The Spanish intervention

Spanish measures to reform energy markets and the EU ETS are an attempt to shield households and industry from high prices, but the intervention may scare away investment and slow the growth of PPAs.

Listen to a discussion on the reforms Madrid plans for energy markets, domestic and international reactions and what the tinkering may achieve.

Guests: 

• Pedro Linares, Professor, Universidad Pontificia Comillas
• Javier Revuelta, Senior Principal, Afry

Transcript

0:01

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Richard Sverrisson, Editor-in-Chief, Montel: 0:30

Hello listeners and welcome to the Montel Weekly podcast, bring You Energy Matters in an informal setting. This week's episode dives deep into developments in Spain, unplanned measures put forward by the government in Madrid to reform energy markets and the EU ETS in an attempt to shield households and industry from high prices. Will the plan succeed and what will the consequences of the intervention be on the country's power and gas markets? So joining me, Richard Sverrisson, to discuss these key issues. Pedro Linares of Universidad Pontificia Comillas and Javier Revuelta of Afry. A warm welcome to you both. I hope I pronounce the name of your university, correct? Pedro?

Pedro Linares, Professor, Universidad Pontificia Comillas: 1:12

Yeah. Quite well. Thank you, Richard. Happy to be here.

Richard Sverrisson, Editor-in-Chief, Montel: 1:15

Let's start then gentlemen, by, by discussing the measures that the Spanish government has put forward. Can we just highlight. The key elements here, please. Javier. What's on the table? What's gone through?

Javier Revuelta, Senior Principal, Afry: 1:26

Yeah, so the government, they've been, analyzing the options. There's no perfect option that addresses all issues. Basically, they care most about residential consumers on one hand and also on well and especially the more vulnerable residential consumers and also commercial and industrial. And the reason for protecting the first is obviously difficulty to pay bills. There's a fair amount of residential consumers who actually struggle to reach end of the month, and also the reduction of purchase power. May affect the economic recovery. On one hand the government wants to keep bills paid and those consum, those vulnerable consumers reaching end of the month and also keeping the economic activity as high as possible for the other customers. For the commercial and industrial, the concern is obviously losing. Some competitiveness against other territories, not so affected by high electricity prices, and also keep inflation as controlled as possible. If inflation goes up, then there are cascading negative impacts, so both keeping inflation low and households with as much per purchase power as possible are important. Now, the government has been addressing taxes as one of the measures. I, and I think this is the most commonly used measure across Europe. Particularly because prices being so high means the government was going to collect anyway, more money than they would have expected. So it's actually a pretty effective measure which doesn't damage much the general state budget. So that's one. And this was applied as early as the escalation of prices started in early in the summer. And then the second largest measure or the second measure with highest impact is. What the government has called the windfall profits from gas prices. Meaning that all infra marginal technologies like nuclear hydrant renewables who are making a lot of money compared to what could be expected a few months ago, then a lot of this money is considered by the government to be not necessary and excessive. Meaning that it shouldn't have been expected in the first place. And it leads to returns above what the government considers reasonable. So the government is basically trying to take some of that windfall profit and give it back to consumers through a reduction of grid connection charges. So there are several issues. One is with the collection. Of money, how much and to which cost to which producers you take the money from. And the second issue is how do you give that money back? On the first one, the measure has been quite controversial because obviously taking money from a generation is of course something fought against by those affected and legally. It is questionable whether you can legally take some money, whatever the cause and whatever the urgency. But also there are issues with some of these generation being affected by the revenue reduction being in long-term contracts or with bilateral contracts with different horizons, which means. The revenue is not the wholesale price, but something agreed between the generation and the supplier company, and also between the supplier company and the end customers. So there's been a lot of discussion around that because the assumption that all generation is receiving the marginal price is basically not true. The government has had to go back in which megawatts are affected and which ones aren't. The very recent news from Tuesday discussed in Tuesday and Wednesday are that a lot of degeneration will be exempted from the reduction. So all by all bilateral. All energy with bilateral contracts will not be affected by the reduction as it was originally. The second issue, which I would highlight, highlight is how this money is given back to consumers. So basically, the government has chosen instead of proposals federal analysis has said in in, in other occasions and other economists or consultants, and which I agree with, is it would be more effective to give this money back in, in the form of a check. Personally, I would have gone for a check to suppliers and then suppliers deducting this some amount to the to end users, to lower bills. I think other proposals, like in France or some other people in Spain have proposed a direct check of whatever the money, 50 euros, a hundred euros per family, whatever the form. I do agree that this would be more effective because you can target very. Precisely who you give the money to. And I think it makes sense to give the money only to customers that really need it, as most families really can pay for an extra 20 or 50 or even 60 Euros bill, which would be a hundred percent increase. Even a hundred percent increases is acceptable. Or can be paid by lots of families and the government instead of this direct help. It has gone for a generic reduction of grid charges. This has two problems in my view. One is you are helping customers that don't really need it. That don't really need it, sorry. And second is because grid charges are designed in a way such that residential consumers contribute more and commercial a bit less. And especially the large industry contributes very little. This means that reducing grid charges is actually not helping much the large industry. So basically the government has gone for a scheme that supports mostly. Residential and all of them and not so much the industry. So the government is still thinking of ways to address the industry, not only to help the industry, but also to keep inflation down. And this is not fully achieved with the measures that have been discussed for now.

