1 Promoting Renewable Energy through Auctions: The Case of Brazil 2014/13 88695 A KNOWLEDGE NOTE SERIES FOR THE ENERGY PRACTICE THE BOTTOM LINE Promoting Renewable Energy through Auctions: The Brazilian experience with wind energy auctions The Case of Brazil illustrates that even carefully designed policies often must be reconsidered in Why is this case interesting? to emerge in the energy mix, but possibly to become competitive the light of a complex and with conventional sources. Contracts were specifically designed to changing environment. Many Brazil’s initial success with developing wind capacity accommodate the characteristics of individual technologies, aiming considerations need to be had unforeseen consequences to attract more investors by offering an attractive product that would taken into account to ensure shield them from several unmanageable risks—such as inflation and Electricity auctions are at the core of the regulatory framework that competitive prices while the uncertainty of variable generation. Brazil adopted after reforming its electricity market in 2004 (Maurer also delivering the required The results of the first stage were wildly successful: The renew- and Barroso 2011). Since then, periodic energy auctions have made renewable energy supply. able auctions were very competitive, drawing large investments from possible the construction of 58 GW of new generation capacity (46 percent hydropower and 29 percent from other renewable sources), both the public and private sectors,2 and allowing consumers to through about $350 billion in long-term contracts.1 This extensive benefit from cleaner energy at lower prices. experience allows a quantitative data-based assessment of the However, the success of the wind auctions brought other chal- strengths and weaknesses of the country’s auction scheme and its lenges. Critics complained that the terms offered in contracts were application to renewable energy development. too generous for investors and that, as a result, generators had an Wind power development is especially interesting because it has incentive to bid aggressively and to make unrealistic promises about progressed in two very distinct stages, both using auctions (Cunha, their plants’ likely performance. Note that regular energy auctions Barroso, and Bezerra 2014; Cunha and others 2012). in Brazil have the express objective of ensuring adequate system Gabriela Elizondo Azuela is a senior The first stage was marked by a strong will to promote the expansion. While this is an important concern in any country where energy specialist in the development of nonconventional renewable sources of energy. Even demand for electricity is growing rapidly (over the past decade, World Bank’s Energy though Brazil has historically relied on the continuous development Brazil’s demand has grown by 4.3 percent per year, on average), in Practice. of large hydropower generation—hydropower represented 70 Brazil there is also the need to maintain an optimal management of Luiz Barroso is a percent of the country’s total installed capacity of 120 GW at the hydropower reserves: If the system is undersupplied (that is, if there managing director at end of 2012—large amounts of small hydro, wind, and biomass is not enough firm generation capacity to meet demand), reservoirs PSR in Brazil. will deplete faster, which could increase the risk of energy shortages. potential remained untapped. The main challenge of this first stage was to create conditions that would allow those sources not only Therefore, when the first stage of wind farm development through Gabriel Cunha is a consultant in 1 All amounts in this document have been updated according to Brazilian inflation indexes 2 The government’s role in the auctions was felt through the direct participation of state- (either IPCA or IGP-M, depending on the indexing terms of each power purchase agreement) owned utilities as well as the indirect participation of the Brazilian development bank, which international energy and converted to U.S. dollars at a rate of 2.2 Brazilian real to the dollar. offered attractive loans to investors. systems and energy policies at PSR. 2 Promoting Renewable Energy through Auctions: The Case of Brazil auctions progressed to the point where wind-based capacity began Figure 1. Capacity factors declared by winners of energy to constitute a significant fraction of system expansion, security of auctions, 2009–12 supply became a concern. 100 These concerns defined the second stage of wind power 2009 Energy sale price (US$/MWh) 90 development in Brazil, which is the main topic of this note. The 2010 2011 Brazilian government began to tackle some of these issues in 2013, 80 “Systematic overestimation revising some aspects of the auction design introduced in 2009 and 2012 70 of the performance of wind seeking an optimal allocation of risk in the contracts offered to wind plants threatened to further producers. 60 upset the system’s supply- 50 What challenge did Brazil face? demand balance.” 