Filenews 2 February 2025 - by Pentelis Kaprou
As of mid-January 2025, the third trial period for the operation of a competitive electricity market is underway in Cyprus, under the auspices of the Cyprus Transmission System Operator (TSO).
Information from various sources indicates that the new "rehearsal" does not take place under the best conditions, as a large number of photovoltaic electricity producers do not participate in the process, while those who participate - mainly EAC Generation - cannot offer prices that will ensure a substantial reduction in costs for consumers.
The initial plan to complete this trial period by June is also in question. F's information indicates that this timetable is very difficult to implement. It is possible that a new trial - and time-consuming - process will be needed.
In addition, within the EU, intensive processes are underway for new significant changes in the competitive market model (target model) adopted by most states but not satisfied by most, as the selling price of energy from RES -mainly photovoltaics- remains very high and is mainly linked to the production cost of conventional energy (natural gas or oil, in Cyprus).
Pending the decisions by the EU and the Cypriot Government, we consider as very interesting the article by Professor Pantelis Kapros of the Technical University of Athens, which was recently published on energypress.gr website. Mr. Kapros insists on the need for green energy to reach the consumer at a low – cost-oriented price, without super-profit – and explains how this can be done. His positions and analysis can also be beneficial for decision makers in Cyprus.
The following is the analysis of Professor Pantelis Kapros:
Following the adoption of the National Energy and Climate Plan (NECP), with a consensus confirming the ambitious target for renewable energy sources (RES), significant institutional reforms will need to be made in 2025 to address weaknesses that undermine the path towards the 2030 targets.
The timing is favorable, since reforms can be easily carried out in the context of the implementation of the relevant European Directive of 2023. This Directive was designed during the great gas price crisis of 2022, which also dragged electricity prices upwards.
What the EU is looking for
In short, the reforms have three main objectives:
A) Direct access of final consumers to the low cost of RES, stability of electricity prices in the retail market and independence from fluctuations in natural gas prices.
B) Ensuring a high rate of investment in RES and electricity storage, facilitating adequate and low financing costs.
C) Ensuring backup power and flexibility in the system, for efficient and economical balancing and supplementation of RES.
As foreseen by the NECP, the electricity system will change radically in just a few years and in 2030 production will be based at least 80% on RES, complemented by large-scale electricity storage, while thermal plants with natural gas will operate poorly and mainly for reasons of reliable system operation.
The cost of production from RES is exclusively linked to the investment cost, is fixed and is needed for the repayment of funds on an annual basis. The average annual cost of new RES per unit of production is decreasing due to the continuous improvement of RES technologies.
The cost of storing electricity is also linked to investment costs, which are also constantly decreasing. Added together, renewable energy and storage costs per unit of electricity are today far cheaper than generation from natural gas and any other generation technology.
In a very few years, the share of natural gas in the electricity generation mix will be very small and this production will be the only one that will have non-zero marginal costs (i.e. operating costs – fuel, which increase when an additional unit of energy needs to be produced).
De facto, it alone will determine the equilibrium limit price of the wholesale market for most of the year. That is, despite its minimal participation in the energy balance, because often every day it will take little to balance the system, natural gas (or oil in Cyprus) will determine wholesale market prices most of the time on a daily basis.
A simple example: suppose that the cost for the repayment of the RES investment, including storage, is €80 per MWh of electricity (8 cents per kilowatt hour) and the cost of electricity production from natural gas is €120 per MWh (12 cents per kilowatt hour, in Cyprus it is much higher, due to the use of only fuel oil and diesel for conventional production).
On average, renewables produce 80% of electricity and natural gas (or oil) the remaining 20%. If in the wholesale market the price is derived from the price of natural gas by 50% of the hours, then the average wholesale market price is 50% x €120/MWh + 50% x €80/MWh = €100 /MWh. However, the real cost of electricity to the consumer is 20% x €120/MWh + 80% x €80/MWh = €88/MWh. the wholesale price will be €100/MWh and the retail price must be €88/MWh. Any automatic pass-through of wholesale prices to retail is equivalent to 13.6% excess profit.
The costs of €80/MWh for RES and storage included recovery of all kinds of costs and reasonable profit of the producer. As is well known, the optimal financing of infrastructures, such as RES and storage, which have only capital costs and not variable costs, is to ensure a stable and certain remuneration equal to the amortization annual cost of servicing the investment capital.
The more certain this remuneration is, the cheaper the interest costs will be and the lower the annual amortization fee. That is, the stability and certainty of remuneration of RES and storage acts simultaneously in favour of the consumer (buyer of energy) and the producer of RES, reducing costs for the former and ensuring certain profit for the latter. It is not optimal to finance RES to raise revenues from a wholesale-stock energy market, because prices in it are fluctuating and uncertain, so the amortization cost of financing increases.