Richard Sverrisson, Editor-in-Chief, Montel: 6:55

Yeah. If I can bring Pedro in here. This is more than protecting value, vulnerable customers. It's also, a look at the fundamentals of marginal pricing in wholesale energy markets. And it seems to be that. The Spanish government wants to make some major reforms here. Is that would be, would that be one way of looking at it?

Pedro Linares, Professor, Universidad Pontificia Comillas: 7:11

That's the way that the government has framed it to some extent. Instead of dealing with this as a kind of, I would say, temporary issue, they're pushing the agenda for a change in the wholesale markets, which is something that has been discussed here in Spain, like since 2005 because of. Our past history, because of, we, we were moving from a totally regulated system to a liberalized system in 1998 with loss of nuclear anhy that were built under the old system. So that discussion has never stopped, and this crisis has rekindled it. So there are some. People and I would say a part of the government that is using that argument as a basis to propose some reform of the wholesale market. Of course, this is being contested by some because the problem is you could argue that maybe nuclear and hydro, we could discuss whether they should be subject to this market or not. But one very important issue is the recent development in renewables. You know that in Spain we had like a. Rather a bleak period for renewals for a time. And then we started up again with a lot of strength. And this recent developments are the ones that may be punished if there is a move towards or against a wholesale market. So to some extent, the discussion now is broader and also has many more implications that make it. Much more difficult.

Richard Sverrisson, Editor-in-Chief, Montel: 8:39

What's been the general reaction Pedro, in Spain to these proposals? Because I know that there's been a lot of discussion, probably high level the EU level and within some EU member states who've come out very strongly against these proposals put forward by Spain.

Pedro Linares, Professor, Universidad Pontificia Comillas: 8:53

Here. I'd say it, it depends very much on whom you ask, right? I would say that among the general population, there is an this, I think I should say that this has been a crisis that has been broadcasted very strongly from media since the summer. So there is this general perception by the population that there is an issue with energy, that energy is becoming. Much more expensive and also an important derivative here is that the message is also getting across that part of the guilt comes with the utilities, that utilities are making a lot of money. And this complicates a of things. So many of the solutions, though, many of the policy measures that have been proposed by the governments, in fact are trying to answer this concern rather than, as Javier said, trying to fix the problems for industry or for residential consumers. So if you talk to people like Kavier or I, or other people working on the system, I would say that there is a. General consensus about what should be done, about whether this is actually a long-term problem or not, or whether we should change the markets. But then there is a and I don't know, maybe we can discuss that Kir and I, but I think both agree that the market should not be eliminated. But of course there should be some design elements that should be fixed. But then there is a large discussion underneath that says and in fact, I was just reading the news these days and even. Seemingly expert people saying that we should get away with the markets and get back to a cost of service system or something like that.

Richard Sverrisson, Editor-in-Chief, Montel: 10:38

What's your view here, Javier? On the one hand, it's quite understandable that the government wants to shield these very vulnerable customers, but on the other, if it's going away from the, these kind of, these liberalized wholesale markets, then that's a fundamental change.

