In our previous materials in this series, where we have pondered on possible options for market development of the electric power industry in Kazakhstan, we talked about how, in our opinion, the design of the energy market in the wholesale part could be structured in general terms, and, in particular, we dwelled in detail on issues of the CHP market integration. But another very important problem remains in the wholesale segment - the issue of integrating renewable energy sources during the transition to a competitive model. In the current realities of the Kazakh market design based on the Single Purchaser in short-term operations, this issue is resolved quite simply - the Settlement Financial Center within the structure of the Ministry of Energy of the Republic of Kazakhstan, RFC (Rasschetny finansovy center), also known as EZ (Ediny Zakupschik) in Russian abbreviation, which was initially created as a special settlement entity for the centralized purchase of renewable energy and its subsequent distribution to all market participants in the form of so-called public power purchase agreements (PPA), basically retained the same pattern of actions. Electricity from renewable energy sources selected at centralized auctions (and subsequently under government agreements with global companies - renewable energy sources investors promising to launch gigawatt projects in the country) is purchased with priority by the RFC (at the same time, renewable energy sources are prioritized in the System Operator's load schedule) and then their costs are charged to consumers through hourly prices averaged across the country, formed as average generation tariffs that cover demand at a given hour. Thus, in essence, renewable energy sources are recouped on the market through individual feed-in tariffs established during auctions, at which the electricity they produce is purchased “out of queue” by all consumers of the country. Consumers of industrial groups - the so-called qualified conditional consumers - buy renewable energy electricity as an addition to consumption from their own or affiliated generation. It is interesting that this mechanism of centralized purchase of electricity at individual tariffs for renewable energy generation with subsequent averaging, to a large extent, seems to have become the model for the Single Buyer mechanism itself in Kazakhstan based on which EZ was tailored. Whatever, this RES support system, called long-term PPA in Kazakhstan, created by local specialists, until recently was a quite effective way to return investments in RES projects due to the centralized distribution of costs to everyone in proportion to the volume of their electricity consumption.
At the latest auctions, prices for renewable energy sources for domestic investors have decreased significantly and amount to 10.5-12.5 tenge/kWh for wind, 13.89–17.38 t/kWh for solar projects, 34-41 tenge/kWh for small hydroelectric power plants. Gigawatt state projects with global international investors (Total, Mazdar, ACWA Power, etc.) will obviously be more expensive, and in hard currency (there is no exact information, as well as conditions equal to domestic projects, which is bad and quite justly criticized by the association of RES investors Qazaq Green) but these projects have battery energy storage systems (BESS) to balance unstable RES. As a whole, BESS are a general requirement of the System Operator (SO) KEGOC in Kazakhstan for all future projects, and the main barrier to further growth of renewable energy sources share in the country’s generation structure in accordance with the indicators of the adopted Strategy for Achieving Carbon Neutrality by 2060. The SO directly states that the country power system does not have its own resources for balancing, which is carried out today mainly through imports, primarily from Russia. You can often hear that this is very expensive electricity, and that is why overall prices are rising. In fact, prices from Russia exceed the average EZ prices by approximately 1.8–2 times, which cannot be called very expensive, because balancing prices in power systems with insufficient flexible capacity can exceed DAM prices several times, albeit these prices are not the average ones in competitive markets, but marginal. The matter of fact is that imports to Kazakhstan cover not only imbalances associated with inaccurate scheduling, but also regular shortages during peak hours. However, the growing RES penetration, restrictions on transit from North to South, the isolation of the Western zone with so much needed relative potential of flexible gas capacities, and insufficient coordination with neighbors really make it difficult for the SO, and in this light, its demands for the mandatory colocation of new RES projects with BESS look quite reasonable. This means that in the current model, further development of renewables falls into the fork of restrictions - either the cost of projects must increase, and significantly, which will include the costs of storage, or the volume of quotas at auctions must be reduced, which contradicts the goals of the Carbon Neutrality Strategy. As a solution, they are talking about the accelerated development of hydroelectric power plants and pumped storage power plants, which involves reformatting auctions for large hydroelectric power plants presuming the inclusion of actually incurred costs in the payback tariffs for projects, and this can probably help, but in the long term and with significant costs, for some reason no one cares about. As well as for the fact that the storage market, which is proposed to be somehow abstractly developed, along with Demand response mechanisms and in general everything that is on the agenda of the global electric power industry, while referring to international experience - these are all integral parts of a larger – a real competitive market , which Kazakhstan is not yet in a great hurry to develop, again referring, but this time to the “existing realities of the Kazakh energy sector.”
