How to escape the financial problems of the RES market: Attempted diagnosis, part 1

We decided to examine the fate of the support system for renewable energy sources in Poland in recent years and the impact now felt by market participants. Understanding what has actually happened can enable all parties to find the best exit from the current difficult situation.

Events on the market for green certificates over the last four years show how difficult it is to establish an effective and stable support system in Poland for renewable energy sources (RES). The system based on certificates of origin generated an increase in RES capacity, but did not really function correctly. It may even be argued that the system had no chance of working without external intervention by the creators of the system. Moreover, each legislative intervention acted like an earthquake in the system, generating waves of aftershocks impacting further segments of the RES market.

Let’s examine the sequence of events. The system of green certificates was introduced in Poland in 2005. For the first few years of its functioning, the situation remained fairly stable and prices for green certificates were close to the level of substitution fees. Periodically the price even exceeded the substitution fee because of the exemption from excise tax on electricity connected with redemption of certificates.

In 2011 a surplus of RES certificates of origin began to build up. Producers of green energy accumulated them probably in the hope that when in 2013 the required share of RES in the energy balance rose to 12%, the surplus would be absorbed by the market without a decline in prices.

Market prices of green certificates

At the end of 2011 RES certificates of origin reached a record price of over PLN 285/MWh. But soon after that it could be observed how far off the expectations of renewables producers were from the actual direction of the market. Hopes to eliminate the surplus of green certificates were not borne out because 2012 brought record investments in RES. Capacity of 1.3 GW was added, 900 MW of it in wind farms alone. It then became clear that the surplus would not disappear, but would grow at an accelerating rate despite significant reductions in cogeneration due to the exclusion from RES of electricity and heat generated from whole wood starting in 2013. New RES capacity and cogeneration raised the output at that time to 6 TWh.

Green certificates

This sparked a drastic decline on the market for green certificates. By February 2013 they had dropped in price by two-thirds, to PLN 100/MWh. This was the first warning that the system was not operating as expected by the RES sector. The situation for certificates of origin began to resemble a classic bear market on the stock exchange.

A debate began on why the system was functioning poorly. Was the main problem that cogeneration held too strong a position? Did the support prove to be too high, and new capacity came online quicker than expected? Or perhaps the mistake was to admit existing installations, including large hydroelectric plants?

In October 2012 the Ministry of Economy published a revised draft of a new Renewable Energy Sources Act in which support for “big hydro” and cogeneration was significantly reduced (and the concept of dedicated cogeneration also appeared). Reassuring statements from the government led to a partial revival in the prices of green certificates until the end of 2013. But in early 2014 a gradual decline in prices began, which continues to this day. (As we write this article, green certificates are trading at about PLN 38/MWh.)

In the meantime, regulations were drafted and adopted establishing an auction system and sunset provisions for the end of the green certificates system. Quarter after quarter the surplus of certificates on the market continues to brow, and it is clear to everyone that there is no chance for rapid improvement in the situation.

Key amendment of RES Act

Under the amended RES Act, from 1 January 2018 all RES installations with a capacity of 500 kW or more will no longer be able to benefit from mandatory purchase of green energy at the average price on the competitive market, with the exception of RES using exclusively agricultural biogas for generation of electricity.

Moreover, in the “old” system a separate “blue” obligation was carved out for redemption of certificates of origin of electricity generated from agricultural biogas. Redemption of green certificates (green obligation) will apply to other RES. The level of the blue and green obligations was set accordingly at 0.65% and 19.35% respectively, but under the interim provisions the obligations for the second half of 2016 are 0.65% and 14.35%, respectively, and by 30 November 2016 the Minister of Energy is to adjust the level of both obligations for 2017 applying the criteria indicated in the amended RES Act. The proposed regulation specifies the level of the blue and green obligations for 2017 at 0.5% and 15.5% respectively. This means a major reduction in the level of the green obligation, despite the existing oversupply of green certificates on the market estimated at more than 20 TWh (exceeding the level of annual demand).

The amendment to the RES Act introduced in the auction system a new separation into auction baskets by adding technological baskets and, from July 2017, separate baskets for energy clusters and cooperatives. Sources not falling into any of the specific categories will be lumped together into a separate basket (also including wind projects). These changes were designed primarily to promote more intensively technologies that generate electricity in a stable and predictable manner.

What will the 2016 auction realistically contribute?

The president of the Energy Regulatory Office (URE) is supposed to announce the first auction in 2016. But according to the proposed regulation, the auction will be very limited and generally apply only to RES generating energy from agricultural biogas and small photovoltaic installations (up to 1 MW). At least for now, there is no apparent prospect for moving existing RES projects to the auction system, which was anticipated by the market and which would reduce the supply of green certificates and guarantee stable income in the future.

