Capacity Remuneration Mechanisms Investor lunch London, 21 October - - PowerPoint PPT Presentation

Capacity Remuneration Mechanisms

Investor lunch London, 21 October 2014 Volker Stehmann Corporate Affairs, RWE AG

Forward Looking Statement

Page 2 RWE Investor Lunch I RWE AG I London, 21 October 2014

» Projections of revenues, income, earnings per share, capital expenditures, dividends, capital structure or other financial items » Statements of plans or objectives for future operations or of future competitive position » Expectations of future economic performance; and » Statements of assumptions underlying several of the foregoing types of statements are forward-looking statements. Also words such as “anticipate”, “believe”, “estimate”, “intend”, “may”, “will”, “expect”, “plan”, “project”, “should” and similar expressions are intended to identify forward-looking statements. The forward-looking statements reflect the judgment of RWE’s management based on factors currently known to it. No assurances can be given that these forward-looking statements will prove accurate and correct, or that anticipated, projected future results will be achieved. All forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. Such risks and uncertainties include, but are not limited to, changes in general economic and social environment, business, political and legal conditions, fluctuating currency exchange rates and interest rates, price and sales risks associated with a market environment in the throes of deregulation and subject to intense competition, changes in the price and availability of raw materials, risks associated with energy trading (e.g. risks of loss in the case of unexpected, extreme market price fluctuations and credit risks resulting in the event that trading partners do not meet their contractual obligations), actions by competitors, application of new or changed accounting standards or other government agency regulations, changes in, or the failure to comply with, laws or regulations, particularly those affecting the environment and water quality (e.g. introduction of a price regulation system for the use of power grid, creating a regulation agency for electricity and gas or introduction of trading in greenhouse gas emissions), changing governmental policies and regulatory actions with respect to the acquisition, disposal, depreciation and amortisation of assets and facilities, operation and construction of plant facilities, production disruption

• r interruption due to accidents or other unforeseen events, delays in the construction of facilities, the inability to obtain or to obtain on acceptable

terms necessary regulatory approvals regarding future transactions, the inability to integrate successfully new companies within the RWE Group to realise synergies from such integration and finally potential liability for remedial actions under existing or future environmental regulations and potential liability resulting from pending or future litigation. Any forward-looking statement speaks only as of the date on which it is made. RWE neither intends to nor assumes any obligation to update these forward-looking statements. For additional information regarding risks, investors are referred to RWE’s latest annual report and to other most recent reports filed with Frankfurt Stock Exchange and to all additional information published on RWE’s Internet Web site

This presentation contains certain forward-looking statements within the meaning of the US federal securities laws. Especially all of the following statements

Agenda

• 1. Why a CRM in Germany?
• 2. The BDEW concept of decentralised capacity market
• 3. CRMs in neighbouring markets
• 4. Options discussed in Germany
• 5. Current government activities in Germany

with respect to market design

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Capacity market – what is the issue?

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> Renewables (RES) are reducing the capacity utilisation of conventional power stations > Overcapacity in conventional power plant park and renewables are lowering wholesale prices and thus revenues for conventional power stations > Renewables cannot provide guaranteed capacity, there is a lack of storage capacity > On a cool, windless evening, the system is under stress > The current electricity market does not provide enough financing for a reserve margin > The electricity market is European. The capacity market which has been introduced in France, for understandable reasons, will place additional pressure on conventional generation in Germany, without being able to replace German power stations > If power station capacity is in short supply, the network connections from France (2.5 GW) will not be sufficient What do we know for sure? What happens in the Central-Western European electricity market?

The current electricity market design will provide a low level of security of supply due to the development of renewable energy and in light of the implementation of the French capacity

• market. The question is: is that politically acceptable?

German electricity market comes under pressure Neighbouring capacity markets Photovoltaics/Wind

RWE Investor Lunch I RWE AG I London, 21 October 2014

Growing uncertainty as to whether sufficient secure capacity will be available

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Development of secure capacity in Germany, 2012 – 2022 [GW]

6 5 12 5 88 Demand side management 5–15 3 Shortfall of secure capacity at end 2022 Secure capacity end 2012 Balancing energy Secure capacity end 2022 69–79 Plant closures for economic reasons 0–10 Phase-out

• f nuclear

energy Closures due to Large Combustion Plant Directive Secure capacity from renewables 2 Addition of thermal power plants by 2015 5–15 0–10 Source: AGORA

RWE Investor Lunch I RWE AG I London, 21 October 2014

Can renewables replace conventional capacities?