Javier Revuelta, Senior Principal, Afry: 10:52

Yes. The thing is I, there are several issues as Pedro said, this is really a discussion with long-term implications. So we can either think of some temporary patches to the, to a situation and do something temporary where you take some money from some megawatts and then give it back in a way that roughly works and makes the industry live through this period and customers not get too angry. You can do that or you can go for reforms which affect long term. The problem with reforms is they need a lot of discussion. They need agreements, I would say, between the main parties, which I think is almost impossible. I don't see the main parties in Spain agreeing on almost anything, and particularly not in energy where there are quite substantial differences in their energy policies around nuclear. Around the way to incentivize specific technologies, the type of technologies you want to incentivize. If you want to go for deep reforms, they need to be thought through. I think in, in, in more months. Than the time it will take for prices to go back to, I would say normal. We, we actually expect and there's quite some consensus that during 2022 there's there's a strong reduction of prices, gas and electricity expected and then an even stronger one in 2023. So honestly, I don't see a reform. Before this period is over. And also the thing is I don't see easy solutions. I don't see going back to to, to the very regulated system being a solution. I, there, there are definitely some problems to a very regulated system. Where the government decides which investments are made and conduct some form of audits where you try to figure out what the exact and reasonable cost is, including some reasonable returns on renewables, on nuclear, on hydro. There are lots of retroactive changes there, which would go to, trial For sure. So personally, I am more inclined to the temporary fixes and try to design something that works as, as well as possible, try to address the needs of the ones that really need to be saved in a way or helped the most. And honestly, I don't see that reform being neither realistic nor fast enough. And I see lots of technical problems to what has been proposed. I see lots of issues with how do you keep, let's say a regulated price with imports and exports with the rest of Europe where other markets remain marginal as they work today. So how do you make it compatible to, to be a regulated system within a liberalized market? When do we buy ourself from neighbors? How do we keep the good things. But try to avoid the bad ones. It, it's really tricky. So personally, I, I am a lot more inclined to to keeping a system which generally works. I think there are some long-term patches that can be, and I would not call them patches but really a compliment to how wholesale markets work. I think there are ways to, to settlements. Post the hourly data head markets. So you have the markets work as they do today, but then there can be settlements done between either the market operator or the regulator giving back money to the customers or actually bringing, taking money from the customers and giving it eventually to, to some generators. Through monthly settlements or annual settlements. And the issue there I think, is we need to have some discussions with Europe because there are some things that Europe does not currently allow. But in my view, these are things that could be discussed with Europe and Europe could agree with. So basically how to find the way for governments to enter. Into long-term agreements where generators would give money back under some circumstances of very high prices. But then in exchange, they would if, for example, in a given year because gas prices are cheap or renewables are very high and it's a very wet year and power prices collapse, then eventually some generators might need to give to be given some money. To cover their their operating expenses. So I think there are ways to make the current market compatible with situations of high prices and low prices that can work for both consumers and for generators. And what I definitely don't see is try to make a very. Drastic change in just a few months. That, that's, in my view, that's never going to work.

Richard Sverrisson, Editor-in-Chief, Montel: 15:08

So you're talking about some kind of contract for different system. Correct?

Javier Revuelta, Senior Principal, Afry: 15:12

Some, exactly. Yeah. Either with a cap and floor or a fixed price, which I know Europe doesn't like, but I think there are ways to design them in a way. That they are a service, let's say a service of high availability at a fixed price. We need to think this through. It's also not easy, but I think this is a lot easier to discuss and negotiate with Europe than telling Europe. We want completely regulated system, but still we want to sell or buy electricity from France or from the neighbors. Europe is going to say, Spain, listen, you need to make up your mind. You cannot keep the good and get rid of the bad things you don't like. You can't cherry, you're exactly, you're either in the market or your end. And honestly, to opt out of a market which has been used for investments, for interconnections. I don't see Europe letting Spain get away with this proposal. And if they do, if they at least want to consider it. I think Spain needs to work a lot more on the details, as we say very frequently, devil is in the details. You actually you cannot just go and submit the proposal without looking at the. Details and saying this is very precisely how we intend, or how we propose that the Spanish wholesale market is run. And for now there's absolutely no detail. Personally, I have lots of questions on the proposals and lots of these the answers to lots of these questions. I think they come with a conclusion that it's just not possible. Or it has major drawbacks, which make it virtually impossible to really implement, and go back to a very regulated system.

Richard Sverrisson, Editor-in-Chief, Montel: 16:43

Absolutely. If Pedro, if I can ask you more about the medium to long-term implications of the current plans being put forward. You highlighted the time when. There was a slowdown in renewable growth in, in Spain, probably to a large extent due to some previous retroactive regulatory intervention. And now you have a very strong regulatory intervention or plans to do. What will be the impact on investments in Spain's, booming renewable sector? Is this a concern?

