Chapter 4: Renewable Generation and Security of Supply
Renewable Generation and Security
A key question this book seeks to address is
what justification exists for the promotion of
renewable generation over other forms of low-
At the same time, a commonly voiced con-
cern with renewable generation is that it will
endanger security of supply by leading to exces-
carbon generation—in other words, for policies sive dependence on intermittent sources such as
that specifically promote renewable generation wind and solar power. To some commentators,
rather than a technology-neutral approach such as this argues against the promotion of renewable
a carbon tax or cap-and-trade mechanism. Simple generation. To others, it implies the need for sig-
economics suggests that the latter approach would nificant changes in power market design to ensure
be more effective in achieving carbon reductions that sufficient backup capacity is available over
at lowest cost, through competition between dif- various time frames.
ferent carbon abatement mechanisms and tech- This chapter therefore focuses on these two
nologies (e.g., renewable energy, nuclear, carbon questions, examining to what extent security of
capture and storage, reductions in non-generation supply concerns related to import dependence
sectors, energy efficiency). warrant additional support for renewable genera-
In the European Union (EU), one of the most tion relative to other forms of low-carbon tech-
common responses is that renewable generation nology, and to what extent security of supply
merits specific support because it enhances secu- concerns related to intermittency undermine the
rity of supply by reducing dependence on case for supporting renewables at all or necessitate
imported fuels. Concerns about import depend- major changes in market design.
ence refer particularly (though not exclusively) to The focus is on the EU, where renewables
dependence on natural gas imports from Russia deployment is most prominent on the policy
and Algeria, which many observers view as poten- agenda and is explicitly linked to security of sup-
tially unreliable because of political instability and, ply by policymakers. However, many of the
in the case of Russia, a willingness to use energy conclusions—in particular, those relating to
supplies as a tool of geopolitics.1 This concern has intermittency—can be applied to other jurisdic-
been greatly enhanced by interruptions in recent tions as well.
winters to the flow of gas from Russia into the The chapter begins by examining the issue of
EU via Ukraine, as a result of disputes between import dependence. It assesses the extent of the
Russia and Ukraine. problem and analyzes whether there are market or
52 Boaz Moselle
other failures that warrant intervention, and if so, ence is a problem for the main fuels used for
whether the promotion of renewable generation power generation and whether the promotion of
is the most efficient form of intervention to renewable generation is the most appropriate
address the problem. It then focuses on the prob- policy response to any such problem.
lems posed by intermittency, again assessing the
problem and analyzing the case for policy inter-
vention and the most appropriate form that inter- Current and Projected Levels of EU
vention might take. Import Dependence
As Table 4.1 illustrates, the EU imports a large
proportion of its primary energy sources, includ-
EU Dependence on ing the main fuels used for power generation. In
Imported Fuels 2006, around 80% of electricity was generated
from coal (29%), gas (21%), and nuclear sources
The need to reduce dependence on imported (30%) (European Commission 2008b).2
fuels is used to justify a range of EU policies, Imports are very significant for natural gas,
including not only the promotion of renewables, which, as explained below, is the main source of
but also the promotion of energy efficiency and concern among policy makers. The EU holds just
the provision by some national governments of 1.6% of the world’s gas reserves and currently
subsidies to domestic coal production. In the past imports 58% of its natural gas demand, mainly
decade, these themes have been developed in from four countries: Russia, Norway, Algeria, and
numerous policy documents and pieces of legisla- Nigeria.3 Gas supplies 24% of total energy
tion, including the European Commission’s 2000 demand and 21% of electricity generation (Euro-
Green Paper on security of supply, the 2002 pean Commission 2008b). Gas import depend-
Regulation on State Aid in the coal sector, the ence is set to increase, as EU indigenous produc-
2008 Energy Security and Solidarity Plan, and the tion is forecast to decline rapidly in the coming
2009 Renewables Directive (European Commis- decade, from 176 million tons of oil equivalent
sion 2000; Regulation 1407/2002; European (Mtoe) in 2010 to 131 Mtoe in 2019 (IEA 2009).4
Commission 2008a; Directive 2009/28/EC). European Commission analysis forecasts net
This section therefore presents evidence on imports of natural gas increasing from 257 Mtoe
the extent of EU import dependence and the fac- in 2005 (58% of total consumption) to 390 Mtoe
tors that have most given rise to concern with in 2020 (77% of total consumption) under a
respect to power generation: the large and grow- business-as-usual scenario, without taking into
ing dependence on Russian gas imports and the account the impact of the new energy policy
effect of supply interruptions in recent winters. It adopted in 2009 (see European Commission
also assesses the extent to which import depend- 2008b, Annex 2).5
Table 4.1. EU import dependence, 2005
EU primary energy EU primary Net imports Import dependence
demand (Mtoe) production (Mtoe) (Mtoe) (percentage)
Oil 666 133 533 80.0%
Natural gas 445 188 257 57.8%
Solid fuel 320 196 127 39.7%
Renewables 123 122 1 0.8%
Nuclear/ 257 8 249 97.0%
Sources: European Commission 2008b, 65; Euratom 2008
Note: Mtoe = million tons of oil equivalent
Renewable Generation and Security of Supply 53
Winter Supply Interruptions were characterized by low gas prices for Ukraine
and low transit charges for delivery of Russian gas
The heavy dependence of the EU on Russian gas to Europe.6
has been brought home to the public and In March 2005, Russia claimed that Ukraine
policymakers alike in recent years by interruptions was not paying for gas and was diverting gas
to the supply of Russian gas at the start of the intended for transit to the EU (BBC 2006). On
calendar year, arising from disputes between Rus- January 1, 2006, Russia retaliated by cutting off
sia and Ukraine. A number of such disputes have gas supplies passing through Ukrainian territory.7
occurred since the breakup of the Soviet Union as Russia and Ukraine reached a preliminary agree-
a result of continuing difficulties in agreeing on ment on January 4, and the supply was restored.
the details of a new gas transit and supply regime, The agreement provided for an increase in the
as well as deeper underlying differences. The most nominal price of gas but did not provide an
serious of these interruptions occurred at the agreed pricing formula for future years or a tran-
beginning of 2006 and 2009. In January 2006, gas sition period to higher prices.The new agreement
supplies to the EU were interrupted for one day; was set to expire on December 31, 2008.
