Why compensations of power prices can cause more harm than good
This is the first time such an unexpected turn of events has occurred in the energy sector. The government lost control of the strategic economy sector and seems surprised with the increase in prices and rising import of coal, gas and electricity. This unexpected situation has led to huge astonishment at a time when elections are imminent.
Experts in the energy market are astonished with the lack of awareness of decision-makers regarding the situation in the economy sector as the symptoms of the events have been observed for a long time. Despite the changing technological, economic and regulatory conditions, the national energy policy is still in a stagnation phase.
The biggest energy market intervention in history
The mutual astonishment of the government and experts changed into panic, which then led to the implementation of the so-called Electricity Act 1 which will, according to the government, stop the increase of energy prices. Implementation of the Act (if it is successful) will cost PLN 9 billion in 2019, a budget equal to annual expenditures on education in Poland. About 30% of “black-smoke-belching stoves”, which are the cause of the poor air quality, could be replaced for this amount of money. The government, however, decided to pay extra for the energy consumption.
The Act consists of the following elements:
- Reduction of excise from PLN 20 to PLN 5/MWh.
- Reduction of transitional charge by 95%, i.e. support for producers resulting from so-called long-term contracts.
- Allocation of the sales proceeds 2 of CO2 emission allowances for the following purposes:
- 20% for financing of the investment in modernization and construction of generation sources and networks in order to reduce atmospheric emissions,
- 80% for establishment of the Price Compensation Fund, which deals with paying compensations to energy trading enterprises with regard to differences between wholesale prices and reduced retail prices in contracts concluded after 30 June 2018. In 2019, the state budget will be the source of funding.
Why do the energy prices increase?
Several factors may have an influence on the increase in energy prices:
1. Rising costs of energy production:
- Prices of CO2 emission allowances.
In June 2017, CO2 emission allowances cost about PLN 20/tonne of CO2. At the end of 2018, they increased up to about PLN 82/tonne. Converting it into the price of MWh – production of 1 MWh in a coal fired unit is connected with the emission of about 0.9 tonne of CO2. It means that the cost of CO2 in 1 MWh increased from PLN 18 to PLN 73, i.e. by PLN 55.
- Prices of hard coal.
Hard coal delivered from national mines became more expensive, increasing from PLN 10.3/GJ to PLN 12.4/GJ. Converting it into MWh, the costs of coal increased from 106.2/MWh to PLN 131.5/MWh (24%), i.e. by PLN 25.
2. Higher costs of property rights:
- Green certificates.
The price of one certificate increased from PLN 52.7/MWh to 129.3/MWh, and the so-called obligation increased from 17.5% to 18.5% 4. Converting it into MWh of energy sold to the end user, the cost of green certificates increased from PLN 9.2 to PLN 23.9.
- Other certificates.
The prices of some certificates increased, others became cheaper, so the influence on MWh cost was neutral.
- The cost of property rights package.
Full property rights package became more expensive from PLN 24.3/MWh to PLN 38.5/MWh, i.e. by PLN 15.2/MWh.
3. The increase of margin in production and trade sectors.
The increase of margin is probably the result of ongoing concentration of the market and little competition between the entities.
Our analysis focuses on current market prices. In practice, large enterprises operate other internal cost and price parameters that are unknown to analysts. For example, trading enterprises could purchase large amounts of property rights when they were cheap. As a result, they could achieve a high margin on this cost position, performing a high profit on energy sales (i.e. expensive energy is accompanied by cheap property rights). So, the seller’s margins 5 are the analytical indices, which indicated a significant improvement of profitability of trading enterprises (increase of margin by PLN 3.6/MWh).
The influence of compensations on the energy market
In recent years, the energy prices were exceptionally low due to the low prices of CO2, coal and large growth of RES. A major increase in the energy prices in 2018 is a challenge for users. Remedial measures should not, however, cause additional chaos and risk for energy companies or users. Unconsidered actions will weaken the competitiveness of the market and will make it more difficult to remedy the situation.