The Minister of Energy has been empowered to specify the length of periods for support in the auction system by issuance of a regulation. Under prior law, the RES Act provided for a statutory 15-year period of support from initial generation of electricity at an RES installation. Under the amendment, the period for sale of electricity will be set by the Minister of Energy on the basis of criteria indicated in the act, but it may not be longer than 15 years. Until the regulation is issued, the period of sale of electricity from RES in the auction system will continue to be 15 years.

Tilting at windmills

But for many wind projects, truly the last nail in the coffin was adoption by the current government of the Wind Farm Projects Act, also known as the “distance act,” which eliminates from the market nearly all projects for which at least an application for a building permit had not been filed.

Existing wind farms will still be able to operate, but without the possibility of expansion or modernisation to increase their capacity. The definition of a structure for this purpose was also revised to include the wind turbine itself, which previously was treated as a movable technical element. This change has a major impact on the amount of tax, particularly real estate tax, which is paid on the value of the structures. Interpretations of the regulations can differ, but the stability of the law has clearly been upset.

Ultimately regulations under which operation of wind farms would have required an additional permit from the Office of Technical Supervision were dropped. This would have imposed significant additional costs on the functioning of wind farms. Nonetheless, abandonment of these rules was accompanied by a promise to introduce them in the future. As of now it is not known whether work on such regulations has begun.

The interim provisions of the “distance act” provided for an exemption from its limitations for all projects for which an application for a building permit had already been filed. This resulted in a significant increase in the number of such applications by investors seeking to salvage projects still in development, even by filing incomplete applications.

Elimination of purchasing of energy output at fixed prices for larger RES

The problems do not end there. At the end of 2017, the guaranteed price for purchase of electricity from RES installations—now calculated on the basis of transactions on the competitive market (currently about PLN 170/MWh)—will come to an end. RES installations with a capacity of at least 500 kW will have to manage on the market on their own. What effects this will have on wind farms is now a great unknown. It may be anticipated that the largest entities on the market will hedge their situation by trading power within capital groups, as they are already doing now. Smaller producers will have to get used to a greater need for flexibility, and recognise that guaranteed income under long-term sales contracts is a thing of the past.

What next?

In the near term it cannot be ruled out that RES (particularly wind farms) will suffer widespread problems with financial liquidity as they become unable to service their debt. Some RES also receive funding from the EU, and they will need to maintain production to demonstrate the projected ecological effect and not cause a “substantial modification” of their projects during the durability period. Otherwise they might have to give back EU funding.

The requirement to maintain production is much more costly in the case of biomass projects; unlike wind projects, their marginal costs of operation are not close to zero. Despite the very low price of green certificates, these producers cannot withdraw from the market—by maintaining production, they minimise their losses. This unfortunately contributes to the growing oversupply of green certificates.

The current situation may threaten Poland’s achievement of its RES target. While URE and PSE data show that in 2015 this target was achieved at a level of over 13.5%, the “distance act” and shift to the new auction system for support will undoubtedly cause at least a temporary slowdown in increase of new RES generating capacity.

Repayment of credit under question

As a result of the total destabilisation of the market, several firms have already withdrawn from Poland. There are known instances of firms closing down operations here without even attempting to sell projects already under development. Others attempt to find buyers for projects at various stages of advancement.

Major market players have decided to take write-downs for revaluation of their wind power assets. The scale of these write-downs can be seen from reports published by companies listed on the Warsaw Stock Exchange. In its results for the 1st half of 2016, PGE recognised a loss in value of its RES assets, mainly in wind power, of PLN 783 million, attributed to “changes in the regulatory environment.” Energa wrote down nearly PLN 250 million in the value of its assets, and Polenergia about PLN 55 million.

Prices of certificates of origin much lower than assumed when arranging financing are starting to present a serious threat to repayment of credit taken out to finance construction. This applies of course to RES producers that did not sign long-term contracts for sale of green certificates at above-market prices. But RES producers that do have long-term contracts in place also face growing pressure to renegotiate their contract terms for sale of green certificates as terms agreed several years ago run counter to market trends.

And considering the increase in financial burdens provided for in the “distance act,” wind farm projects financed under commercial conditions may not generate sufficient revenue to repay their obligations. In turn, the elimination of mandatory purchase of electricity at the average price on the competitive market introduces one more element of risk for the operations of RES producers. Not all of them will be able to deal with trading in power under market conditions.

Seeing no prospects for improvement in the situation, RES investors struggling with repayment of credit seek support from their parent companies, which in any event are often required to provide support under the existing financing documents. Investors are also attempting to sell projects, but it is hard to find anyone eager to buy projects generating losses without clear prospects for improvement.

Marek Dolatowski, Energy Law Practice, Wardyński & Partners

Justyna Piszczatowska,

This article was originally published on the power industry portal