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Today, 480 TWhs are financing 85 GW capacity. In 2030, only 315 TWhs need to finance the same 85 GW

2012 2012: BDEW, Entsoe 85 GW

Firm Capacity Needed Generated Electricity

RES 135 TWh 480 TWh 2030 DENA 85 GW

Firm Capacity Needed Generated Electricity

RES 308 TWh 315 TWh

RWE Investor Lunch I RWE AG I London, 21 October 2014

Rights, obligations and responsibilities in a capacity certificate system

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Seller (voluntary) Purchaser (obligated) Capacity certificates are recorded in a central registry (issuer and current holder). In times of shortage in the system, compliance with obligations will be checked, penalties will be imposed for violations Monitoring (TSO & Certificate Registry) To be stipulated by the state: Monitoring period/system shortage (BDEW proposal €300/MWh on the day-ahead market) Amount of penalty (BDEW proposal, 3 to 4 times the price of capacity certificates) Capacity certificate (MW) Obligation to produce electricity in times of shortage in the system Right to draw power for end customers in times of shortage in the system Product The issuer of capacity certificates is obliged to produce electricity in times of shortage or to offer electricity no higher than the scarcity price Certificate Issuer Every balancing group manager must hold capacity certificates which amount to his energy supply to end customers at a time of shortage in the system Balancing group manager

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The capacity market complements the energy market: Required power plants receive two sources of income

The following costs of plant operators have to be covered in the long term Supply behaviour in electricity and capacity market A power plant operator offers power in a competitive market on the basis of its short term marginal costs. i.e. the revenue must cover at least the variable costs of the electricity production (fuel, carbon certificates, etc.)

+

The operator requires additional income through higher electricity prices firstly to cover his fixed costs (costs for

• perating staff, running repairs and

maintenance) In the long term, the revenue should cover the investment costs to stipulate new builds (= cost of capital)

+

> The energy market will continue to exist in its current form > In the competitive capacity market, operators will offer just enough capacity to compensate the revenue short-fall from the energy market required to cover fixed costs > In case of excess capacity, the capacity price tends to zero

Electricity market Unit price

EUR/MWh Marginal costs Fixed costs Cost of capital Full costs Marginal costs Fixed costs Cost of capital Marginal costs Fixed costs Cost of capital

Demand

MW

Capacity market Unit price

EUR/MW Full costs

Demand

MW RWE Investor Lunch I RWE AG I London, 21 October 2014

New responsibilities of the suppliers/ balancing group managers

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Suppliers contribute together with their customers to the reduction

• f the required volume of firm capacity

Estimation of own load at times of shortage

• 1. Estimation of own load at times
• f system shortage
• 2. Utilisation of opportunities for load

reduction by customers

• 3. Incentivising customers to reduce

load at times of shortage (e.g. load related tariffs)

• 4. Commercial decision as to how many

capacity certificates to purchase or be substituted by other measures Responsibilities of suppliers

Load profile Customer 2 Load profile Customer 1 Σ Load profile Load of supplier relevant for capacity certificate Time Load Times of shortage in the whole system

RWE Investor Lunch I RWE AG I London, 21 October 2014

The decentralised capacity market provides earlier incentives to provider guaranteed capacity

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Energy Only Electricity market after introduction

• f capacity market

Max RLoad DSM P MW Max RLoad DSM MW P 99% 99% Capacity equilibrium Assumption: DSM in both market designs is the same size. In the Energy Only Market, DSM is financed via avoided price peaks; in the decentralised capacity market via avoided capacity certificate purchases Safety margin DSM Max RLoad P MW PScarcity Safety margin 99% Securing the capacity due to penalty Capacity equilibrium Excess capacity Excess capacity Max RLoad P MW PScarcity Safety margin DSM 99%

Capacity price = 0, as trigger price not reached

DSM offers a trigger price, in order to avoid the need to purchase certificates RLoad = Residual Load DSM = Demand Side Management

RWE Investor Lunch I RWE AG I London, 21 October 2014

Capacity mechanisms are a European issue

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A purely national introduction of a capacity mechanism ... > is expensive because capacity available abroad is not used, > does not guarantee per se definite security of supply as the markets are connected to one another, > is contrary to the idea of a European internal market.

2018 2016 2017

?

Capacity market introduced Capacity market planned

Regionally harmonised concept pays off!

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Pilot: Germany – France?

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> Many similarities between the BDEW proposal and the French capacity market model > Coupling the two systems could serve as a pilot for the region Points to be agreed with France > Close, cross-border network operator co-operation necessary > How to deal with different supply safety standards and how to deal with shortage situations > Prohibition of marketing capacities in multiple markets > Requirements for entitlement to participate in foreign capacity markets > Determination of sufficient capacity at border connections

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> Government program acknowledges the necessity of a capacity mechanism > Meseberg conclave confirmed this view

After the reform of the renewables support scheme until summer, market design is next on the agenda

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Four competing concepts for capacity mechanisms Power plant reserve

• r

enhanced balancing market e.g. BNetzA Bundeskartellamt Decentralised capacity market BDEW VKU France Centralised capacity market EWI Centralised, discriminatory capacity market Green Party Öko-Institut Agora

RWE Investor Lunch I RWE AG I London, 21 October 2014

Which capacity mechanism proposals are discussed in Germany?