The Electricity Act is a temporary solution, which (if it is successfully implemented) will hide the problem in 2019 at a huge cost. However, the problem will not be solved and it will return in the near future. Increase of the energy prices is inevitable due, among others, to the following reasons:
- As of 2021 the capacity charge will be collected via distribution system operators. It will cost PLN 5.4 billion (about PLN 40/MWh, i.e. PLN 80/year per household).
- In January 2019, the Market Stability Reserve was implemented as part of the ETC reform, the purpose of which is to initially freeze and then remove the excess of CO2 allowances from the market. Elimination of over supply will lead to an increase in allowance prices.
Why do we think that compensations are not a good idea if energy prices are and will remain high?
1. Surcharges distort price incentives
FRC distorts economic incentives shaping the price. Artificial reduction of prices for end users leads to inefficient allocation of resources in economy. Energy consumption is supported instead of investments in emission reduction (energy efficiency and low-carbon resources).
2. It is not a socially fair solution
The implemented solution causes the transfer of values from the poor to the rich. If we treat the revenue package of CO2 emission allowances as a national good, each citizen should have the same share.
- An average household contains 2.5 people, i.e. the value of proceeds from allowances per household is PLN 320.
- Retail prices were to increase by 30%, so by PLN 78/MWh (i.e. from PLN 260/MWh to PLN 338/MWh).
- A small, well-to-do household (2.5 people) consuming 1.5 MWh per year will be a beneficiary of a surcharge amounting to PLN 117/MWh. Although the average value of CO2 allowances is PLN 320, the household will de facto receive PLN 117 and thus lose PLN 203.
- A rich household (2.5 people) with many electrical appliances in a single-family house (e.g. heated floor, air-conditioning) and consuming about 8 MWh per year, will be a beneficiary of state compensation amounting to PLN 612. These will be funds from potential income from CO2 emission allowances, which should be the same for all citizens. It is a transfer of funds from the less affluent people to the rich.
3. A huge risk for electricity sellers
The implemented compensation mechanism is a threat to operations for independent trading enterprises. For them, the cost of adapting to the new regulation is high and introduces a high operational risk, including:
- High additional transaction costs – necessity to amend all the contracts.
- Liquidity risk caused by delayed receipt of compensation from the Fund in relation to the date of energy sale.
- Loss of potential customers due to the belief that when the state intervenes in the market, it is better to stick to large state companies. The chance that the state will try to protect their interests is bigger.
The effect of regulation might be a change in the number of players and weakening of competitiveness on the energy market.
4. Compensations reduce motivation for energy saving
On one hand, a sudden and surprising increase in energy prices is controversial. On the other hand, it mobilizes people to save energy. The proposed solution works the other way round – it artificially reduces prices for end users, which leads to the increase or maintenance of energy demand.
5. Compensations burden the state budget
It is not clear what will happen with compensations next year. It is difficult to expect that the Minister of Finance will accept the implementation of surcharges to the Fund as a fixed expenditure. Furthermore, it is obvious that we reduce expenditures on other important purposes by allocating funds for energy consumption.
6. A strong state intervention means a decrease in predictability and trust in market solutions
How to deal with the increase in energy prices?
1. Low-emission diversification of production
A high share of coal in the Polish energy mix causes significant exposure to the risk of fluctuations in coal prices and the costs of CO2 emission allowances. We have presented the proposal for a low-emission diversification of the mix in our comments to the Polish Energy Policy until 2040. 7
2. Distribution – operation for the benefit of all network users
Development of renewable energy sources on a micro- and prosumer scale is strongly conditioned by the ease of network connection. Distribution network operators can play a key role in reducing costs for users through easier access to the network. The government, in cooperation with the President of the Energy Regulatory Office, has an influence on relations between the users and operators. This can be used by reformulating the objectives of quality regulation.
3. Improvement of transparency of the wholesale market
It is necessary to develop the analytical tools of the President of ERO to monitor prices, costs and competition on the market. This should be associated with the increase in the budget of this office, which has been underfunded for years despite the widening scope of competences.
4. Remedy on power exchange liquidity
The Polish Power Exchange should provide robust competition on the energy market. This can be achieved through a reform aimed at achieving high liquidity on the power exchange – in particular on the Day-Ahead Market and the Intra-Day Market.
