of the taxpayer that is (i) necessary for the production of property designed for the uses listed above;
(ii) tangible personal property or other tangible property (not including a building or its structural components), but only
if such property is used as an integral part of the qualified advanced energy project; and (iii) with respect to which
depreciation (or amortization) is allowable. The basis of the property is reduced by the full amount of the credit, and
recapture rules apply to the credit.
14
www.wsgr.com
To claim this credit, among other things a taxpayer must file applications for a project with the Department of Energy
and the IRS and be awarded an amount of credit. A total of $2.3 billion of credits is authorized for awards. In January
2010, the federal government announced that the entire $2.3 billion available had been awarded to projects. However,
because some approved projects might never be completed (or qualify for a lesser amount of credit) and because of
the possibility that an additional several billion dollars of credit might be authorized for future awards, credits might
become available in the future. The techniques described below to monetize tax benefits may also be available for this
credit. Because this credit is awarded to a specific applicant, any monetization technique that involves the transfer of
the property to another person (or a change in tax status of the person awarded a credit) will require that the IRS
approve the transfer of the credit to the successor.
6. Cellulosic Biofuels
An income tax credit is available for a producer of cellulosic biofuels equal to $1.01 for each gallon of qualified fuel
produced. This credit is reduced by the amount of other ethanol credits (which will expire on December 31, 2010), so
that the sum of this credit and those other credits is $1.01 per gallon of qualified fuel produced. In addition, the owner
of a cellulosic biofuel plant placed in service in the United States before January 1, 2013 (or the construction of which
begins after December 20, 2006 and before January 1, 2013) may claim a depreciation deduction equal to 50 percent
of the cost of the plant for the year in which it is placed in service; the remaining 50 percent of the cost of the plant may
qualify for accelerated depreciation.
B.
State Tax Incentives
Although not the focus of this discussion, many states and local municipalities also offer tax incentives, in various
forms (e.g., income tax credits, sales and use tax exemptions, property tax exemptions, and tax abatements), to
promote the development of projects utilizing a wide variety of renewable energy sources. Of course, in budgeting for
and deciding where to site a renewable energy project, Sponsors should also consider the impact of state and local
taxes (such as sales and use tax and property tax) on the proposed project.
An example of an available state income tax credit is the renewable energy property investment tax credit established
by North Carolina to encourage the development and expansion of renewable energy property in that state. This
income tax credit is equal to 35 percent of the cost of renewable energy property constructed, purchased or leased by
a taxpayer and placed in service in North Carolina, with limits of (i) $2.5 million of credit per installation for
nonresidential property and (ii) $1,400 to $10,500 of credit per installation (depending on the type of renewable energy
used) for residential property. If the property serves a single-family dwelling, the credit is taken for the taxable year in
which the property is placed in service; if the property is a multi-family dwelling or is non-residential, the credit is taken
in five equal installments beginning with the year the property is placed in service. Renewable energy property
includes biomass, solar, geothermal, wind, and hydroelectric. An example of a sales and use tax exemption is the
state of New York exemption for the sale and installation of residential solar-energy systems. The exemption applies
to the sale or use of a solar-energy system that utilizes solar radiation to produce energy designed to provide heating,
cooling, hot water, and/or electricity.
C.
Tax Incentive Monetization Structures
For many reasons, a developer of a renewable energy project may not be able to benefit from the various tax
subsidies available to the project. Various strategies have developed that allow a developer to receive value for, or
monetize, the tax incentives the developer would not otherwise be able to utilize. These strategies generally involve
an institutional investor that can benefit from the tax incentives acquiring an equity interest in the project. Two of the
main strategies, the partnership flip and the sale-leaseback, are discussed below. These monetization structures
may also be used for the Treasury grant in lieu of the ITC, described above.
1. Partnership Flip
In a typical partnership flip transaction, an institutional investor will form a partnership with the developer, which will
own the Solar Project or other renewable energy project. The investor will receive an allocation of tax benefits and
cash distributions from the partnership until the investor achieves an agreed-upon after-tax return. Subject to some
limitations, the investor may make its investment in the partnership over time, which effectively allows the investor to
fund its investment in the partnership with reductions in future federal income tax liability.
In the initial stage of the project, the investor generally will receive a disproportionate allocation of the partnerships
income or loss and any tax credits (e.g., PTC, ITC) available to the partnership. When the investors target return is
achieved (the flip-point), the investors allocation of partnership items is reduced to a small portion.
15
www.wsgr.com
The partnership generally will distribute its available cash flow 100 percent to the developer until the developer
recoups its cash investment in the project, and cash would thereafter be distributed 100 percent to the investor until
the flip-point is reached. Following the flip-point, cash distributions would be made in accordance with partnership
allocations (e.g., 95% to the developer and 5% to the investor). The developer will typically have an option,
exercisable on or after the flip-point, to purchase the investors interest in the partnership at its then fair market value.
In late 2007, the IRS published safe harbor guidelines for wind partnership transactions under which it would treat the
investor as a partner in the partnership (rather than a purchaser of tax credits) and respect the disproportionate
allocation of PTCs to the investor. These guidelines were revised in late 2009. The revised guidelines provide that the
safe harbor guidelines are not intended to provide substantive rules and are not to be used as IRS audit guidelines.
Although the safe harbor applies only to wind transactions and the allocation of PTCs, the renewable energy industry
is generally following the safe-harbor guidelines in structuring partnership flip transactions for non-wind projects and for