Meanwhile, the reality is that flexible (and all other) capacities can be developed when there are the necessary incentives and price signals for this, created by a solid, efficient, well-designed, transparent, and resilient market. And if in order to pay off the same BESS in the current realities, the price for reserving renewable energy sources for 2-4 hours is 60–90 tenge/kWh, and import from Russia costs 30, and for several days, then there are few options for the development of BESS in this capacity. But BESS also have other functions, for example, the frequency control in the system in the real-time balancing mode, and there they can be in demand even at these prices, but again, for their full functionality as a resource, an equally full-fledged market with all its nuances and attributes is needed. A market that does not exist, and which is not yet perceived as mainstream by the country’s energy community, although the same Carbon Neutrality Strategy directly provides that the path to achieving it should be based on market mechanisms.
In this context, an important issue is the integration of renewable energy sources into the future real market, which has no alternatives in the electric power industry of Kazakhstan, whether today’s industry representatives like it or not, and precisely because it is the competitive model that is the way out of the stalemate, at which the perspectives for the fast development of renewables have been being trapped in the country. It is integration into a competitive market, the transformation of renewables from a burden and encumbrance imposed on consumers and the power system into truly requested efficient generation, together with the maneuverable capacities that complement it, that will precisely ensure the achievement of the goals set in the Carbon Neutrality Strategy, and thereby - in an optimal way - through market mechanisms. This is not an easy task; many countries are struggling with it today in the process of the Energy Transition, including countries with well-established competitive markets in the electricity sector. RES have their own characteristics; they differ significantly from traditional energy sources in their basic features - primarily in that their short-term costs, the modern energy markets competition mechanism is based on, tend to zero. And this creates significant modeling problems, especially with a substantial penetration of renewable energy sources into power systems. Kazakhstan also is doomed to solve this problem.
The seamless process of integrating RES into the market is based on the postulate that RES should be equal participants in all segments of the short-term market, starting with the DAM, then on to the Intraday and BM. This requires significantly higher competence from renewable energy operators in terms of planning, forecasting weather conditions and use of non-trivial trading strategies. In a properly structured market model, renewables, in particular wind generators, will be quite competitive with other resources, although the latter are more accurately dispatchable and convenient to use from the SO point of view. The experience of such power systems around the world, for example in Denmark, shows that in any case, the output of wind farms mainly ends up in the balancing market, where investors in renewables could earn significant additional income if they also invest in flexible resources. Renewables, although cheaper to produce and therefore with primeral inframarginal income, create additional volatility and uncertainty in the market, but these same circumstances result in new opportunities for investors in renewables with the right approaches and strategies. It is no coincidence that many of them diversify their portfolios by investing in flexibility on such markets, turning RES into a kind of tool for increasing the income of flexible resources, and ultimately making money “both ways” - on the advantages of RES (especially when internalizing the price of CO2), and at high prices in the balancing market.
This approach is less applicable to solar power plants where output is more predictable and better suited to PPAs structured as contracts for differences (CfDs) of various types. Without going into details, we note that both solar and wind PPAs will be quite in demand, but not publicly mandatory ones like today, perceived as a kind of tax, but voluntary-private, physical and synthetic ones, aimed at reducing the carbon footprint and long-term hedging of short-term prices for electricity. With an explicit capacity market, such contracts will also have to consider the capacity parameters of renewable energy sources, which is a separate difficult but solvable task, since there is already experience all over the world in this area.
