Spain: The high cost of political interference in power markets

IEEFA

The Spanish government’s move this week to block closures of inefficient power plants presents the latest example of a trend toward expensive political interference in electricity markets.

Elsewhere in Europe, similar intervention can be seen in the shape of “capacity payments” that prop up gas, coal and nuclear power, as well as more recently in the U.S., where the government is proposing “grid reliability” payments to coal and nuclear plants.

Such interference adds directly to electricity costs, through consumer or taxpayer supports, and indirectly, by creating system overcapacity. Random government interventions like the one proposed in Spain also create market uncertainty.

The Spanish-government intrusion would allow the government a veto over closures of uneconomic plants, regardless of the wishes of the electric utilities that operate them.

While the stated goal of the policy is to preserve the country’s security of supply, Spain has a capacity margin of about 30 percent, measured as the excess of supply above peak demand.

That far exceeds the 10 to 15 percent margin that grid operators might actually need to insure against the risk of large plant outages and to mediate the variability of wind power.

Spain’s overcapacity is a result of previous government interventions in the market, and in particular the country’s capacity market, which pays to keep coal, gas and hydro power plants in the system regardless of whether they generate electricity.

We can point to three costs of political intervention in the Spanish electricity-market example. First are the direct costs of nearly €1 billion paid out annually to subsidize Spain’s capacity market. IEEFA last year reported in detail on this aspect (“Spain’s Capacity Market: Energy Security or Subsidy?”).

Second, the capacity market combined with regulations that prevent the closure of idle capacity, has led to over-capacity, where cleaner-burning gas power plants as a result sit idle in favor of older, more expensive, and more polluting coal plants. Remarkably, for each of the past five consecutive years, Spain’s 25 gigawatts (GW) or so of combined cycle gas turbines (CCGT) have operated at below 20 percent capacity.

Clearly, capacity payments to prop up widespread idle generation are a poor value, and one result are additional social costs in terms of sulfur-oxide, nitrogen-dioxide and carbon-dioxide emissions.

Third, government interference undermines sound economic decisions by utilities. This point was writ large last week when Spain rolled out its draft decree in what appeared to be a rebuke of Iberdrola’s announcement that it wants to close its last two coal-fired plants.

Iberdrola knows what it’s doing, and has stated that the closures of the plants in question will not undermine grid stability, given that Iberdrola operates some 5.7 GW of CCGTs.

Last month, we published a report EXPLAINING WHY Endesa, a Spanish utility that is 70 percent owned by the Italian company Enel, should reconsider some €400 million of proposed upgrades to extend the life of three coal power plants, Alcudia, Litoral and AS Pontes (“How European Utilities Can Capitalize on New Air Pollution Limits to Drive Decarbonization: The Case of Endesa”).

We pointed out that Endesa’s combined cycle gas turbines in the first half of this year ran at just 12 percent of their capacity, and that was notwithstanding a 208 percent increase in their output compared with the same period the year before.

We contrasted the poor financial performance of the utility’s fossil-fuel generation with the expected double-digit returns on its successful bid this year to build more onshore wind.

We found that Endesa’s strategy of investing in old coal power plants did not fit with that of its parent, Enel Group, which is focusing instead on renewables, digitalization and customer services.

Our report explained also how Endesa’s outdated coal-preservation investments run afoul of an emerging trend toward coal phase-out across Europe — in the U.K. (by 2025), in Portugal and the Netherlands (by 2030), and most recently, in Italy, which has proposed a phase-out by 2025/2030.

We understand Endesa’s argument: that it wants to upgrade its coal plants in hopes of retaining electricity supply market share. Still, the company would do well to reconsider, and to tend more to growing the future-looking side of its business.

The Spanish government isn’t helping by opposing coal power plant closures through policies that will only weigh against more considered strategies.

Gerard Wynn is an IEEFA energy finance consultant.