in January 2009, the interruption lasted 16 days The 2009 crisis began on January 1, when
Gazprom cut off suppliers (again, it stopped sup-
(European Commission 2009a).
plying gas for Ukrainian consumption while the
supply of gas that was theoretically to be transited
Ukraine’s Role as a Gas Consumer through for European consumption continued).
and Transit Country Initially disruption of supply to the EU was only
minor, but by January 7, all supplies from Russia
Ukraine is both a significant consumer of gas and to the EU were cut, and supplies were not
a key transit country. Its daily consumption in resumed until January 20. This was the most seri-
winter is about 300 million cubic meters per day ous gas supply crisis ever to hit the EU, depriving
(mcm/day), and another 300 to 350 mcm/day of it of 20% of its total gas supply (European Com-
gas passes through Ukraine to the EU (European mission 2009a). Within days of the supply disrup-
Commission 2009a). Imports from Russia via tion, 12 countries were affected. They responded
Ukraine constitute around 80% of EU imports of by drawing on storage, importing additional LNG
gas from Russia and about 20% of total gas supplies, and fuel-switching by the use of fuel oil
demand in the EU (European Commission and coal. Increased supplies were sourced from
2009a). The Ukrainian gas sector features below- Russia via Belarus and Turkey, as well as from
cost pricing for domestic and government cus- Norway and Libya. Gazprom is estimated to have
tomers, and chronic underinvestment in its oil lost sales of $2 billion (European Commission
and gas sector, including the gas pipeline infra- 2009a).
structure (Chow and Elkind 2009).
Disputes between Ukraine and Russia over Is Import Dependence Really a Problem?
gas supplies, transit, and payment for gas have Reliance on imported fuels is not, per se, a cause
been a feature of this market since the early 1990s. for concern. For policy intervention to be justi-
Ukrainian inability to pay for the huge volumes of fied on security-of-supply grounds, a number of
gas contracted (despite the very low prices Russia conditions must be satisfied, including that:
gave Ukraine) led to high levels of debt and
unpaid bills on a continuous basis for many years • The reliance on imports creates a genuine
(Stern 2005). The disputes remained unresolved security-of-supply risk. This is unlikely to be
despite a series of agreements covering the gas the case for a fuel that can be imported easily
volumes and prices, the price of gas transit across from a number of different countries that are
Ukraine, and the level of debt owed to Gazprom politically stable, friendly, and geographically
by the Ukrainian gas company Naftokhaz, which diverse.
54 Boaz Moselle
• There is good reason to think that the normal world, as Figure 4.2 illustrates. At the current rate
market response will not efficiently address of consumption, this would constitute about 100
any security-of-supply risks and that policy years’ worth of supply.
intervention can be expected to do better. Uranium’s extraordinarily high energy density
makes it practical to maintain large stockpiles
The first of these conditions is assessed below for (Euratom 2008), reducing the risks associated
each of the main fuels used for generation: coal, with a short-term interruption in supply. This fac-
uranium, and natural gas. This is followed by a tor and the diverse range of supply sources suggest
discussion of the potential for market or other that dependence on uranium imports is not a sig-
failures that might justify intervention. nificant security-of-supply risk for Europe,
despite the high level of import dependence, una-
Coal voidable given that Europe has less than 2% of the
world’s identified uranium resources (European
Globally, coal is much more abundant than oil or
natural gas. There are proven coal reserves of 826
billion tons of coal, with a proven reserve-to-
production ratio of 122 years (BP 2009).8 Coal Gas
reserves are available in almost every country, with
recoverable reserves in around 70 countries. Six The picture for natural gas is very different than
countries together account for about 80% of coal that for coal or uranium. Prima facie there is good
reserves, as shown in Figure 4.1. reason to consider that the EU’s import depend-
Given that world coal reserves are spread ence does represent a potential threat to security
across a politically and geographically diverse set of supply. As noted earlier, the EU imports more
of countries, large in number and including some than half of its gas, of which a large proportion
of Europe’s closest political allies, the prospect of comes from Algeria and Russia, and gas imports
significant supply interruption seems relatively are predicted to increase in coming years (Euro-
remote. It is therefore implausible to argue that pean Commission 2007) as output continues to
dependence on coal imports is a significant threat decline in the main EU producing nations.
to EU security of supply. Dependence on Algerian and Russian gas is of
concern because of the absence or weakness of
democratic institutions and transparent govern-
ance arrangements in these countries. Algeria has
The earth has 5.5 million metric tons of identified experienced recent civil war and ranks poorly on
uranium resources, distributed widely around the international league tables in terms of democracy
South Africa Brazil 5%
India 7.1% 3.7% Namibia 5%
United States 28.9% Australia 23%
South Africa 15%
Other 18.2% 19.0% 8%
Figure 4.1. World coal reserves Figure 4.2. World uranium resources
Renewable Generation and Security of Supply 55
and civil rights (World Audit 2010). Russia also Nigeria 2.8% Venezuela 2.6% Algeria 2.4%
has a low rank, and the poor climate for business United Arab
investment raises questions as to whether new United States Russia 23.4%
investment required to maintain and increase gas 3.6%
supply will be forthcoming. There is also a ques- Saudi Arabia
tion as to how far the supply of gas is a commer-
cial decision versus an instrument to exercise geo- Turkmenistan
political influence. This means that the extent to
which the supply of gas will respond to increased
demand is unclear. Qatar 13.8% Iran 16.0%
In addition, analysts have noted that Russia
needs to replace declining fields with new pro-
Figure 4.3. World gas reserves: top 10 countries
duction from the Yamal Peninsula and offshore
fields and to refurbish a large, aging high-pressure
of-supply risk for the EU. It is possible that a
pipeline network (Stern 2005). As mentioned
combination of LNG imports and the arrival of
above, there is also a need to invest in the Ukrain-
unconventional gas (either in Europe or in the
ian pipeline network or construct new pipelines
United States but “liberating” LNG flows that
to maintain transit capacity to Europe. could come to the EU) will mitigate the problem.