tax incentives other than the PTC.
2. Sale-Leaseback
The sale-leaseback is another structure utilized to monetize various tax incentives. Although the sale-leaseback
generally may not be used to monetize PTCs, the technique has been used extensively to monetize ITCs in solar
projects. In a typical sale-leaseback transaction involving a solar project, the developer will install, operate, and
maintain the project and a customer will agree to purchase the power generated from the project under a long-term
PPA. The developer will incur all expenses related to the installation, operation, and maintenance of the solar
equipment.
To monetize the ITC and other tax benefits, the developer will sell the facility to an investor within three months after its
in-service date. The investor will lease the project back to the developer for a lease term approximating the term of the
PPA and the developer will typically use the PPA as collateral for its lease payment obligations. The developers
revenue from the PPA is utilized to make rental payments under the lease.
The investor is considered the owner of the project for tax purposes, and it therefore claims the ITC and other tax
benefits. The investor shares its tax savings with the developer in the form of reduced rents. The developer will
typically have an option, exercisable at the end of the lease term, to purchase the project from the investor at its then
fair market value.
For the sale-lease back structure to work, the lease must be structured as a true lease for tax purposes. There is an
extensive body of law addressing the characterization of transactions cast in the form of a lease. In general, under
IRS guidelines, a lease would be respected as a true lease if the lessee does not have an option to purchase the
property for an amount less than its fair market value, the lessor retains the risk that the property will decline in value
(e.g., the lessor does not have the right to require the lessee to purchase the asset at a fixed price), and at the end of
the lease, the leased asset is expected to have a significant residual value (e.g., 20% of its original cost) and a
significant remaining useful life (e.g., 20% of its originally estimated useful life). Case law has held that arrangements
that do not fully comply with the IRSs ruling guidelines nonetheless qualify as leases. Equity investors and lenders
may require that a lease of a renewable energy project qualify as a guideline lease, however.
3. Pass-through Lease
Pass-through leases, used extensively to monetize the rehabilitation tax credit, have been used recently to monetize
solar energy credits (and more recently Treasury grants). Typically, an entity (Owner) would acquire a solar energy
project from a developer at fair market value. The project would include not only the tangible solar assets but also the
contract rights to sell the energy to the off-taker or homeowner (or lease the solar equipment to the offtaker/homeowner). The Owner would be structured as a limited liability company owned 50.01% by the developer (or
an affiliate of the developer) and 49.99% by another limited liability company (Tenant). Tenant typically would be
owned 99.9% by the investor and 0.01% by the developer (or an affiliate). Owner would lease the project to the
Tenant under an arrangement that would qualify as a true lease for income tax purposes. Owner then elects to have
any available federal credits (or Treasury grants) pass though to its lessee, Tenant. (The legislation governing
Treasury grants also permits this election for Treasury grants.) Under the election, the lessees cost basis in the
property (for claiming the credit) is the appraised value of the property, which is not necessarily limited to the lessors
cost basis in the property. The basis of the property is not adjusted for the amount of the credit/Treasury grant, but the
lessee is required to include in income 50% of the amount of the credit/Treasury grant ratably over a 5-year period.
The effect of the election is to bifurcate the credit/Treasury grant from the depreciation, since the investor owns more
than 99% of the lessee, but indirectly owns approximately 50% of the Owner, the entity that will claim depreciation.
16
www.wsgr.com
Thus, this structure is usually proposed by investors who value the credit/grant but place less importance on
depreciation. Developers would typically prefer a partnership flip or sale-leaseback structure, because, among other
things, those structures monetize nearly all of the accelerated depreciation (which developers often cannot use).
In addition to being allocated nearly all tax credits/grants, investors in pass-though structures typically received a fixed
annual equity distribution from the Tenant entity in the range of 2-5% of their invested capital. The economics and
cash flows of these deals are harder to generalize than the cash flows in a sale leaseback (where the investor gets
everything) or flip (where the investor gets nearly everything prior to the flip) and extensive modeling is usually
required to ensure the economics of the deal meet expectations and are consistent with the legal structure.
VI. Conclusion
Companies that are in the business of developing renewable energy projects confront a host of complex and inter-related
commercial and legal issues that must be successfully navigated to ensure a projects success and realize potential
investor returns. Regardless of whether project finance is employed, it is important for Sponsors to assemble a team of
professional advisors that can not only assist in executing a debt or equity transaction, but also analyze the various
options that may exist in the course of developing projects. The currently tight credit environment, which is characterized
by a lack of liquidity in the marketplace and a general risk aversion on the part of lenders, serves only to heighten
competition for available debt. However, in such an environment, the right combination of business model, project scale,
contractual structure, and equity support will still be attractive to project lenders for long-term debt commitments.
Determining whether to pursue project financing in the course of developing renewable projects is one of the most
fundamental decisions that developers must make. An affirmative decision will dictate the legal and contractual
structure of the projects, place certain operational limitations on how the projects operate, and limit the developers
discretion regarding the use of much of the cash flow from the project. On the other hand, a successful project
financing can maximize equity returns through increased project leverage, remove significant liabilities from the
Sponsors balance sheet, capitalize on tax financing opportunities, and protect key Sponsor assets. In order to take
full advantage of project financing opportunities, it is vital that companies invest the time and resources during the
initial development stages to obtain the best possible terms and conditions in commercial agreements which serve as
the foundation to project financing on successful terms.
August 2010
17
www.wsgr.com

