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December 14, 2017

To: Concerned Albertans

From: Blake Shaffer

Date: December 14, 2017

Re: Alberta’s Renewable Auction Sets a New Low for Prices, but Tweaks Are Needed in the Future

The results are in, and the price is… low. At $37 per megawatt-hour, Alberta joins the trend of global renewable auctions delivering power at a fraction of the prices seen only a few years ago.

But while the results are certainly encouraging, and should allay the fears of those expecting a repeat of Ontario’s debacles, we can do better. Low cost is certainly desirable, but the adage remains: you get what you pay for.

Let’s start with the good news: the price. This is unquestionably low. Impressively low. For perspective, Ontario’s renewable power was procured at prices ranging from the low $100s to as much as $800 per MWh. The reason, in large part, is better policy design. Alberta eschewed the administratively-set tariffs used in Ontario and instead relied on the forces of competition to drive prices down.

The design of Alberta’s auction also encouraged aggressively low bids by removing price risk. Winning firms sell their electricity into the hourly power market, receiving the prevailing price, and the contract pays the difference between that same hourly price and the fixed price set in the auction for 20 years. If market prices are higher, the firm pays back money. In effect, they receive a fixed price.

But removing price risk has a downside: firms no longer care about the value of energy when they generate (i.e. the hourly market price), they only care about cost and volume.

This poses a problem. The lack of meaningful storage in electricity means its value fluctuates greatly both within the day and across the year. Wind blowing at night, for example, is of less value than solar generation during peak demand hours of the day. The auction doesn’t reflect the difference in their value – only their cost.

Moreover, since cost is the motivator, repeated auctions are likely to deliver wind facilities mostly concentrated in the windiest regions of the province, where costs will be lowest. This is not a big deal now, but as more wind generation comes online and gets increasingly concentrated, it is likely to become one. The whim of the wind will result in very low prices during times of generation. As a result, the auction contracts will pay out ever-larger amounts to keep the generators whole. If this auction design remains beyond a couple of runs, Alberta will be saddled with low cost but increasingly low value resources.

Can we do better? (Spoiler: I wouldn’t be writing this if I didn’t think so!)

The key is to align firms with the incentive to deliver power when it is valuable, not simply the lowest cost. The goal, after all, should be the greatest net benefit.

One option is to do nothing. Simply let the power market and the carbon price do its thing. But uncertainty over the future of carbon pricing in Alberta may deter investment, and the carbon price may not deliver the targeted 30 percent share of renewables. (Whether or not such a target is needed or desirable is a question for another day).

Another option is to follow the recommendations of the Climate Leadership Panel with a “competitive renewable energy credit”. Rather than a fixed price, firms would compete via auction for a fixed adder to all their generation. They would be motivated to maximize the value of their energy production, receiving a constant top-up from the adder. While this is likely the purest method, it also imposes the most risk. At a time when Alberta’s electricity market is undergoing large change, the risk premium charged by firms would be high.

There remains a third option, a sort of hybrid approach. Firms would again compete via auction, but for a contract that pays out the difference between a fixed price and a floating benchmark based on the generation of a collection of peers, not simply their own facility. This would encourage developers to ‘beat the benchmark’ by siting wind projects away from the herd, or even choosing different technologies, such as solar, while the floating benchmark would mitigate macro swings in average pool prices.

But despite my focus on tweaks to the auction design – it’s never too early to start looking ahead – the results of this first auction are a good news story on cost reduction. While renewables remain an intermittent source of energy, they can no longer be accused of being high cost; our focus needs to shift towards how best to use this now-cheap source of raw energy.

Blake Shaffer is a PhD candidate at the University of Calgary, fellow-in-residence at the C.D. Howe Institute, and former Director of Energy Trading for TransAlta Corporation. He has also served as a Policy Advisor to the Government of Alberta. The opinions expressed herein are his own.

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