Until recently, the retail energy trading market was competitive. Margins on retail trade were low, and often even negative. However, the margins increased significantly between 2018 and 2019 (as illustrated in Figure 1 and in the explanation).
5. Protection of consumer rights
According to the Supreme Audit Office (2018), consumer rights in Poland are not fully respected 8.
In our view, there is a need for an Energy Consumer Rights Advocate able to support consumer interests in the legislative process. That person should be responsible for informing the consumers in regards to costs, energy saving opportunities and support them when concluding energy purchase contracts.
The average household uses 2 MWh of electricity annually, paying PLN 1,460 for it. The increase of energy prices by 30%, which was announced by the largest trading enterprises, is in fact the increase by 15%, because only half of the bill is energy, the other is distribution. The household would pay PLN 225 more annually.
The government could, for example, provide households with financial resources to replace traditional lighting with energy-efficient lighting instead of ordinary surcharges. As a result, it would be possible to reduce the energy consumption by about 10-20%. What is the difference? The decrease in energy consumption by 10-20% translates into a reduction of the bill by 8.5-17%, as the electricity charge and consumption-dependent variable distribution charges are reduced (in a typical household bill, variable charges account for 85% of the total expenditure). The most important thing is to find a permanent solution to the problem (for at least 8 years which is the life-span of the best sources of energy-efficient lighting) for PLN 225 per household. Spending PLN 3 billion solves the problem in the household sector for a long period of time and not only temporarily. It should be noted that the old type of lighting (ordinary light bulbs) is mainly used by less affluent households and that therefore, such intervention is consistent with the principles of social justice – we help, to a greater extent, those who are poorer. The program could be implemented through municipalities in the form of reimbursement of bills for the purchase of energy-efficient lighting.
The regulation of prices by the Energy Regulatory Office is considered to be a form of consumer protection in Poland. On the other hand, there are no selective or effective mechanisms to support the poorest energy consumers. Electricity allowances are associated with housing allowances (the allocation of which depends on the size of the flat). However, most of the people blighted by energy poverty live in quite large houses in the countryside. Housing allowances are out of their reach. The allowance program is not fully used, which is confirmed by the report of the Supreme Audit Office (2018) 9. Protection of sensitive users should start with a remedy of this instrument.
Title of report: Why compensations of power prices can cause more harm than good?
Date of publication: January 2019
Authors: dr Joanna Maćkowiak-Pandera, dr Jan Rączka – Forum Energii
- The Act amending the Excise Tax Act and some other Acts of 28 December 2018, Dz.U. Journal of Laws of 2018, item 2538.
- 55 million of allowances x EUR 20 per tonne of emission allowance, the budget will receive PLN 4.62 billion.
- Forum Analiz Energetycznych (2015): Effcient use of Modernization Fund http://forum-energii.eu/en/analizy/jak-optymalnie-wykorzystac-fundusz-modernizacyjny.
- The obligation to redeem the property rights is established by the Minister of Energy by means of the Regulation. It obliges trading enterprises to cover a particular percent of energy sold with green certificates. For instance, the obligation in the amount of 17.5% means that 175 certificates should be redeemed in the Energy Regulatory Office per each 1000 MWh of energy sold to end users.
- Red – negative. It is PLN -5.3/MWh for 2018 and PLN -11.7/MWh for 2019.
- In terms of economy and politics, this situation is similar to the flood of 1997 when many houses were destroyed, and Prime Minister Włodzimierz Cimoszewicz said that the inhabitants should have been insured from such an event and they should not count on state aid. As is known, this view was wrong on political grounds (it contributed to the defeat of the left wing in the parliamentary elections), but correct on the basis of economy. Does the full compensation of increase of energy prices for all the users mean that the government perceives the current situation as a disaster?
- Forum Energii (2018), PEP2040 http://www.forum-energii.eu/en/analizy/pep-2040-uwagi
- Supreme Audit Office 2018, https://www.nik.gov.pl/aktualnosci/ochrona-praw-konsumenta-energii.html