Underlying these concerns is the absence of It is also possible that the risk is overestimated
realistic alternative sources of natural gas. Relative because of the mutual dependence between the
to other fuels, the ability to bring gas from differ- EU and its suppliers: revenue from gas sales is of
ent sources is inherently limited by the more great importance to both Russia and Algeria, and
costly, capital-intensive and inflexible means of indeed, they have been known to express concern
transportation required, in the form of long- about “security of demand” from the EU, mirror-
distance pipelines or liquefied natural gas (LNG). ing the EU’s concerns about security of supply
Moreover, while gas remains abundant at global (see, e.g., Yenikeyeff 2006). Neither of these pos-
level, with world proven reserves as of 2007 stand- sibilities can be viewed as certain, however, and
ing at some 177 trillion cubic meters (tcm),9 the risk is therefore a real one, albeit difficult to
equivalent to some 60 years of consumption at assess or quantify.
current rates (BP 2009), those reserves are con- The problem is particularly acute for eastern
centrated in a small number of countries, as Europe. Estonia, Latvia, Lithuania, Bulgaria,
shown in Figure 4.3. Of these, just three coun- Slovakia, and Finland are completely dependent
tries, Russia, Iran, and Qatar, hold about 53% of on Russia for gas imports, while Greece, Hun-
the total. gary, and Austria are more than 80% dependent
There is an unknown potential for European (European Commission 2008b). Among the seven
domestic gas supply to be boosted by unconven- new eastern European member states, depend-
tional or shale gas. In the United States, substan- ence on Russian gas imports averages about 77%
tial discoveries of unconventional gas have been (European Commission 2009a). Eastern Euro-
made.10 However, estimates of the potential for pean commentators point to the experience in
unconventional gas in Europe are lower. One Lithuania—where oil supplies from Russia to the
study estimates that Europe has 29 tcm, whereas Mazeikiu refinery were halted because, it is
the United States has around 233 tcm of uncon- claimed, Russia objected to its sale to a Polish
ventional gas (Holditch 2007).11 Moreover, the refiner, PKN Orlen—as a sign of the potential
ability to extract the resources will depend on risks they face (Geropoulos 2007). The political
environmental consents and the cost of extracting temperature is clearly at its highest with regard to
unconventional gas in Europe. eastern Europe, given Russian resentment at its
In conclusion, it seems that gas import loss of influence there since the breakup of the
dependence is a potentially significant security- Soviet Union.
56 Boaz Moselle
The Case for Policy Intervention judgments and use them to implement better
policies. A case may therefore exist for interven-
Gas import dependence is therefore an under- tion on essentially paternalistic grounds.
standable source of concern for European The second problem is the issue of politically
policymakers. However, it does not automatically motivated supply interruptions. Arguably, the risk
follow that policy intervention is warranted. Mar- of supply interruption by a hostile state actor is
kets already provide strong incentives for market greater the more disruptive the effect of the inter-
participants to appropriately ensure against unreli- ruption.13 Thus, although ensuring against low
able supplies. Contracts between suppliers and rainfall in a hydro-dominated power system does
consumers generally oblige suppliers to deliver not make rain more likely to fall, ensuring against
energy, and suppliers that choose to contract with gas supply interruptions in the EU actually
less reliable sources (in other words, are too reliant reduces the threat of interruption, because if such
on gas from Russia and Algeria) will face what- interruptions are relatively painless, then a hostile
ever penalties their contracts contain. These pen- state gets little strategic benefit from interrupting
alties are negotiated on a bilateral basis and there- or threatening to interrupt supplies. If so, then
fore represent accurately the costs to consumers of individual investments in supply security (e.g.,
loss of supply, or the trade-offs consumers are booking more gas storage or installing dual fuel
willing to make between price and security of capability at gas-fired power stations) create a
supply (for example, a consumer may be willing positive externality, and as with any such external-
to sign a contract that has no penalties in the event ity, there will be an incentive to free ride: con-
of supply failure, such as through the operation of sumers will spend less than is socially optimal,
a force majeure clause, but in that case the supplier because they face all the costs but only a small part
accepts a lower price in return). A similar logic of the benefits (the so-called “tragedy of the com-
applies for consumers that choose to rely on mons”). Moving down the chain, it follows that
short-term contracts or spot markets: they accept suppliers will not face appropriate incentives to
the higher level of risk in return for greater flex- ensure security, and the market will under-
ibility or an expected lower price. provide security.
The key question therefore is whether these Third, experience shows that in conditions of
incentives are sufficient to provide an efficient12 energy scarcity, regulatory or political interven-
level of security—or, more accurately, whether tion will almost certainly prevent the market from
they provide a more efficient level of security than functioning efficiently.The prospect of such inter-
can be expected from policy intervention, bearing vention will therefore undermine investment
in mind that real-world policy interventions and incentives. For example, a private investor might
real-world markets are both inherently imperfect consider investing in a gas storage facility even if
compared to any theoretical ideal. the market already appears well supplied with gas
In that context, a number of problems could storage, on the basis that it would offer a very high
undermine the ability of these market-based return in the low-probability event that a major
incentives to give an efficient outcome. These gas shortage leads to prolonged spikes in spot gas
include some market failures that typically provide prices. Experience in Great Britain suggests that
the theoretical justification for policy interven- these spikes could involve prices many times as
tions, but also other issues that are arguably more high as under normal conditions,14 implying
important from both normative and positive per- spectacular returns to anyone holding gas in stor-
spectives (i.e., they should be taken more seri- age.
ously, and they have a bigger impact on policy In reality, however, the investor will be aware
outcomes). that many regulators or governments have
First, it may be that consumers (individuals arrangements in place that suspend the price
and firms) are not good at making judgments of mechanism in such emergencies. Such an investor
this kind, and that governments could make better will also be aware that even if those mechanisms
Renewable Generation and Security of Supply 57
are not yet in place, they could be introduced at supply. An individual consumer therefore has no
short notice, and moreover, in the absence of incentive to purchase energy from more reliable
price controls, they would be likely to suffer ret- sources, as the higher levels of security are spread
ribution if they were judged to have profiteered or across all consumers. Purchasing from a more reli-
“price-gouged” during a crisis.15 able source creates a positive externality but
Conversely, market participants will also be almost no private benefit (see Joskow 2007).
aware that emergency arrangements typically Again, this gives rise to free riding and
involve the imposition of “shared pain” rules, underprovision of security by the market.
which undermine private incentives to ensure
against scarcity of supply. For example, scarce gas
supplies might be allocated to all suppliers on a
pro rata basis related to the size of their customer How material these problems are for security of
load. Such an outcome would do nothing to supply is a difficult empirical question, both in
reward the supplier who had purchased gas from a absolute terms and because assessment should be
more reliable source. against a counterfactual that is based on a realistic
Examples of these two tendencies— assessment of the likely intervention that the
nonreliance on the price mechanism and a policy process would give rise to. Nonetheless,
“shared pain” approach—can be found in the gas some simple observations are in order.