The capacity market will also play a very important role in terms of integrating existing long-term public PPAs, taking into account their duration of 15–20 years. In Kazakhstan today, the volume of available RES is about 10% of the total installed capacity in the country, and at some hours, with an average load in the energy system of 9–10 GW, the share of RES in the balance can approach 10–15%. Therefore, during the transition to a marginal competitive short-term market, the continuation of priority loading and payment to renewable energy sources at individual tariffs, as of today, will lead to serious distortions both in pricing and in the market participants’ behavior. This is especially true for future gigawatt projects concluded on the take or pay principle, since, in fact, they are to be paid for regardless of the actual generation load schedule, although its optimization is one of the main priorities of the short-term competitive market. And the capacity market in these conditions will have to become a kind of bridge between “old”, pre-market RES projects and new ones, maximally immersed into a competitive environment. Tariffs of old projects and payments for them will have to be transferred to the capacity market, as premiums, based on averaged retrospective data on the capacity of certain resources. This design is to some extent reminiscent of the mechanism of capacity delivery agreements - RES CDAs, used in Russia, which has often been criticized and is being criticized precisely because the amount of RES capacity in the economic sense is very far from the installed one. But in the conditions of Kazakhstan, when integrating existing long-term renewable energy projects into new market conditions, this investment return mechanism will be quite suitable, especially in the context of a possible choice for investors - to transfer payments to a competitive power market as a conservative option, translating its value to capacity consumers at the peak hours (and that creates additional market signals on the demand side and develops distributed resources, which we will discuss later in this series), or invite them to terminate “pre-market” contracts and move to competitive segments as a full-fledged participant with some privileges.
In the latter case, the point is that those projects and investors who feel that they can work in the competitive environment of short-term operations, confidently forecast production, develop flexible resources that increase total income, will most likely earn more than if they remain in contracts of low-risk stable payments from the capacity market according to calculated capacity utilization rates. At the same time, in competitive conditions, they will receive additional cash flow from the capacity market, but in the volumes of so-called “solid capacity”, calculated in one way or another, and perhaps with some bonus in relation to new resources. Such projects, as well as new ones, will be given the opportunity to enter long-term PPAs in one way or another, which will also provide additional confidence when deciding to leave pre-market agreements.
And we are confident that this approach will not only not stop the trend towards the development of renewable energy sources in Kazakhstan, as some quite convinced supporters of the Energy Transition sometimes present, questioning the need for a market scenario development of the power industry in Kazakhstan, proposing instead a certain deterministic model for achieving the goals of the Carbon Neutrality Strategy, built on mathematical calculations models of a given generation mix in the perspective energy balances, but will also provide real optimization of this versatile and complex process. This approach answers the main question in the Energy Transition – how to make it the most effective and harmonious for the country’s economy. Because the answer to the question of what the energy sector should look like in 2035 or 2050 and 2060 from the point of view of its carbon footprint is clear, and it is surely possible to guess what kind of energy balance in terms of the composition of sources this will provide, but more or less, in our opinion, meaningless, especially on the horizon beyond 2035. Almost the entire world experience in forecasting of this kind, from the level of companies and individual countries to IEA forecasts, shows that this kind of documents ultimately turn out to be nothing more than general ideas about the future, what are called visions and outlooks. And the main point here is still the creation of a sustainable model of transition to a new quality and structure of the industry. The model – based on competitive economic relations of market subjects, since it is exactly competition that is the engine of progress, no matter how banal it may sound.
But competition in the electric power industry is necessary and important not only between suppliers, but also between consumers and suppliers, including the trends when consumers, based on technological progress, increasingly influence the price, becoming more elastic to supply - in the retail segment of the energy market. And this is also an important segment that must be correctly designed, especially in the conditions of post-Soviet countries undergoing complex economic reforms over a long period, and where the prices of electricity for the population and mass consumers have been being kept disproportionately low to alleviate social tensions. We'll discuss it next time in this series.