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Coalition agreement states the development of a capacity mechanism. Debate has started in summer, and outcome is highly uncertain. Government will issue a green paper in late 2014, a white paper in 2015 and eventually regulation in 2016

Strategic Reserve Centralised Capacity Market EWI Focussed Capacity Market Öko-Institut Decentralised Capacity Market BDEW/VKU Ensures sufficient firm capacity Non-discrimi- natory Technology- neutral European

?

  

Ensures sufficient firm capacity Non-discrimi- natory Technology- neutral European

  

Ensures sufficient firm capacity Non-discrimi- natory Technology- neutral European



Ensures sufficient firm capacity Non-discrimi- natory Technology- neutral European

       

RWE Investor Lunch I RWE AG I London, 21 October 2014

Impacts of capacity mechanism concepts on RWE

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RWE acknowledges the strategic reserve as possible interim solution but in the long term the reserve would have to be designed quite large to ensure security of supply. RWE won‘t benefit significantly and neither face adverse effects. From a political point of view, the proposal is very close to status quo and therefore a possible outcome. The introduction of a centralised capacity market is currently politically unlikely because it lacks

• advocates. The proposed concept would lead to market distortions (compulsive bid with „zero“ for

existing power plants). The focussed capacity market with a biased towards gas-fired capacity would imply a complete re- regulation of power supply and threatens RWE’s hard coal and lignite stack. The proposal is backed by green NGOs, the Green Party and the German federal states of Bavaria and Baden- Württemberg. The decentralised capacity market is supported by the energy industry. It will lead to a sufficient and reliable financing of secured capacity. The concept is market based and provides a non-biased competition between all providers of secured capacity. Impacts & Probability

RWE Investor Lunch I RWE AG I London, 21 October 2014

Reports for the German Government on the need for CRMs, July 2014

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EOM (today) Effectiveness (political accuracy)

• Note:

not an economic value by itself

Core criteria

Effectiveness (consumer preferences) Efficiency Regulatory risks / policy International compatibility Competition Reversibility Distributional effects Note: not an economic criteria Here evaluation from the perspective of consumers (at the expense of producers and

• verall efficiency)

EOM 2.0 Reserve Decentralised capacity mechanism Centralised capacity mechanism Focused capacity mechanism

+/- + +/- + + +/- + +/- +

• +/-

++ +/- +

• ++

++ + +/-

• ++

++ + +/-

• +/-

+ +/- +/- +/- +/- +/- +/- +/- +

• +

Less relevant criteria

Source: Frontier/Consentec

RWE Investor Lunch I RWE AG I London, 21 October 2014

Government reports: CRMs offer security of supply at limited extra cost

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* Based on the period 2015 – 2039, interest rate 5% (real post tax)

Total extra costs of different CRMs (NPV 2015*)

Comprehensive CM includes centralised and decentralised models

€ bn

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EOM 2.0 Reserve Reserve (higher capacity requirement) Comprehen- sive CM Comprehen- sive CM (higher capacity) Focussed CM Focussed CM (higher capacity requirement)

Source: Frontier/Consentec

RWE’s view on the government reports: Results are valid in theory only, but not in practice

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Pro: EOM offers sufficient security of supply

Today‘s overcapacity needs to be removed When overcapacity is removed, we will witness again scarcity and price spikes in times of high residual demand EOM can be improved to make sure that sufficient price spikes occur. This is the basic idea of „EOM 2.0“ Price spikes will render the operation of fossile power plants profitable and eventually new build

Contra: EOM does not offer sufficient security of supply

OK OK Proposed reforms make sense, but will not guarantee security of supply This only applies in theory: Policy makers might not accept price spikes. And will there be sufficient investment

• n the basis of unforeseeable spikes?

   

RWE Investor Lunch I RWE AG I London, 21 October 2014

Back-up

Decentralised capacity markets require intelligent rules – however these are few in number

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FAQs Who has to purchase capacity certificates? How high is the penalty? Who can issue capacity certificates? How is system shortage defined? What will be monitored? When will monitoring take place? What about sheddable/ deferrable load? Who controls the capa- city certificate system? Arrangement Suppliers/balancing group managers who provide energy to end customers A multiple of the certificate price (e.g. 4 times) Any entity that can produce electricity in times of shortage If the day ahead price on the exchange exceeds x €/MWh (e.g. 300 €/MWh) Electricity supplied to end customers (including network losses) and electricity production or offer (due to pro rata cuts) When the predefined system shortage situation occurs (e.g. 300 €/MWh) Entities which can reduce their load in times of shortage do not need to purchase capacity certificates. Any electricity output purchased shall be offered on the exchange at no higher than scarcity prices All required capacity data is already available to the transmission system operators

• today. They only have to be reconciled against the capacity certificate register

RWE Investor Lunch I RWE AG I London, 21 October 2014