Megatrends and surroundings
We are witnessing dynamic changes in the power sector. Electricity is a key element of economic and everyday life, and the powerindustry is one of the main domains of civilisational progress.
In 2017, industrial-scale power plants fuelled by hard coal and lignite supplied 78% of national energy consumption - four years ago this was 90%. Centralised energy generation based on the economies of scale and fossil fuels remains the base of the system’s security but the importance of low-emission dispersed sources of energy is growing. In five years, the production of energy from renewable sources increased by 10 TWh. This means that the increase in electricity consumption in Poland was almost entirely covered by renewable energy from new sources.
This trend will continue. In accordance with the Renewable Energy Directive, Poland is required to achieve a 15% share of renewables in gross consumption by 2020. In accordance with the package "Clean energy for all Europeans" the European Union is declaring a reduction of CO2 emissions by 40% by 2030.
Changes in the sector are stimulated by three factors: development of technology, ecological awareness of customers and regulatory pressure. On the one hand, these are incentives for a low-emission economy, on the other - restrictive environmental standards and the need to adapt installations to best available technologies (BAT).
The electricity distribution model is changing, driven by the development of prosumer energy: unidirectional flows from the power plant to the consumer are being replaced with networks that collect energy from dispersed installations. Uncontrollability is a weakness of renewable energy - generation is dependent on weather conditions rather than on the level of demand at a given moment.
This mismatch between supply and demand translates into higher volatility of wholesale electricity prices. Renewable energy has priority of use in the energy system as a result of which the role of conventional plants is changing. Conventional units previously working in base (around the clock, all week) are gradually shifted into reserve - their role is to balance the system complement supply in adverse weather conditions). This trend is especially noticeable on markets with a larger share of renewables than in Poland.
Revenue from volumes of energy produced at reserve-type installations is insufficient to cover their fixed costs, i.e. costs that are independent of production volume. A solution to the problem of these assets' profitability would be a capacity market in which these units would receive remuneration for availability (this mechanism will be in place in Poland from 2021).
Scientific research on energy storage technology and the progressing commercialisation of this technology on an industrial scale might potentially solve the problem of the uncontrollability of renewable energy. Electric vehicles and their batteries might play an interesting role. Electric vehicles are not just an additional source of demand for electricity producers but also an operational challenge for distributors. Thanks to the development of smart grids, metering systems and the Internet of Things, it will be possible to locally balance energy between smart homes, electric vehicles and dispersed installations and to optimise consumption. The popularisation of these technologies translates into customers' greater demands from energy companies and the need to adapt product offerings to their expectations.
The power industry's future vision also includes an active role of the demand side in system balancing. This is referred to as demand side response, i.e. short-term reduction of electricity consumption, for a fee, by large and energy-intensive customers.
The rising importance of cross-border exchange should also be noted amongst the changes taking place across the power sector. The European Commission non-obligatory interconnection targets are 10% of installed electricity production capacity by 2020 and 15% of installed production capacity by 2030 – taking into account regional cost and market circumstances. The development of interconnection capacities enhances the security of supply and is in line with the EU's single market concept. It also means that generation units must be competitive also on regional markets rather than just on the domestic market.
How is PGE Group responding to the megatrends in its surroundings?
PGE Group is responsibly, actively and deliberately participating in the process of transforming the Polish power industry. We want the transformation from the traditional model to the future model to be harmonised, deliberate and coordinated – so that recipients of electricity have uninterrupted supply of energy at acceptable cost and simultaneously the trend of diminishing environmental impact of electricity generation is continued. As the largest energy group in Poland, we are also the largest industry investor. Our investment expenditures last year reached nearly PLN 7 billion - these funds are mainly used for the construction of new highly efficient generation units, adaptation of the existing units to mandatory environmental standards and construction of a modern and reliable distribution network. Looking into the future, we are intensifying an offshore wind farm construction project in the Baltic Sea and we are preparing to invest in a portfolio of flexible gas-fired units and are developing modern district heating, which will improve the quality of air in Polish cities.
Organisation of the electricity market
The electricity market is organised in such a way that units with a lower variable cost have priority over units with higher costs. This rule is called "Merit order". During the demand peak ("PEAK"), a larger number of generating units is involved in satisfying demand than in off-peak hours ("OFF-PEAK"), when electricity is generated only in the most economical units. Naturally, the electricity in the peak is more expensive than outside the peak.
Conventional power plants can adapt their production to demand and market conditions as part of their technical capabilities. On the other hand, the supply of electricity from renewable sources depends only on atmospheric conditions.
Large production from RES
During the windy weather, a lot of renewable power is available. If there is no high electricity demand, there is no need for a lot of conventional power and the price is set at a low level - equal to variable production costs in more efficient units for hard coal.
Large production from RES
When the wind blows but the energy demand increases, less efficient power plants are used for production. Because the variable production cost is higher in them - the price on the market is growing. Occasionally, pumped storage will be used.
