Europe’s renewable power boom has come at a considerable cost and now represents a material burden on the region’s energy consumers. Against the current economic background, rising retail energy prices have led to governments becoming increasingly aware of achieving a balance between the cost and volume of renewable supply.
In response to this significant challenge, policymakers throughout the region are in the process of reassessing the basis and generosity of the support measures that they are willing to provide to renewables. So far, there has been significant variation between the solutions emerging in different countries. In the UK, a far-reaching reorganisation of the electricity market is under way, while in Germany the level of support available for renewables is being rapidly reduced, as rising consumer costs become an increasingly sensitive topic for politicians.
However, it is in the Spanish electricity market where the difficulty of the task facing policymakers has been most clearly demonstrated. The Spanish government has been forced to introduce a number of reform packages to drastically reduce the cost of renewable subsidies in an attempt to redress the long-standing imbalance of costs and revenues in the power market.
Between 2000 and 2012, the Spanish power market accumulated a â¬26 billion shortfall between market costs and revenue from end-users. Driven by unanticipated increases in the cost of power supply, the shortfall is known as the “tariff deficit”. In response, the government has overhauled regulated retail electricity tariffs, increased taxes on generators of both conventional and renewable power, and in July 2013 announced a major package of reforms, including a proposal to abandon feed-in tariffs altogether in favour of a system of fixed returns on investments in renewables. This new incentive regime is likely to come into effect in 2014. Once a global leader in wind and solar investment, Spain is currently the only major European power market without a support programme for new, large-scale investment in renewables.
The tariff deficit is a major concern, both for the government and for large utilities such as Iberdrola, Endesa and Gas Natural Fenosa, to whom most of the debt is owed. The debt burden has negatively affected the borrowing costs and credit ratings of the companies, and has contributed to some shift in corporate strategies away from Spain and towards higher growth and lower risk markets.
While the government has made some progress towards increasing revenue from the power market, it has, so far, been unable to stem the growth of the tariff deficit. The solution most likely to resolve the issue is also the least palatable to policymakers: the regulated tariffs paid by consumers must be raised sufficiently to cover the full cost of subsidised renewable power supplies and the operation of electricity networks. Despite significant pressure for tariff deficit reduction, there are a number of reasons why the implementation of such reforms to regulated tariffs are likely to be both challenging and protracted.
Tariff reform is politically sensitive. Weak post-recession power demand would make it difficult for the government to spread the costs of deficit-related tariff increases and limit the financial impact on individual consumers. The component of government-set regulated tariffs that is intended to cover the costs of feed-in tariffs has already risen from around â¬40/MWh in the first quarter of 2010 to â¬54/MWh in the first quarter of 2013. The latest proposals outline a further increase of 3.2 per cent. Both consumers and Spain’s energy regulator, the CNE, have expressed concern about the scale of these increases and their potential financial impact on vulnerable consumers.
The diversity of priorities within Spain’s large utilities may also effectively slow progress towards a solution to the tariff deficit. There is a view within some of these companies that the inflated costs of renewables are primarily to blame for the increasing tariff deficit and that the renewables industry should bear the costs of a solution, via reduced payments for photovoltaics or wind. However, the same companies (or their subsidiaries) also own large fleets of subsidised wind capacity and wish to preserve their profitability.
Given these political and corporate influences, we expect that reforms to end the tariff deficit will be slow to implement. It is clearly in the interests of both the government and utilities to take a pragmatic approach to further changes to power sector tariffs and taxes.
In 2009, the Spanish government created the Fondo de Amortizacion del Deficit Electrico (FADE), which enabled the tariff deficit to be financed through the sale of the debt as bonds, with some of the income from those sales being paid to utilities to whom the deficit is owed. As of the end of 2012, the fund had sold around â¬17 million of debt.
While we still expect Spain to finance the tariff deficit, it is currently unclear how much debt FADE will securitise in the future. The Treasury wants to limit FADE-issued debt because of the potential impact on European Union deficit targets, while the energy department wants the flexibility to issue FADE debt without strict conditions. This is a key issue to watch because reforms could have an impact on regulated tariffs and the debt levels of Spanish energy companies.
The finances of Spain’s power market have been allowed to remain out of balance for far too long. The development of the tariff deficit highlights how difficult it is to balance government-funded renewable expansion while minimising the cost to consumers.
Failure to satisfactorily resolve the tariff deficit could risk severely weakening the investment attractiveness of the power sector. Finding investors willing to support additions of conventional capacity – which will eventually be required by a return of demand growth and plant retirements – may prove difficult given the uncertain and rapidly changing policy environment.
With the absence of incentives for new renewable supply, there is mounting risk that the market will fail to satisfy its 2020 climate and energy obligations. Spain faces the challenge of ensuring that any new renewable support package is affordable, sustainable and sufficiently attractive compared with similar systems elsewhere in Europe.
On balance, considering the political interests and financial structures in place, the tariff deficit’s role in the Spanish power market seems set to continue for some time to come.
David Brown, energy markets analyst and Tom Heggarty, European power analyst, Wood Mackenzie. Visit www.woodmac.com/spaindeficit for more information
This article first appeared in Utility Week’s print edition of 6th September July 2013.
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