"Contracts for difference" for RES projects in Ukraine. Interview with Maxim Sysoiev

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GetMarket platform coordinator Maxim Babaiev interviewed Maxim Sysoiev, a partner at Dentons. They discussed contracts for difference and future support mechanisms for RES manufacturers in Ukraine.

- The phrase "contracts for difference" is very often used in our information, energy present. Explain what it is, why it is an important question, and what difference are we talking about?

- Indeed, we have been hearing the expression "contracts for difference" more and more recently. A year ago, there was talk about the need for producers of electricity from renewable sources to sell electricity directly on the market. In Europe, there is such a term as "contracts for difference", and in fact, I propose to understand what forms of support for renewable energies are provided. It would then be clearer where "Contracts for Difference" fits into this mosaic. So, the first form of support, one of the best, is a feed-in tariff or "green" tariff. This is a fixed tariff, where manufacturers of RES receive a fixed payment for generated electricity. This form of support was the most common until recently. Reforms have since begun in European countries and they have seen that it is not the optimal form of support. Many countries have therefore moved to a new form of support - Feed-in Premium. This is the called "green" premium for electricity producers from renewable energy sources who produce this electricity, sell it directly to consumers, traders or any other market participant, and above this, they receive a premium. In other words, the tariff is no longer fixed here. The amount that the producer receives may vary. Here, interesting points begin to emerge as to how the base for variation is calculated and how the premium is set.

There are several approaches for setting it now. For example, when all producers sell electricity to market participants and they are given a fixed sliding premium, the so-called monthly sliding premium, which is set every month evenly for all producers from renewable energy sources. And the basis is calculated for calculating this bonus. In Germany, for example, it is calculated for each source, i.e. the sun or wind, separately. They analyse the prices on the exchange, on certain indices and calculate the base price for each technology. A bonus is then calculated on this base price. In Europe, the premium is now determined based on auctions.

In Poland, the situation is slightly different and there are no specific technologies. It takes a weighted average price on the market at which electrical energy is sold in general. A certain premium is calculated on this basis, which is determined based on the results of the auction.

Contracts for Difference is one type of fixed premium, where there is a base and there is a level that a fixed premium should reach. If the wholesale price is below this level, we must reach this level thanks to the fixed premium. Then the premium is paid by the market player who is entrusted with these responsibilities, for example, the transmission system operator as in Europe or Ukraine it could be the Guaranteed Buyer. If the wholesale price is higher than the level of support to be received by the producer, then the producer, as in Poland for example, must either pay the difference so that there is no "super support". And contracts for difference are the difference of plus or minus. Of course, if the producer has to pay, then why do you need this kind of support? This producer has to enter the market and sell at market conditions. But as a rule, it is the producer who is paid extra for this difference.

- That is, as far as I am concerned, "Contracts for Difference" has been talked about in part in the sense that there is a big problem with the Guaranteed Buyer and deficit and all support for RES is now going through Garpok. And I understand that if we have direct transactions between market participants besides Garpoc, and it only covers a certain difference, it will partly relieve the burden and be able to balance it out.

- Indeed, I agree that this may help manufacturers first of all because they already have some guaranteed part of the payments if they sell on the market 24 hours a day ahead or under bilateral contracts. If we look at the liquidity of the Guaranteed Buyer, really fewer payments will go through the Guaranteed Buyer. That is, it loses a lot of headaches in the form of buying all the electricity, then selling it somewhere, going into auctions with bilateral contracts or the day-ahead market, or falling into the balancing market. Of course, this optimises the process, as it is not Garpok's headache, but the manufacturer's, where it is better to sell the electricity. And the producer will know where it is best to sell because he will be interested. Everyone will benefit from that. This is the first aspect, and the second aspect, fewer payments will come from Garpok to the producer, because some players will be less likely to claim certain amounts of support. And the most important positive aspect of this whole system for the government is that in order to implement it, producers must exit the Guaranteed Buyer balancing group and be directly responsible for their imbalances. Because then producers are interested in correct forecasting, correct submission of relevant bids and the like. They are interested in creating their own balancing groups and joining other balancing groups. In other words, the producers from renewable energy sources are fully integrated into the electricity production system. As is currently happening in Europe. These are the advantages that this mechanism provides.

- Judging by the statements and publications on information resources, it seems to me that the Ministry of Energy is already working on draft legislation that will allow RES producers to leave the Garpoc Balancing Group and work freely on the market. Do you have any details, as you are often involved in this process?

- Yes, of course. Private and public stakeholders are currently involved in this matter. I have seen at least three potential drafts of legislation from private stakeholders. The Ministry of Energy has not yet decided on the final concept and I will now explain that there are problems. On Friday, there was an online meeting with representatives of DENA, a German organization that helps Ukraine in energy issues and shares its experience. A representative of the Ministry of Energy confirmed that they are working on the draft law and will be coordinating the concept with the central executive authorities, the regulator, etc. after some time. This will be followed by public discussions on the draft law. Expectations from the Ministry of Energy that by the end of the year we will see the final version of the draft law that will go to Radu. Unfortunately, everything is not going so fast. Why not?