“emergency cash-out” arrangements in Great First, the paternalistic argument that consum-
Britain, which suspend the market-based deter-
ers are unlikely to make wise decisions is at least
mination of prices for the duration of the emer-
plausible. Extensive research in psychology and
gency (Ofgem 2006). The European Commis-
behavioral economics shows that human beings
sion’s proposed new legislation on gas security of
have particular difficulty making decisions involv-
supply provides for a variety of non-market-based
measures including compulsory demand reduc- ing low-probability events that are well outside
tion and forced fuel switching (European Com- their normal range of experience (Tversky and
mission 2009c). Kahneman 1992). However, the claim that gov-
A fourth problem is a more conventional mar- ernment intervention will lead to better outcomes
ket failure: because security of supply is to some is more contentious (apart from any other consid-
extent a public good, markets will tend to eration, governments are made up of human
undersupply it.16 Specifically, the issue arises for beings subject to the same biases as others).
natural gas and electricity because they are trans- Second, the argument concerning politically
mitted via networks used by many consumers, motivated interruptions is also at least plausible.
and most individual consumers cannot be The key question for EU policymakers to answer
remotely interrupted when supplies are tight.17 is how likely Russia is to interrupt gas supplies for
Domestic and commercial consumers generally political reasons. On the one hand, instances have
do not have real-time metering and are not already occurred where Russia has cut off oil sup-
exposed to higher spot prices when supplies are plies to an EU member state for essentially politi-
scarce. There is therefore no incentive for indi- cal reasons. On the other hand, as noted earlier,
vidual consumers to ensure against supply risks, profits from Gazprom are of great importance to
for example by paying more to purchase from a Russia and members of its political elite, creating
supplier that has more gas in storage.18 a relationship of mutual dependence between
In particular, with electricity the absence of Russia and the EU.
remote disconnection means that in the event of a Third, the combination of regulatory and
blackout, all consumers will lose supply in an area, market failures described above seems to imply
even though in general it would be possible to set that all but the very largest consumers are cut off
a price—if all consumers were exposed to real- from any of the upside from investing in enhanced
time prices—that would allow demand to match security of supply.
58 Boaz Moselle
Finally, whatever the objective merits, it is also able energy, with a binding target of 20% of final
clear that governments are increasingly set on energy consumption; and reduce greenhouse gas
intervention in this area, at EU and national lev- emissions, with a 20% reduction relative to 1990
els. In the context of this book, it is therefore levels.
appropriate to ask whether, assuming that As the table shows, the combination of meas-
policymakers are intent on intervention, the pro- ures is predicted to reduce gas imports by about a
motion of renewable generation is the best form quarter, relative to business-as-usual. However,
of intervention to address the EU’s concerns this analysis also raises a number of questions.
about import dependence and its impact on secu- First, it is clear that much of the reduction in
rity of supply. gas consumption reflects the impact of energy
efficiency measures that reduce total energy con-
Is Promotion of Renewables sumption, rather than the displacement of gas-
the Right Intervention? fired generation by renewables. Indeed, one can
see from the table (see the “Impact of new policy”
It is natural to expect that the promotion of rows), that the predicted reduction in gas con-
renewable generation will reduce gas consump- sumption induced by the new energy policy (sec-
tion and hence gas import dependence, by substi- ond column) is much larger than the induced
tuting away from gas-fired generation. Analysis increase in renewable energy (last column).
carried out for the European Commission is con- Second, although the analysis does not allow
sistent with this logic. Table 4.2 shows the pre- one to separate out these two effects, it is likely
dicted effects of the EU’s new 20-20-20 energy that the impact of renewables on gas-fired
policy adopted in 2008, whose main components generation is materially affected by the need for
are commitments to achieve several goals by the continued use of gas to provide flexible backup
year 2020: reduce demand, with an indicative tar- for intermittent renewables. Recent analysis by
get of 20% reduction in energy consumption rela- Capros et al. (2008) suggests that the new energy
tive to business as usual; increase the use of renew- policy will reduce coal-fired generation signifi-
Table 4.2. Energy consumption and import dependence by 2020
Gas Gas con- Gas imports/ Solids Solids con- Solids imports/ Renewable
imports sumption consumption imports sumption consumption energy
(Mtoe) (Mtoe) (%) (Mtoe) (Mtoe) (%) production
2005 257 445 57.8% 127 320 39.7% 122
2020 (oil $61/bbl)
Business as usual 390 505 77.2% 200 342 58.5% 193
New policy 291 399 72.9% 108 216 50.0% 247
Impact of new –99 –106 –4.3% –92 –126 –8.5% 54
2020 (oil $100/bbl)
Business as usual 330 443 74.5% 194 340 57.1% 213
New policy 245 345 71.0% 124 253 49.0% 250
Impact of new –85 –98 –3.5% –70 –87 –8.0% 37
Source: European Commission 2008b, 65
Renewable Generation and Security of Supply 59
cantly more than gas-fired, both because of the imports of uranium or coal, I have argued above
impact of carbon prices and because renewable that no significant security-of-supply issue should
power requires extensive support by flexible arise from such imports.
reserve power, supplied mainly by gas units. In conclusion, therefore, a policy that pro-
Indeed, the analysis in Table 4.2 also shows the motes low-carbon generation in general would
impact of the new policy on coal (solids) to be probably be more effective in addressing gas
equal to or larger than the impact on gas. import dependency and enhancing security of
Third, it is unclear which gas sources are most supply than the current policies that specifically
likely to be affected by the reduction in gas promote renewable generation.
imports. If the main effect of the policy is to dis-
place imports of LNG from relatively friendly
sources, then the effect on security of supply is
small. However, this is likely to be the case. LNG
is often viewed as the marginal source of gas, Some of the most prominent forms of renewable
because of the relatively high cost of bringing generation—in particular wind but also solar and
LNG to the EU, and also because Algerian and wave power—are variable in output, with the
Russian producers are to some extent captive sup- level of production determined by exogenous fac-
pliers, given the high cost of attempting to diver- tors such as wind speed, and also unpredictable to
sify away from their European customer base.19 a lesser or greater degree. “Intermittency” is the
Finally, the analysis described above suffers term generally used to refer to this combination
from a more fundamental flaw, in that the of variability and relative unpredictability.