40 For system planning purposes, the performance 20 25 30 35 40 45 50 55 60 65 Capacity factor (percent) of auctioned wind projects needed to become more reliable Source: Authors. Note: Multiple auctions in the same year are represented by different icons of the same color. Challenges introduced in the first stage of wind power development had to be solved in the second. The chief challenges were (i) the Investors were very aggressive in the certification of Brazilian system had to be able to balance supply and demand more their wind generation capabilities. The contract designed for accurately; (ii) investors were overoptimistic about the amount of wind producers offered attractive settlement rules that were aimed electricity they would be able to generate; and (iii) the government’s at protecting generators against unforeseeable wind fluctuations. arrangements for coordinating the planning of generation and Even if yearly average generation deviated from the amount prom- transmission left too little room for error. ised in the auction, generators suffered only mild penalties, and the The Brazilian system needed a more accurate assess- full settlement of differences was carried out only once every four ment of its supply-demand balance. Typically, the country’s years. These rules may have encouraged aggressive certification security of supply is ensured through the purchase of firm energy of wind production on the part of investors. Indeed, as illustrated certificates (FECs) by all consumers. (Utilities are responsible for in figure 1, average capacity factors declared by wind investors in procuring FECs on behalf of regulated consumers). The government the auctions rose from an average of 44 percent in 2009 to more issues FECs to generators in accordance with their capability to than 50 percent in 2012—both figures being much higher than most generate reliable energy. As wind power comes to constitute a larger wind production sites in the world. Systematic overestimation of the and larger share of Brazil’s generation system, the technology inev- performance of wind plants threatened to further upset the system’s itably takes on a greater role in the security of supply. However, the supply-demand balance. current method of calculating FECs for wind plants is very simplistic The government’s scheme to coordinate generation and and does not take into account how the wind power injections transmission planning faced difficulties. Another benefit offered interact and synchronize with the system as a whole. Because this to the participants in early energy auctions was that the government mechanism does not represent the true expected contribution of was poised to assume responsibility for organizing the reinforce- wind plants when integrated with a large hydro system, the task of ments and expansions to the grid that were needed to accom- determining the system’s new capacity needs becomes much harder. modate the new generation contracted through auction (Rudnick 3 Promoting Renewable Energy through Auctions: The Case of Brazil Figure 2. Status of projects auctioned in the first three Brazilian wind auctions, as of December 2013 Among the positive effects of the stage-one auctions were 2,000 (i) undeniable economic devel- opment of several sectors; (ii) 1,500 a lowering of the price of new Capacity (MW) Started operations on time generation, which has been “With periodic auctions passed through to consumers 1,000 Delayed up to one year providing a steady stream Delayed more than one year—constuction problems in the form of lower tariffs; of newly contracted wind 500 Delayed more than one year—connection problems and (iii) an increase in capacity * Reserve auction factors for wind power.3 power projects, the wind 0 Wind-power auctions equipment industry in December 2009* August 2010* August 2010 contributed to the develop- Brazil flourished … which Wind auction date ment of various economic helped reduce wind power Source: Authors. sectors. With periodic investment costs.” auctions providing a steady stream of newly contracted and others 2012). While very attractive on paper, this practice put wind power projects, the wind equipment industry in Brazil flour- transmission on a very tight schedule that left very little margin for ished. Several manufacturers of wind turbine components set up error. The end result, illustrated in figure 2, was that more than half of factories in the country, which in turn helped reduce wind power the wind plants contracted in the first three Brazilian wind auctions investment costs. The development of wind power also has brought have suffered severe delays (greater than a year) owing specifically economic development to historically poor regions in the Brazilian to problems in the construction of the transmission lines and substa- Northeast. tions needed to connect them to the grid. Under the contract terms, Wind power has driven down the price of new gener- consumers must pay for energy that is not actually being delivered, ation as a whole. Since the 2004 power market reform, auction resulting in cost overruns. prices for contracts to develop new capacity (conventional thermal Most of these problems can be traced to difficulties with and renewable) have trended downward (figure 3). Between 2005 environmental licensing and to management problems incurred and 2009 auction prices were fairly stable at around $80/MWh by the winners of the transmission auction. These weaknesses are (except in three mega-hydro auctions), but after 2011 prices settled not necessarily intrinsic to the proposed scheme of co-planned on a lower value of about $50/MWh. Because these price reductions generation and transmission, but countries considering a similar coincided with the advent of wind power as a competitive generation policy should keep in mind the possibility that this obstacle may be source, it is reasonable to conclude that the development of the wind encountered. power industry in Brazil helped increase competition in conventional On the other hand, the first stage of Brazilian wind power energy auctions, driving down investors’ profits and allowing development had brought benefits to the country, and retracting consumers to capture the benefits of the resulting lower prices. some of what was offered in the original wind generation contracts Auctions have helped raise the average capacity factors might have done more harm than good (by possibly halting the wind of wind power plants. As noted above, the government had been development program). 