Firstly, we have not yet decided who will pay the difference. Now there is only one off-taker, it is the Guaranteed Buyer, and it would be logical for him to continue this support mission. But there is another approach. Why should we create and use a separate legal entity if this function can be performed by a TSO? I will explain how the financing of the "green" tariff is going now. Most of the payments are collected from TSO consumers and transferred to Garpok, i.e. these are certain procedures, then approved by the Regulator of all these amounts. Therefore, to simplify the situation, let the TSO pay directly. And there was a similar discussion about compensation for underprocessing, and who will pay it on the instructions of the TSO. In the end, we came to the point where it would be more logical for the TSO to do this because it would be easier for them. Firstly, the chain is shorter, and secondly, he has all the information from the market and can verify it.

The second nuance is that it is not yet defined. Okay, we move on to this Feed-in Premium, but what base should there be? Why isn't this a simple question? Because we take the weighted average price on the market a day ahead, which seems to be quite good. And if you take the intraday market, there may be slightly different prices. In Europe, the situation is simpler, and exchanges are developed there. Exchanges are more or less objective, we may have certain distortions in these markets, and we know which players may be responsible for them. The second question, for example, will we take a weighted average price for each technology or a total weighted average price? To me, more fairly, for each technology, because the distortion is less. If you take the total weighted average, there may be a distortion that is happening in Poland somewhere, because the sun gets more support than the wind. When electricity is generated from the sun, it peaks just in the peak hours of consumption, the price of electricity there is the highest, and therefore they get the biggest amount of compensation. If the wind, it also produces at night, and the price is lower there. If a weighted average of all technologies is taken, then, in the end, they get less. So, it is also a question for the Ministry of Energy how they will do it. I don't know, in Ukraine, it might be too difficult to analyze at the beginning by technology. Most likely, they will simply take the weighted average price on the day-ahead market, or the intraday market, or two markets, and they will charge a premium on that amount.

- We can say that Contracts for Difference is this type of virtual corporate PPA. Because a producer can leave the Garpoc Balancing Group, enter into long-term contracts with the consumer at a certain price, but still receive a premium from the state.

- In fact, yes. This is the case if there will be electricity sales under a bilateral contract. Again, it's very interesting for the producer when they plan to build a plant and then produce energy, they have many options and they are already analyzing what is more profitable for them. And it's precise because of this mechanism that we use resources more efficiently.

- Each type of RES has its own generation characteristics, the financial performance of projects and operating costs. Can we say now, for which technologies can this mechanism be more profitable in general?

Everything depends on what kind of support system will be provided. In the case of Poland, through a certain approach, it is more advantageous for the sun. If there is a Poland-like approach in Ukraine, it will probably be more beneficial for the sun. Since the sun's production peaks on the day-ahead or intraday market.

- How do you see the future in terms of bioenergy? After all, it is for them that we are now looking for new mechanisms.

- For bioenergy, the situation is the same as for wind, because bioenergy has the same output. And if we do not have a base to calculate for each technology, then they will receive less than they received under the green tariff. But in the example of Germany, this bonus is set every month. The "green" tariff is recalculated for us every quarter. This bonus is also likely to be recalculated at a certain frequency. The question is whether it will be fixed and go towards the price on the market, and the producer will be somewhere in the plus and somewhere in the minus. If the price on the market goes up, then, of course, the producer will be in the plus and vice versa. There is another approach, it is a dynamic premium, it is calculated hourly. And it is as if this system is levelling out fluctuations through market price fluctuations. But do you have any idea what software should be, how many people are involved? In Ukraine, TSO works well, but even for my clients, there are delays due to COVID-19. So, they just can't do it administratively. Most likely, at first, there will be a simplified solution, I think everyone will get the same premium for about a month, then they will look and list it for the next month. So, there is an option that we will have the same as in Poland, that the sun will be more in the plus than others.

- In any case, it is important to make choices, it is important to create different mechanisms and opportunities for different types of projects. Let them choose how they want to play in this market because then there will be no crisis situations like this. The more diverse the system, the safer it is. That's why we have to go forward, to start. Perhaps some projects will be in the negative and some will be in the excessive plus, but if you don't do anything, if you don't try anything, then nothing will happen in the end.

 

- One additional remark. Above all, this transition must be voluntary. You cannot just force everyone to switch to this system. The state must think of a mechanism that makes the players interested. It is indeed possible to change the rules of the game for new projects, for auctions, for projects that will be put into operation in the future. But for those investors who have invested, we do not want to repeat the negative experience of retrospective tariff reductions.