The measures nobody likes, will they be the cure for the Spanish power system flaws?

By Alejandro de Roca Jordà

Everyone knows that the goal of the Government through its Ministry of Energy is to come up with the ultimate solution to the financial imbalances of the Spanish electricity system. For that purpose, on Saturday July 13, they issued the new Royal Decree (9/2013) as unique derogatory provision and therefore new regulatory framework for the power sector.

The agenda has established a period of only 10 days for market players affected by government measures to issue comments. Given the depth and complexity of this issue every one considers this as an outrageously short period.

Measures, on the other hand, aim to put an end to persistent imbalances in the electrical system. Despite the measures already taken in 2012, the imbalance on the budget for 2013 will reach 4,500 million euros. So, as a Solomonic solution and as the main measure for correction, the government will be cutting the amount of 2,700 million euros to transport, distribution and renewable electricity system costs, another additional 900 million euros will be assigned to the State’s general budget and grid fees will be increased to raise another 900 million euros.

But, is it just increases to the regulated part of the energy bill or will these proposals for changes affect the current market price? Let’s analyze each of the points of the Decree:

1. New economic status for existing electricity production facilities from renewable energy sources and cogeneration: Meaning that, the measures propose to change from subsidized production technologies to a remuneration based on their market participation plus a payment (when necessary) to cover any investment costs based on a reasonable profitability (before taxes) of 7.5% (10-Year Bond Spanish plus 300 basic points).  Although we don’t have yet the standards to be applied and the final effect, the retroactivity and the aim of the measure will condition future investment in Renewable and/or Cogeneration in the coming years. If the government gets the economics wrong, this could affect the current and future profitability of the facilities already producing and could lead to the bankruptcy of some companies that invested at that time.
2. New measures relating to remuneration of power distribution and transportation activities: Establishes a new remuneration for Transport (REE) and distribution (UNESA) networks in which an appropriate and homogeneous compensation is defined for an activity under risk (i.e., with a return below 6, 5% before taxes).  As immediate impact, we have a substantial cut in the current budget for these activities. This could disincentive investments initiatives and could affect the development of our current power network. An additional difficulty if we consider that a good network and interconnection with other countries would solve the current overcapacity problem.
3. Further measures to Fund Deficit Securitization Electric System: increase by 4.000 million Euros in the FADE guarantee to ensure enough margin to cover additional emission requirements and planned refinancing during the life of FADE.
4. Additional Provision on funding from the State Budget: The State Budget will be responsible for half of the costs related to the island and non-mainland electricity costs (about 900 million Euros).
5. Review of Payment for Capacity: The current capacity payments compensation for combined cycle plants decreases (from 23,400 €/MW/year to 10,000 €/MW/year) has established a market mechanism to stimulate interruptive supply. The Government also enables the possibility of temporary closure of facilities (hibernation) under strict criteria ensuring security of supply.
6. The social bond cost: The social bond cost will be assumed by the matrices of the vertically integrated company groups that develop simultaneously activities of production, distribution and commercialization of energy (UNESA). Up to 260 million Euro.
7. Review of the Grid Fees: Regulatory framework for financial stability of the system: It provides an automatic review that will prevent the appearance of new imbalances. It limits the introduction of new charges in the electrical system without being compensated by an equivalent increase in income. Grid fees could be reviewed quarterly and only in the case that there is an imbalance between revenues and higher system costs by more than 2.5%. On the contrary would there be a surplus, Grid Fees will not be decreases and the extra money would serve to cover the accumulated tariff deficit.
8. New Grid fees from August 2013: We report a substantial change in the structure of Grid Fees for the second half of 2013 due to which costs related to the Capacity Term would increase and costs related to the Consumption Term would decrease. That would increase costs for domestic consumption but would reduce costs for industrial sites.
9. Creation of a Registry for Self consumption / net balance: for proper monitoring of consumers benefiting from self consumption supply modalities, also necessary for proper monitoring of its economic system. There is no regulation defined for self consumption.
10. Cancellation of efficiency and reactive bonus complements: these concepts are suppressed for all facilities that were perceived according to Articles 28 and 29 of Royal Decree 661/2007.

This avalanche of measures affects all players in the Spanish electricity market (generation, transport, distribution, commercialization, consumption). The derogatory nature and, in some cases, the retro-activeness of the measures represents a clear threat to the legal security of the country. Affected companies could submit claims and requests for European arbitrage to avoid the deployment of the measures. We are at the beginning of a period of general uncertainty that could last 3 to 6 months.

As the measures are directly related to the regulated part of the power market, in principle, they should not have any direct effect on the wholesale market. However, the possibility exists that companies that have suffered the worst part of the adjustment and that currently manage over 60% of energy production, might consider balancing the losses on distribution activities to get more margin in Generation (market). This is something that is under the watchful eye of all agents. Additionally, this practice will become more and more difficult as the control mechanisms put in place seem to work properly and this type of action would be penalized with several million fines.

In addition, technologies that historically participate at zero price in the wholesale market (subsidized  Renewables) now can participate in the market like any other technology. Apparently this might be the only measure that would have an effect on the wholesale market as soon as more details will be known. But in any case renewable energy will remain in the wholesale market at zero (variable) cost anyhow. Therefore, it shouldn’t have too much effect on wholesale prices. The situation is somewhat different for cogeneration, where an end of (over-)subsidization might reduce the amount of electricity being put on the grid, pushing up the marginal cost.

The measures, on the other hand, should be beneficial to bring stability to the Spanish electric system. For example: giving a blow to the continued growth of the deficit, limiting the continuous escalation of uncontrolled subsidy costs of and establishing a new market control entity.

Thus, the uncertainty over the measures bode a difficult autumn for the electricity market that remains at the mercy of what is going to happen the coming months. Will the devil be in the details?