business-as-usual counterfactual is arguably some- Two concerns arise from the intermittent
thing of a straw man. A more interesting counter- nature of renewable generation. A short-run con-
factual would be a scenario with a policy that cern is the impact on “system balancing”—
involves the promotion of all forms of low-carbon ensuring that supply and demand of power are
energy on a technology-neutral basis: a carbon tax matched on a second-by-second basis. A long-run
or cap-and-trade scheme (in this context, the EU concern is whether a liberalized power market can
ETS with a tighter cap) and no policies aimed be relied on to produce enough investment to
specifically at promoting the large-scale deploy- meet the much greater need for backup
ment of renewables.20 generation—flexible capacity that will be used
The effect of such a policy would be to pro- primarily when demand is high and wind output
mote some combination of energy efficiency is low, and whose overall utilization will therefore
measures, nuclear power, coal-fired generation be comparatively low.
with carbon capture and storage (CCS), and
renewables. The noteworthy point here is that of System Balancing
those four classes of technology, renewable
generation—at least in the forms of wind, solar, or The basic physics of electric power systems
wave power—may well be the least suited to requires that production and consumption22 are
enhancing security of supply, because as noted matched on a second-by-second basis. In any
earlier many renewable generation technologies power system, a system operator (SO) is responsi-
are intermittent and will likely be associated with ble for continuously ensuring this balancing. The
continued extensive use of gas-fired generation as SO has short-term control of certain generating
“backup”.21 It is therefore likely that they will dis- assets, which it uses close to and in real time to
place less gas-fired output than equivalent correct any difference between the amounts of
amounts of nuclear power or coal-fired genera- electricity supplied to the system and the amount
tion (or investments in energy efficiency). being consumed.
Although increased use of nuclear power or coal- Small deviations from perfect balance take
fired generation would probably entail increased place continuously and result in fluctuations in the
60 Boaz Moselle
frequency of AC power. Certain generating units ter 2 and references therein. In brief, it is clear
are configured to react automatically and instanta- that significant advances have been made in the
neously to these deviations. This so-called “pri- ability to forecast wind speeds and the output
mary reserve” acts as a first line of defense against from wind generation, such that while high levels
imbalances. In case of larger deviations, after the of penetration of wind generation may add to the
immediate response of the primary reserve, gen- cost of system operation, they need not under-
erators providing the so-called “secondary mine system stability. Current evidence suggests
reserve” increase or reduce injections within sec- this is the case at least for penetration up to 20%
onds, following the instructions of a central (i.e., with up to 20% of electric power being gen-
device in a process known as automatic genera- erated by wind).
tion control. Secondary reserve is a scarce The issue is at present less clear for other
resource, because it is provided by units with spe- intermittent sources, and in climates with cloudy
cific technical capabilities. As soon as possible, skies, solar photovoltaic (PV) power may present
therefore, typically with a lag of minutes, injec- greater challenges, as cloud cover means the vari-
tions by units providing so called “tertiary ability in output can occur over seconds rather
reserve” are increased or decreased, following the than hours (although geographic dispersion will
instructions of the system operator, and secondary mitigate this to some extent). Nonetheless, Boyle
reserve capacity is restored to the pre-deviation argues in Chapter 2 that they can probably be
level. dealt with in similar fashion (for more details, see
In a liberalized market, the SO generally con- also Boyle 2007).
tracts with generators, and sometimes large con- The findings of a very comprehensive survey
sumers, to procure these services.23 The nature of paper by Gross et al. are consistent with this con-
the reserve contracts varies, but for the purpose of clusion: “none of the 200+ studies [we have]
this chapter, it is sufficient to note that the SO will reviewed suggest that introducing significant lev-
pay plants to be available to provide balancing els of intermittent renewable energy generation
services, as well as for the provision of the services on to the British electricity system must lead to
when called on. reduced reliability of electricity supply” (2006,
Clearly the task of system balancing becomes iv).
more difficult the greater the changes in the levels However, these conclusions do assume that
of output, especially if those changes are advances in forecasting will be effectively incor-
unpredicted or occur with only very short porated into system operation procedures. Chap-
notice.24 The prospect of high levels of penetra- ter 11 notes the example of Texas, where a much-
tion of intermittent generation therefore gives rise discussed emergency occurred in 2008 following
to concern that the job of system balancing will a rapid reduction in wind output. The reduction
become more costly and less certain of success: had been predicted by commercially available
the SO will have to purchase more balancing forecasts, but the SO had not purchased those
services, and if it fails to purchase enough, it could forecasts.
find itself overwhelmed by unexpectedly volatile
shifts in output from intermittent generation,
endangering security of supply.25
The same survey by Gross et al. (2006) also
System Stability Implications analyzes the cost implications of intermittency,
looking at how much additional reserve capacity
From a system stability perspective (i.e., in terms is likely to be required and how much this
of the risk of supply disruptions), these concerns is likely to cost. The authors conclude that “for
are probably exaggerated. The more technical penetrations of intermittent renewables up to 20%
aspects of the system-balancing challenges posed of electricity supply, additional system balancing
by intermittent generation are addressed in Chap- reserves due to short term (hourly) fluctuations in
Renewable Generation and Security of Supply 61
wind generation amount to about 5–10% of The size of this requirement will clearly
installed wind capacity. Globally, most studies esti- depend on the level of penetration of intermittent
mate that the associated costs are less than generation, the technologies involved, the specific
£5/MWh of intermittent output, in some cases electricity system, relevant physical features (e.g.,
substantially less.” Of course, an additional cost of the geographic and temporal distribution of
£5 ($7.50) per MWh is a material issue,26 but that wind), and many other factors. This has been the
forms part of a larger set of questions about the object of many engineering studies. For the pur-
cost-effectiveness of renewable generation and is pose of synthesis, it is convenient to summarize
not really a security-of-supply issue. any such study in terms of its estimated “capacity
All of this analysis assumes, however, that the credit,” which measures how much conventional
necessary reserve will be there for the SO to call thermal generation is displaced by a unit of inter-
on. This naturally leads back to the question of mittent generation. So, for example, a capacity
investment incentives. credit of 20% means that adding 100 megawatts
(MW) of intermittent generation would allow
one to retire 20 MW of conventional generation
Investment in Backup Generation while maintaining the same overall level of system
Given the difficulty of storing electricity and the security.