Pedro Linares, Professor, Universidad Pontificia Comillas: 17:10

Yeah so of course that is one of the elements that are becoming compromised with this type of intervention. When somebody decides to invest in renewables, of course they are ready to accept very low prices as we expect to have, and maybe 2030. But they're also ready to get the high prices that we will get sometimes, right? So when there is an intervention like this, it's basically, no, you cannot get Guy the high prices, but you should accept the low ones. So that of course brings the profitability of the investments much lower. And also the, it's not only the fact that there is a, there may be a cap on the price, it's also the way the intervention has been done. And I think the perception of insecurity. Is quite high. So I'm sure that will affect somehow the prospects for investments in the future. On the other hand, I think that, as Javier said, all these movements, although the probably right answer to this crisis would be we need to get more into long-term contracts, right? We need to convince people to become more hedged. Which is something that they were not doing. Again, what happens to long-term contracts? If people think that when the prices are low, they'll benefit from them. And when the prices are high, the government will come in and cap them. The incentive to long-term contracting is going to be much lower because you always expect the government to, to intervene, right? So I think this type of signals are quite damaging. To long-term contracting, to long-term investment and renewables, and we will need to see how the trust is rebuilt and hopefully yeah.

Richard Sverrisson, Editor-in-Chief, Montel: 18:55

Javier, if I can ask you finally now about these measures seem to be temporary, but will they be hard to pull back once prices ease? It seems to be, it could be more easy to extend them.

Javier Revuelta, Senior Principal, Afry: 19:06

Yeah in, in my view, this will really depend on the situation. If power prices stay high, I think families will keep, or some families and some industry will keep struggling to pay the bills. So chances are that at least beyond March, there is some extension. I don't see this being extended during 2023. Beyond, because I think prices will be much lower as a consequence of firstly, gas prices going back to the mid twenties or so, definitely below 30 euros per megawatt hour, which is, in our view, a long-term cap, at least an average price in the long term because this is the cost of bringing the most expensive gas from the other side of the world. We f first, we expect gas prices coming down. Second, the impact of renewables is going to be substantial in, in Spain. And actually maybe a slightly different view from Pedro is that I don't see these measures scaring away enough investment such that the investment is actually low. We actually have a situation of an over appetite compared to the market size. So we, we actually have 140 gigawatts. Which have been granted grid access, which is absolutely a nonsense figure. So if a lot of those, let's say, leave, because they see Spain as a country with more risk than than other markets. Still, we are left with more annual capacity than we can actually digest because of the bottlenecks in the permitting. So I, I see lots of renewables coming no matter what. The fundamentals are still there. Even when those revenue reductions are applied, net revenues collected by renewables in these situations are still very high and very attractive. So it's not like this this intervention is is completely destroying the returns of investors, as Pedro said, I do agree that you know when you think that the government might, may bring down the periods of high prices and not compensate the low prices, of course these. Affects your hurdle rates. But given that our central expectation is power prices in the medium and long term, going below the level which the government considers excessive, basically we do not expect further intervention in the medium and long term. With prices being, let's say in the 50 euros or so, a bit less for solar, for capture prices for solar, but we expect returns to be low, sorry, prices and revenues from the market to be on average low enough such that no intervention is needed. So this is really as we say, this is really a unique situation which we don't expect will happen again in the future. Of course, there will be periods of strong volatility where gas can go back up for a few months. But we don't see several years in a situation like this, and we don't see, the intervention being permanent and investors being permanently scared away. Actually, if you think of it, if a situation like this. Remains. It means for investors that we are in a situation of high revenues and keep in mind that wind and solar are telling us in the auctions that they can live with less than 40 euros, even less than 30 euros. So situations of 50, 60 euros are fine for investors and should seem fine for the government. Anything above that yes, may bring some intervention, but always keeping net revenues very attractive. So I only see this, as a temporary measures, we should not scare investments away.

Richard Sverrisson, Editor-in-Chief, Montel: 22:18

So there may be some hesitancy on the behalf of some investors before coming in, but certainly the returns, as you say, Javier will be there. So this is an area that we'll be watching very closely in, in the weeks and months to come. Certainly from Spanish perspective, but also European. With some countries arguing against, very strongly opposed to the Spanish measures. But some more in favor. Javier and Pedro, thank you very much for joining the Montel Weekly podcast this week. So listeners, you can now follow the podcast on our own Twitter account, aply named the Montel Weekly podcast. Please direct message. Any suggestions, questions, or let us know if you think you have a good idea for a guest on the show, you can also send us an email to podcast@montenews.com. Lastly, remember to keep up to date with all that's happening in energy markets on Montel News. You can subscribe on Apple Podcasts and Spotify or wherever you get your podcasts from. Thank you and goodbye. I.