Electricity Markets and Renewable Generation

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Electricity Markets and Renewable Generation

Uploaded by

Copyright:

Available Formats

2015

Energy Risk Professional

REQUIRED ONLINE READINGS

2015 Global Association of Risk Professionals. All rights reserved.

Energy Risk Professional

REQUIRED ONLINE READINGS

Distinguish between DR and energy eciency programs.

Compare and contrast the DR programs for various RTOs.

Describe the various methods used to encourage end-user participation in DR programs.

Understand how technology facilitates the implementation of DR programs.

Retail and wholesale electricity prices

Baseload generators, including fossil-fuel and nuclear plants

Transmission system development costs and grid usage fees

2015 Global Association of Risk Professionals. All rights reserved.

Energy Risk Professional

REQUIRED ONLINE READINGS

Identify the primary stakeholders in a project nance agreement.

Dierentiate the characteristics of common loan structures used to nance renewable

2015 Global Association of Risk Professionals. All rights reserved.

NREL is a national laboratory of the U.S. Department of Energy, Office of Energy

California Independent System Operator

Toward 21st Century Power Systems

Figure ES-1. Illustrative view of 21 century power systems. NREL

Wholesale Market Design Principles for Integrating Variable

More frequent markets

Primary frequency response

Ancillary service provision by

Bridging Wholesale Markets and Emerging Technologies

Challenges to 21st Century Market Design

Wholesale market designs provide significant efficiency in real-time dispatch of system

Toward 21 Century Power Systems ................................................................................................. 3

Bridging Opportunities Between Wholesale Markets and Emerging Technologies ................... 26

Challenges to 21 Century Market Design ....................................................................................... 33

Market-Design Research As a Platform for International Collaboration ...................................... 36

3.1 Adequacy ......................................................................................................................................... 7

4.1 Demand Response.......................................................................................................................... 26

Minimizing Complexity ................................................................................................................. 33

6.1 Short-term Operational Timescale ................................................................................................. 36

Figure 2. Illustrative view of 21 century power systems. NREL ........................................................... 4

2 Toward 21st Century Power Systems

Figure 1. Projected electricity demand by sector, 20102035.

Figure 2. Illustrative view of 21 century power systems. NREL

4. Reducing the health and environmental impacts of electricity service,

Promoting the entry of new sources of distributed generation could be perceived as a

Text Box 2. Electricity Markets in the Context of Power System Reform

3 Wholesale Market Design Principles for Integrating

More frequent markets

Primary frequency response

Ancillary service provision by

3.1.1 Energy-only Markets with Scarcity Pricing

Text Box 3. Revisions to Spains Capacity Mechanisms

Text Box 5. Bidding Demand Response into U.S. Capacity Markets

3.1.3 Variable Renewable EnergyImpact on Adequacy

3.1.4 Capabilities Markets

Negative pricing can provide a transparent mechanism for curtailment of renewable

3.2.6 Allowing Variable Renewable Energy to Participate as

3.3 Ancillary Services

3.3.2 Primary Frequency Response

Text Box 10. Provision of Ancillary Services by Demand-side Resources

4 Bridging Opportunities Between Wholesale Markets

4.1 Demand Response

4.2 Distributed Generation

Distributed generation, which is generation located within distribution networks or on the

In Denmark, real-time energy markets are called regulating power markets.