limited potential for shifting demand across time, A comprehensive survey of these studies can
the use of intermittent generation means that a be found in Gross et al. (2006), whose summary
large set of backup generation is required to of the estimates of the capacity credit from 19 of
ensure that demand can be met at times when the the studies is shown in Figure 4.4.
intermittent sources have low availability because Clearly a capacity credit in the range implied
of a lack of wind, sunshine, and so on. This need by these studies would add significantly to the
for spare capacity is not unique to systems with total capital costs of the system. With regard to
intermittent generation: no type of generation is security of supply, however, the concern is that a
available with 100% certainty, and conventional liberalized market will not have sufficient invest-
units also close down for planned and unplanned ment to provide the required level of generation
maintenance. Nevertheless, large-scale penetra- capacity.
tion of intermittent generation gives rise to a
much higher requirement.
intermittent generation capacity)
Capacity credit (% of installed
20 79 121 204
15 250 243 238
0 5 10 15 20 25 30 35 40
Intermittent generation penetration level (% of total system energy)
Source: Gross et al. 2006, 43
Note: the shaded area refers to UK studies
Figure 4.4. Capacity credit values
62 Boaz Moselle
Starting Point: Excess Capacity requirements of new environmental legisla-
tion. So, for example, in the EU, the cost of
In the short run, there may be little issue with the adding “scrubbers” to coal-fired units by
availability of reserves and peaking generation 2015, to comply with the Large Combustion
more generally, because as new intermittent Plant Directive, would have to be recovered
capacity is added to the network, the existing through future profits, and this could be dif-
conventional capacity remains available. Although ficult if utilization is expected to be very low.
generators could choose to retire this capacity, the
incentives to do so are relatively weak, because the
investment is already sunk and profits from opera- Investment Incentives in Energy-Only Markets
tion need cover only annual fixed costs (such as
In the long run, however, there is a real question
transmission charges or taxes levied annually) to
as to whether energy markets will deliver the
make it worth keeping the plant open.
needed investment. This question falls into a
Experience to date in Germany and Spain is
wider debate as to the ability of liberalized energy
consistent with these arguments. Sensfuß et al.
markets to provide sufficient levels of investment.
(2008) note that for Germany, “the development
The issue has been extensively discussed in aca-
of renewable electricity generation has had no
demic and policy circles for some years (Cramton
major impact on investments into new generation
and Stoft 2005; Stoft 2002). This chapter can do
capacity up to the year 2006. One reason is that
no more than briefly sketch out the main posi-
the period after the liberalization of the electricity
market was characterized by excess capacity and a
The issue relates specifically to “energy-only”
subsequent decommissioning of power plants,”
markets, where generators’ only sources of rev-
while “most of the decommissioned capacity was
enue are the sale of electricity and the provision of
decommissioned for economic reasons such as
reserves, as described earlier in this chapter.27
low efficiency of the plant, need for repairs or
Theoretical models suggest that although genera-
inefficient use of expensive fuels such as oil and
gas.” Chapter 15 in this book describes the evolu- tors in a competitive energy-only power market
tion of Spanish capacity, characterized by high can earn sufficient operating profits to cover their
levels of excess capacity due in large part to the cost of capital (i.e., the variable profit from selling
rapid expansion of renewable generation, and as power can provide a sufficient return on invest-
yet without any consequent retirement or ment), the requirements for that to happen are
mothballing of plants. rather stringent and may not be met in practice in
In some markets, however, this initial over- most real-world power markets.
hang of excess capacity might erode relatively The problem arises because if such a market is
quickly, for a number of reasons: competitive, then the spot price of electricity will
approximate the marginal cost of the most costly
• If there is too much capacity, then prices generator being called on—the “system marginal
might fall to a level that induces plant cost”—at any point in time except hours when
mothballing or early retirement. Chapter 15 demand (strictly speaking, demand for energy and
indicates that this situation may be develop- operating reserves) exceeds available capacity. In
ing in Spain. those hours, it is possible for price to exceed sys-
• Generators with zonal or regional market tem marginal cost, for example if it is set by price-
power might have an incentive to retire some responsive demand. The difference between price
of these plants so as to raise peak prices and and system marginal cost is referred to as a “scar-
the price of reserve. city rent”.
• Incentives for early retirement may be exac- For peaking plants (the plants with the highest
erbated by the costs of refurbishments, marginal cost on the system), these scarcity rents
including those necessary to meet the are the only way to create a return on capital. It is
Renewable Generation and Security of Supply 63
possible to show that at least in theory, scarcity underinvestment, particularly in peaking capacity.
rents are also necessary for plants with lower mar- This issue is commonly referred to as the “missing
ginal cost, if they are to earn a sufficient return to money” problem.
cover their sunk costs. It is therefore necessary On the other hand, proponents of a more
that prices in those hours be sufficiently high to market-oriented approach argue or assert that in
provide an appropriate return on capital, i.e., one the absence of price caps, the market can in prac-
that will provide the right incentive for new gen- tice be expected to provide sufficient capacity,
eration in peaking plants. theoretical models notwithstanding. In Great
Prices at times of scarcity should generally be Britain, this view underlies the existing market
set either by demand-side response or by actions design, the so-called New Electricity Trading
of the system operator in its procurement of oper- Arrangements (NETA), which does not have any
ating reserves (Hogan 2005). If those mechanisms price caps in place. Practical experience in the
work appropriately, then it can be shown that in decade since NETA was put in place is somewhat
theory, the level of scarcity rents will be efficient, ambiguous. Despite many claims of imminent
in the sense of ensuring that generators earn their crisis, the lights have stayed on. However, this has
cost of capital and have appropriate incentives for been achieved with very little new investment in
new investment. generation, indicating that the system may have
However, this outcome depends on the pres- enjoyed an overhang of excess capacity from the
ence of flexible scarcity pricing mechanisms and preceding decade.