Small production from RES
Windless weather causes a large number of renewable power plants to disappear from the market. At that time, conventional power plants are responsible for ensuring energy supplies. Even those less-efficient coal-fired power plants. The price increases to the level of their variable production costs.
Small production from RES
When there is no wind and the demand is very high, the situation becomes tense. The market price increases to the level of variable production costs in the most expensive power plants. In some cases, production takes place in gas burning units.
Renewable Energy Sources (RES) - their variable cost is close to zero, they enter the system first, they have guaranteed energy reception, additionally supported by green certificates or an auction system
CHP plants - treated as "have to work", produce heat, and electricity is an additional product, additionally supported by yellow or red certificates
Industrial CHP plants - produce heat and electricity for the needs of own industrial plants, additional surplus energy can be delivered to the market
Lignite power plants
Hard coal power plants
Pumped storage power plants - they work on the demand of the system operator, separately remunerated for their readiness to work
Gas-fired combined heat and power plants operating in condensation
 Consumption growth in 2012-2017 was 11 TWh (data from PSE)
 It is worth to note that methodology of interconnection target computation requires further verification (see the report of the Commission Expert Group on electricity interconnection targets “Towards a sustainable and integrated Europe”)
The cost of electricity is made up of the following:
- cost of investment, i.e. construction of the power plant. This cost is amortised over the plant’s lifecycle.
- fixed costs, i.e. on-going maintenance: employee wages, repairs, equipment, etc. These costs are incurred regardless of whether the plant is producing electricity or not.
- variable costs, i.e. how much it costs to generate each additional MWh of energy. The level of variable costs directly depends on the level of production. The main component of variable costs is the cost of fuel.
For different types of power plants, the relation between these costs varies. For example, for wind farms or photovoltaics, the cost of investment and its share in total costs are high. However, operating, fixed and variable costs are relatively low. In the case of conventional plants, variable and fixed costs are more balanced, largely depending on the cost of fuel.
This is why in Poland the levelized cost of electricity per 1 MWh is still higher for renewable energy than conventional. However, at PGE we are also forecasting a gradual decline in the cost of generating energy from renewable sources.
The price on the wholesale market is driven by variable costs, and more precisely – by the marginal cost to produce 1 MWh of electricity. Based on the level of these costs, from the lowest to the highest, a supply curve (merit order) is created. The point where the demand curve crosses the supply curve is the current market price of energy.
Fixed costs are incurred regardless of whether a given plant operates or not. Therefore, they have no present impact on the price of electricity.
High costs of investing in renewable sources (i.e. sources with low variable cost) are financed outside the electricity market, from subsidies that all consumers pay for.
Not all capacities are always available on the market. Therefore, the price is driven by their availability and by demand for electricity – lower at night, higher during the day, and seasonally shifting – higher in the winter, lower in the summer.
In Poland, we have limited water resources and limited capability of using solar energy, which translates into a limited number of plants fuelled by these forces of nature. This is why the most important renewable source is wind energy. It is wind conditions that largely determine the level of available capacity.
The most important factor in capacity availability is thus the weather. Therefore, the level of the availability of renewable capacities is variable, and there must always be an appropriate conventional capacity reserve, ready for immediate use whenever weather conditions make it impossible to generate energy from wind.
It is because variable costs have an impact on the price of electricity. For conventional plants, the main costs are: cost of fuel and cost of CO2 emission allowances.
Wind farms, hydro plants and photovoltaic units do not incur these costs. Therefore, they are always first in the merit order. CHP plants are similar – their primary role is to produce heat, while electricity is generated in addition to that. Given the cost of fuel (coal, gas) and CO2 allowances, conventional plants are further out in the merit order.
In Poland, lignite plants usually have the lowest variable costs, followed by hard coal plants, with gas-fired plants being the most expensive.
The production cost, of course, depends on the efficiency of fuel processing at the plant. Therefore, new units will offer cheaper electricity than existing ones.
The mechanism for setting prices based on variable costs was effective in a free market situation, undistorted by the subsidising of select technologies.
Subsidising the costs of investing in renewables has distorted the energy market, worsening the economics of conventional unit operations because these cannot operate at full capacity. In many markets, the operation of permanently or temporarily unprofitable assets is being limited. This may not be allowed on the market for electricity, which is one of the basic human needs. In disadvantageous weather conditions (e.g. no wind), there would not be enough energy, which would cause a blackout. This is destructive for the economy and for the regular life of people.
This is where the concept of capacity market comes in – as a market supplementary to the electricity market, offering the certainty of electricity supplies irrespective of the weather or time of day.
The need to support the operational readiness of generating sources results directly from market distortions caused by non-market support for uncontrollable renewable energy sources. This is not additional support – this is really just levelling the playing field. Thanks to this, stable generating sources may receive partial compensation for declining wholesale prices (which until now covered variable costs and fixed costs). This will allow plants to be maintained and modernised so that they can be cleaner and more efficient – for uninterrupted and reliable supplies of energy to our clients.