3 Although the lower tariffs were not large enough to be felt by consumers, the Brazilian tariff structure does ensure that the gains are reflected in the consumer tariff. 4 Promoting Renewable Energy through Auctions: The Case of Brazil Figure 3. Auctions of rights to develop new power capacity (conventional and renewable) in Brazil, 2005–13 Thermal Hydro and biomass Wind 12,000 100 Prices “It is reasonable to 10,000 * Reserve auction † Mega hydro 80 conclude that the Contracted capacity (MW) Average price (US$/MWh) 8,000 development of the 60 2013 values wind power industry in 6,000 Brazil helped increase 40 4,000 competition in conventional energy auctions.” 2,000 20 0 0 December 2005 June 2006 October 2006 June 2007 July 2007 October 2007 December 2007† May 2008† August 2008* September 2008 September 2008 August 2009 December 2009* April 2010† July 2010* August 2010* August 2010 December 2010 August 2011 August 2011* December 2011 December 2012 August 2013* August 2013 November 2013 December 2013 Source: Authors. concerned that the capacity factors of auctioned plants may have How were the problems of stage one addressed? been overstated. The short track record of wind farms, coupled with climate variability, makes this issue difficult to assess. However, a The benefits offered to the auctioned plants were comparison of the capacity factors achieved by plants operated reduced, as was government involvement in planning under a feed-in tariff policy introduced in 2002 under the Program of and coordinating transmission expansion Incentives for Alternative Sources (Proinfa) and the auctioned plants To address the issues identified in the second stage of wind develop- reveals that, on average, the auctioned plants outperformed the ment in Brazil, policy makers pragmatically proposed two significant Proinfa plants by four percentage points in 2012 (38 percent vs. 34 changes to the auction scheme. The changes began to take effect percent capacity factor; figure 4). While this result is not conclusive with the three wind energy auctions carried out in 2013. and may be subject to sampling variance, it suggests that the com- The fraction of certified wind production that can be petitive auction mechanism did indeed motivate the development sold at auction was reduced. Originally, wind farms could sell at of better wind sites, even if the capacity factors calculated by the auction an amount of electricity equal to their mean certified wind investors were indeed overestimated. production (close to the 50th percentile, or “P50”), calculated by an independent company based on historical wind measurements. 5 Promoting Renewable Energy through Auctions: The Case of Brazil Figure 4. Installed capacity and capacity factor of wind generation in Brazil, 2008–12 Proinfa installed capacity Auctions installed capacity 60 Proinfa capacity factors 2,000 “Even though it is Auctions capacity factors 1,800 now more difficult for 50 1,600 generators to overstate Capacity factor (percent) 1,400 Installed capacity (MW) 40 their certified annual 1,200 generation, the incentives 30 1,000 for generators to do so 800 remain in place, with the 20 600 result that estimates of 400 10 capacity factors are likely 200 to remain unreasonably 0 0 January 2008 April 2008 July 2008 October 2008 January 2009 April 2009 July 2009 October 2009 January 2010 April 2010 July 2010 October 2010 January 2011 April 2011 July 2011 October 2011 January 2012 April 2012 July 2012 October 2012 high.” Source: Authors. (The FEC issued to a given wind farm was also equal to this mean The government would no longer coordinate expansion certification when applicable.) Starting in 2013, however, wind farms of generation and transmission. In the August 2013 auction, the could offer at auction not the mean but a lesser amount of their government organized preliminary subauctions for each collector certified wind generation—namely, an amount known as P90 (90th substation in the basic grid in order to ensure that no unplanned percentile), which, according to the independent certifying company, transmission infrastructure would be needed to accommodate the is expected to be lower than future annual generation in 9 out of 10 winning projects. At some substations, this constraint had eliminated years. Under this new policy, a lower amount of firm energy would some competitive projects that could have been contracted based be associated with new wind farms (all else being equal), leading to on price alone. In the other two auctions (regular energy auctions in a slight overcontracting of new capacity that should help to avoid the November and December 2013), the government declared simply potential issues of undersupply. that it was the investors’ responsibility to ensure that the connection to the grid became operational at the same time as the generation 6 Promoting Renewable Energy through Auctions: The Case of Brazil facility. The practical limitations of centralized coordination of Figure 5. Capacity factors of winners of energy auctions in 2013 planning for the expansion of generation and transmission proved to 90 be too great, as shown after the first Brazilian wind auctions. The new 2009–12 Energy sale price (US$/MWh) paradigm is expected to be the norm going forward. 80 2013 (LER) Periodic revisions and successive adjustments are necessary 2013 (A–3) to ensure both competitive prices and effective supply. Despite 70 2013 (A–5) “Although the challenges the government’s efforts, it is not likely that these changes will 60 imposed by the second completely solve the issues that have been identified. One concern is stage of the development that investors still seem to be promising more than they can deliver. 50 Another is that the government’s policy for setting auction price of wind power in Brazil ceilings needs to be revised. 