the absence of market or regulatory imperfections In sum, there are theoretical reasons to believe
that in the absence of some form of capacity
that limit demand-side response or distort system
mechanism, a competitive energy-only market
operator decisions. In practice, such imperfections
without efficient scarcity pricing mechanisms may
underdeliver on investment in reserve capacity
(i.e., in flexible units that will experience low
• The development of mechanisms to allow
average utilization). Although the materiality of
demand-side participation has been generally
those concerns is open to debate, it is clear that
rather slow in most electricity markets, limit-
any problems would be exacerbated considerably
ing the potential for demand-side response to by the much greater need for such units that
set prices at times of scarcity. comes with high levels of penetration by renew-
• The protocols followed by many system able generation. Moreover, in practice, concerns
operators at times of scarcity do not lead to about underinvestment are likely to be well
the appropriate level of scarcity pricing.28 founded because of the combination of explicit
• The potential for prices to depart from gen- price caps and the implicit threat or shadow of
erators’ marginal costs at times of scarcity is future price regulation in most or all liberalized
often limited by administrative measures con- markets. Even in Great Britain, which until
straining prices, to mitigate market power or recently was viewed as the paragon of energy
for other reasons. For example, many cen- market liberalization, reregulation is now being
trally organized markets (“pools”) have openly discussed (see, e.g., Ofgem 2010).
explicit price caps in place,29 and some limit The example of Great Britain also illustrates a
the offer prices as a part of the ex ante market deeper problem with investment incentives in the
power mitigation process. In many markets, context of current energy policy, of which policy
regulators monitor prices and perform ex toward renewables forms only a part. The nature
post investigations of price spikes, with a of the policy response to climate change, particu-
chilling effect on scarcity pricing. larly in the EU, means that all forms of investment
in new generation capacity are heavily influenced
It is therefore argued that in practice, imperfec- by government intervention. Thus renewables,
tions in energy-only markets will lead to nuclear, and CCS each attract technology-specific
64 Boaz Moselle
forms of support, whereas environmental regula- high penetration of intermittent generation
tion in the form of the EU Emissions Trading means that a number of EU regulators are likely to
Scheme as well as non-climate-related measures30 be addressing those challenges in the coming
affect the relative and absolute returns on different years.
technologies. Investments are thus arguably sub- Finally I note one caveat: the picture may be
ject to very high levels of political risk, and it is by somewhat different in countries where generation
no means clear that markets are able to assess and investment decisions are more naturally influ-
bear these risks. enced by informal ties between industry and gov-
In conclusion, therefore, the possibility that ernment. For example, in Germany needed
competitive liberalized markets will struggle to investments may take place as the outcome of
provide sufficient peaking capacity to accommo- informal (or at least non-contractual) agreements
date large amounts of intermittent generation is a between government and industry, rather than
very real one, for a variety of reasons. The biggest being either a pure market outcome or one
factor undermining investment incentives is the induced by regulatory mechanisms such as cap-
high level of uncertainty and political risk, which acity payments.
affects all generation investments to a lesser or
greater degree, except for projects that can rely on
explicit and iron-clad government guarantees. Conclusions
The design of wholesale power markets may
need to change to reflect these concerns, by pro- Dependence on imported gas gives rise to real,
viding stronger and more reliable incentives for albeit hard-to-quantify, security-of-supply issues
investment, such as in the form of capacity pay- for the EU, because of geopolitical concerns
ments or similar mechanisms. Capacity payments around both Russia and Algeria. Those problems
are widely used in the United States and have had are particularly acute for many of the new EU
some application in Europe (in Spain, for exam- member states in eastern Europe, where depend-
ple, as well as in England and Wales in the 1990s) ence is highest and relations with Russia are most
(Perekhodtsev and Blumsack 2009). These are strained. Dependence on imported coal and ura-
payments to generators that are additional to the nium does not give rise to such concerns, because
revenue they receive from the sale of energy. Dif- of the number, diversity, and friendliness of
ferent countries have taken alternative approaches potential sources.
toward implementing such a mechanism. In Market outcomes may not provide an efficient
Europe, the approach generally has been for the level of protection against the security-of-supply
transmission system operator (TSO) to make pay- risks associated with gas import dependence,
ments to generation on the basis of its availability because of a variety of market and regulatory fail-
to generate, recovering those payments as a sur- ures. However, the promotion of renewable gen-
charge on transmission tariffs. In the United eration is not the best policy response. Increased
States, regulators have tended to place obligations promotion of all forms of low-carbon energy
on demand-side participants to contract forward (including energy efficiency) would appear to be
for capacity via organized “capacity markets”. The at least as effective in enhancing security of supply,
level of the obligation then determines the at lower overall cost.
demand for capacity in those markets, and that Security-of-supply concerns related to inter-
combines with supply to determine a capacity mittency and its impact on system operation and
price. In either case, the details of design (includ- grid stability are exaggerated. In particular, recent
ing, for example, determining the appropriate improvements in wind forecasting mean that even
level at which to place the price, or the quantity rather high levels of penetration for wind genera-
associated with an obligation) are extensive and tion can safely be accommodated by an efficiently
potentially challenging (Harvey 2005). For the run and appropriately regulated system operator.
purposes of this chapter, it is sufficient to note that The impact is one of cost rather than a threat to
Renewable Generation and Security of Supply 65
stability. High levels of penetration of intermittent converted from billion cubic meters (bcm) to
generation do, however, raise real questions about Mtoe using 1 bcm = 0.90 Mtoe (www.bp.com/
market design and security of supply—in particu- conversionfactors.jsp).
lar, whether existing energy-only markets will 5. The 390 Mtoe figure assumes an oil price of $61
per barrel (bbl). A second business-as-usual sce-
provide strong enough incentives for the invest-
nario has an oil price of $100/bbl and forecasts net
ment needed in peaking generation to cope with
imports of 330 Mtoe (75% of total consumption).
periods where high demand coincides with low 6. Some observers note that the actual price paid by
intermittent output. Ukraine is higher than the contracted price
In principle, market mechanisms are sufficient because of an agreement due to arrangements to
to ensure the right levels of investment. In prac- provide free gas in exchange for delivery of gas
tice, however, the absence in most EU power into Ukraine. However, even allowing for the
markets of appropriate mechanisms for scarcity additional cost, the price remains well below
pricing, combined with very high levels of regu- European levels. See Chow and Elkind 2009.
latory uncertainty and risk, suggests that there 7. In principle, Gazprom did not cut off supplies to
may be a need for some form of enhanced incen- the EU; it reduced the level of flows by the
amount of gas that previously would have been
tive such as capacity payments that reward genera-
intended for Ukraine, while continuing to flow
tion for availability, except in markets where the
gas for transit across Ukraine to the EU. However,
level of investment is strongly influenced by it was easily predictable that Ukraine would con-
implicit regulation and consensus-based decision- tinue to consume gas, with the effect of reducing
making involving industry, government, and transit flows significantly.
other stakeholders. 8. Corresponding figures are 42 years for oil and 60
years for gas (BP 2009).