Consequently, the objective of direct access to the low cost of renewables and retail price stability without over-reliance on fluctuating gas prices can only be achieved outside energy stock markets and through long-term bilateral contracts concluded by suppliers and consumers with RES and storage directly or through the state.
Bilateral contracts through the state have the privilege of ensuring greater certainty and a longer duration of income for the investment and therefore lower capital servicing costs for the benefit of the consumer and the producer.
Financial dispute contracts (CfD)
The new European Directive promotes financial dispute contracts (CfDs) as mandatory. It is therefore appropriate to convert all renewable energy and storage contracts into CFD contracts, to conclude new ones for the additional investments and to offer them directly, outside the wholesale market, to suppliers and consumers.
In this way, price stability at a reasonable – cost-oriented level will be achieved immediately. In this way, all RES will be managed as contracts of economic disputes with physical delivery.
The regulation of the regulatory provisions on access of suppliers and consumers to RES energy will allow the exercise of various policies to promote individual objectives, such as the mitigation of costs of energy-intensive industry, the protection of small and decentralized consumptions, etc.
In any case, suppliers will thus be able to build an energy portfolio, consisting of RES with direct costing and energy extraction, storage and part of energy from wholesale, with variable costs.
Thus, they will pass on to consumer prices the weighted average costs of the three components of their portfolio and not just the costs of the wholesale market, as they do today.
In addition, due to the long-term and fixed cost structure of most of the portfolio, suppliers can build hedging futures to protect against any large fluctuations in the segment with floating costs. This works to the benefit of the consumer and the market share of the supplier and is in the pursuits of the new Directive (on hedging contracts for consumers).
Electricity reserves and changes
The more renewables and storage dominate the system, the greater the need for relatively inactive generation resources that will be rarely or very little needed to maintain the reliability of power supply. These production resources must be flexible in terms of power variation, quick response to start and extinguish orders, and low cost.
Keeping such flexible productive resources on standby essentially entails the cost of servicing fixed capital, investment and maintenance costs. As in any similar case, the best way to secure such infrastructure is through long-term bilateral contracts that confidently pay for fixed maintenance and availability (capital) costs, rather than through revenues from stock markets.
Through bilateral contracts, in this case with the system operator, which enjoys regulatory stability of revenues, reliable and cheap financing is ensured, while when payment is made through stock markets, the cost of servicing capital increases due to uncertainty and therefore the cost of the service becomes high.
For these reasons, the new European Directive allows the establishment of mechanisms for the remuneration of the availability of capacity of productive resources that offer flexibility to the system, such as storage, hydropower, demand response and conditionally gas plants.
Capacity availability remuneration mechanisms apply bilateral contracts, resulting from annual tenders and not dependent on the wholesale market.
In return for the low burden (reliability costs) they impose on consumer prices, capacity availability mechanisms include in bilateral contracts an obligation for producers to return to operators, and thus consumers, any revenues above a certain price threshold. These clawback terms are called contracts with reliability options and refer only to resources contracted to provide redundancy and flexibility services with the system. Clawbacks offer additional protection against fluctuations in wholesale market prices, so availability contracts contribute both to the reliable supply of energy and power and to avoiding high costs.
With the advent of 2025, the time has come for serious reforms in the electricity market, especially in the context of the obligations for the implementation of the new European Directive. There must be no further delay.
The immediate access of all to cheap RES, price stability and independence from natural gas, ensuring high investment rates in RES and storage and the availability of redundancy and flexibility in the system are the objectives that are crucial to achieve the course of the NECP effectively and economically.
Non-wholesale Mandatory CfDs
Indeed, ensuring a stable and high rate of investment in RES and storage requires state intervention in a market that has such ambitious goals for the coming years. This is because if revenues depended only on the free wholesale market, any new investment in renewables or storage would reduce revenues for both the same and previous investments, that is, it would "cannibalize" similar investments, as they say on the street.
Already today, the increase in RES is accompanied by an increase in cuts in energy from RES due to restrictions in demand and the system, since RES have stochastic uncontrolled production.
The cuts reduce wholesale revenues and increase with additional renewable energy investments. This is a vicious circle that discourages new investment.
Similarly, each new storage reduces revenue for the same and previous storage investments. This is because storage reduces the difference in wholesale market prices between the times storage draws energy and the prices when storage produces energy. So if storage makes the repayment of the investment dependent on revenue from the wholesale market, any new storage investment discourages new investment.
These inherent features of renewable energy and storage economics make the wholesale market multiply risky for investors to repay their investments.
The only viable solution again is bilateral contracts with prices and management outside the energy stock market.
In addition, the financing would be facilitated by the implementation of a mechanism according to which the payment of RES and storage under the bilateral contract would be made in proportion to their potential production (capability payment) and not to their actual production (injection payment). Already major European energy operators and designers are proposing contracts based on potential production. This way needs further specialization and legal protection, but it is the only one that can seamlessly ensure the continuation of high rates of investment in renewables and storage in order to address the impact of "cannibalism" on discouraging investors.