9. The corresponding figure for 1987 was 70 tcm.
10. The U.S. Energy Information Agency (EIA 2008)
Acknowledgments has reported increases in the level of proven gas
reserves as a result of the development of uncon-
Thanks to Luis Agosti, David Black, Godfrey ventional gas resources. The Potential Gas Com-
Boyle, Toby Brown, Guido Cervigni, Dmitri mittee (2009) reported an increase in reserves,
(including proven, possible and speculative
Perekhodtsev, and Dick Schmalensee for many
reserves) in 2008 to the highest level in its 44-year
helpful suggestions and input. All errors and omis-
sions are mine. 11. Figures converted from trillion cubic feet (tcf) to
tcm using 1 tcm = 35.3 tcf (www.bp.com/
12. Here “efficiency” refers to the trade-off between
Notes cost and risk. Arrangements are efficient if the
additional cost of investing to increase security
1. A parallel argument is made in the EU and the outweighs the additional benefit (and the saving
United States about the benefit of renewable fuels from spending less does not justify the increased
in reducing the risks arising from dependence on level of risk).
imported oil for transportation. The focus of this 13. So either supply interruptions become more
book, however, is on renewable generation. probable/frequent, or society pays a higher price
2. The bulk of the remainder was from renewables to avoid them, in the form, for example, of higher
(14%). national security costs or unwanted changes in
3. Russia provides 42% of the EU’s gas imports, foreign policy to appease the potential interrupter.
Norway 24%, Algeria 18%, and Nigeria 5%. This argument has been used in the past to justify
4. A more recent forecast is even more dramatic, the requirements for strategic oil storage.
showing a fall from 166 Mtoe in 2010 to 14. For example, in 2005, a combination of factors
113 Mtoe in 2019 (ENTSOG 2009); all figures temporarily reducing supplies to the United King-
66 Boaz Moselle
dom led to price spikes of up to 500% between mittent generation will displace less gas-fired gen-
February 23 and March 11 (Trade and Industry eration than will non-intermittent. Clearly this
Committee 2005). would not apply to hydro generation or to
15. Some U.S. states even have legislation specifically biomass. The potential for new hydro is relatively
prohibiting price-gouging. For example, Florida limited, however, and intermittent sources (in par-
Statute 501.160 states that during a state of emer- ticular wind) are forecast to be the dominant form
gency, it is unlawful to sell “essential commodi- of new installed renewable generation capacity in
ties” for an amount that grossly exceeds the aver- the coming decade at least.
age price for such commodities during the pre- 22. Including consumption in the form of losses aris-
ceding 30 days. ing from transmission and distribution.
16. A public good is a good that is non-rivalrous and 23. With the exception of primary reserve, whose
non-excludable. This means that consumption of provision is typically an obligation placed by
the good by one individual does not reduce avail- administrative means on generators connected to
ability of the good for consumption by others, and the system.
that no one can be effectively excluded from using 24. An important distinction must be made here
the good. between wind and solar photovoltaic (PV) power.
17. In other words, it is not possible for the system Wind variability occurs over a matter of hours and
operator to cut off supply to individual consumers, is relatively amenable to forecasting. Except in cli-
other than very large consumers (who often have mates with cloudless skies, solar PV can vary over
“interruptible supply” contracts that allow for seconds and is therefore more difficult to forecast.
such actions). 25. This account has greatly simplified the complexi-
18. Given metering technologies currently in place, it ties of running an electric power system. As well as
is not possible to create such an incentive. For the need to match total supply with total demand,
example, gas meters typically record only cumula- the system has a number of other technical
tive consumption, and unless they were read on a requirements, including so-called “voltage regula-
daily basis—which would clearly be impossibly tion”, and the need to respect transmission con-
costly—there would be no way to know how straints. The latter task in particular is likely to
much has been consumed by an individual cus- become more costly and challenging with the
tomer on a day when supplies were particularly addition of large amounts of new intermittent
scarce. generation, as discussed in a number of the case
19. This is a general analysis; individual import con- study chapters in this book.
tracts can vary significantly. 26. As of February 2010, this is about €5.70 ($7.75)
20. Another interesting counterfactual, and one that per MWh.
in principle should be the starting point for the 27. This is in contrast to markets where generators
design of any intervention, would be to use taxa- also receive payments for being available to gener-
tion to correct for any security-of-supply exter- ate, via “capacity payment” mechanisms or cap-
nalities. In theory, this might lead to different lev- acity requirements and auctions, as discussed later
els of taxation applied to gas from different in this chapter.
sources, with Russian gas probably incurring the 28. Mechanisms allowing the scarcity of operating
highest tax. In practice, this could create difficul- reserves to set the price in the energy market are
ties with World Trade Organization (WTO) rules, not in place in most EU markets. Such mecha-
and it would also raise difficult questions about the nisms require an advanced level of integration
quantitative assessment of the size of the external- between the markets for energy and the markets
ity. A more realistic approach would be to tax all for reserves, as well as between the spot and bal-
gas. However, this would also be politically diffi- ancing markets. Market designs allowing such
cult because of the aversion of key member states integration can be seen mostly in the United
(notably the United Kingdom) to EU-level taxes, States. See, e.g., Kranz et al. 2003.
and because the United Kingdom and the Neth- 29. For example, the markets in Alberta and Ontario
erlands are both major gas producers. have price caps of C$1,000 ($979) and C$2,000
21. This is not to assert that intermittency per se is a ($1,958) per MWh (Adib et al, 2008), and Texas
security-of-supply risk (see next section), but (ERCOT) has a price caps of $2,250 (ERCOT
merely to observe that all else being equal, inter- 2008). In Europe, Nordpool caps the day-ahead
Renewable Generation and Security of Supply 67
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