40 have not yet fully been Certification based on the P90 does not seem to have 20 25 30 35 40 45 50 55 60 65 Capacity factor (percent) solved, the constructive altered investors’ incentives to overpromise. Under the current responses of policy scheme, generators’ contract revenues will tend to be higher in the Source: Authors. makers reflected in the first few years if the certified generation is overestimated, despite the fact that this effect would be nullified in the long run as the plant’s 2013 auctions are an auctions was relatively low (even bids offering the ceiling price were true mean annual generation became known. This aspect of the orig- encouraging sign.” inal design has not been meaningfully modified. A small additional accepted). This is a dangerous path to follow, since if the entirety penalty has been introduced, but its effect is expected to be minor of the auctioned demand is not met, consumers will incur a higher (Cunha, Barroso, and Bezerra 2014). Even though it is now more risk of undersupply. The benefits of enforcing a lower price ceiling in difficult for generators to overstate their certified annual generation Brazilian wind auctions are questionable, since the experience with (because of the more conservative P90 approach), the incentives for past auctions has shown that competition has been driving prices generators to do so remain in place, with the result that estimates much lower than the ceiling. of capacity factors are likely to remain unreasonably high. Indeed, as seen in figure 5 (compare to figure 1), declared capacity factors in What is the key lesson? 2013 (based on the P90) are close to 47 percent on average—a very Standing policies should be challenged and revised in optimistic figure. response to a changing environment The government’s policy for auction ceiling prices is in need of revision. The Brazilian auction mechanism involves a The Brazilian experience with wind energy auctions illustrates that two-phase hybrid scheme, so that the auction price ceiling is the even carefully designed policies often must be reconsidered in the opening price of the descending-clock auction in the first phase. (For light of a complex and changing environment. more information on auction design mechanisms, see Maurer and The wind auction scheme put in place in Brazil in 2009 was Barroso 2011.) Despite the changes introduced in the 2013 auctions, designed to address concerns with the wind power sector at the which could in principle justify higher revenues for investors (to time: (i) that significant untapped potential needed to be exploited, (ii) compensate for less-attractive contract terms), the ceiling prices that major uncertainties (with respect to stochastic wind fluctuations issued by the government have been comparatively low. As a result, and the volatility of Brazilian spot prices for electricity) worried the marginal price of each of the three auctions was very close investors, and (iii) that the Brazilian wind sector needed to reach to the ceiling price, indicating that competition in those recent critical mass before prices could fall substantially. This diagnosis was 7 Promoting Renewable Energy through Auctions: The Case of Brazil generally correct, and, as a consequence, the policies adopted by the References MAKE FURTHER government in this first stage were very successful in ensuring the Cunha, G., L. Barroso, and B. Bezerra. 2014. “Lessons Learned from CONNECTIONS initial scale-up of wind power in the country, as well as a dramatic the Auction-Based Approach to Integrate Wind Generation in the drop in prices. Brazilian Electricity Market.” Paper C5-303 at Cigre Session 45, Live Wire 2014/12. “Promoting But new conditions emerged with the success of stage one, August 26–29 2014, Paris. Renewable Energy through bringing other important considerations to the surface. Security of Cunha, G., L. Barroso, F. Porrua, and B. Bezerra. 2012. “Fostering Wind Auctions,” by Gabriela supply became an important consideration when wind plants began Power through Auctions: The Brazilian Experience.” IAEE Energy Elizondo-Azuela and Luiz to represent a substantial portion of the contracted expansion of the Forum, Second Quarter 2012: 25–28. Barroso. system. Maurer, L. T., and L. A. Barroso. 2011. Electricity Auctions: An Overview Although the challenges imposed by the second stage of the Live Wire 2014/14. “Promoting of Efficient Practices. Washington, DC: World Bank. development of wind power in Brazil have not yet fully been solved, Renewable Energy through Rudnick, H., L. Barroso, D. Llarens, D. Watts, and R. Ferreira. 2012. the constructive responses of policy makers reflected in the 2013 Auctions: The Case of “Transmission Challenges in the Integration of Renewables in auctions are an encouraging sign. Ultimately, a technical analysis is China,” by Xiaodong Wang, South America.” IEEE Power and Energy Magazine 10(2): 24–36. needed to evaluate the ability of Brazil’s system to accommodate Luiz Barroso, and Gabriela wind power expansion. Fortunately, that analysis is already on the The peer reviewers for this note were Luiz Maurer (principal industry Elizondo-Azuela. agenda. specialist for climate strategy and business development, IFC) and Katharina Live Wire 2014/15. “Promoting Gassner (senior investment climate economist, World Bank Group). Renewable Energy through Auctions: The Case of India,” by Ashish Khana and Luiz Barroso. 8 Get Connected to Live Wire Get Connected to Live Wire Live Wires have been designed for easy reading on the screen and for The Live Wire series of online knowledge notes is a new initiative of the World Bank Group’s downloading and self-printing “Live Wire is designed Energy Practice, reflecting the emphasis on knowledge management and solutions-oriented in color or black and white. knowledge that is emerging from the ongoing change process within the Bank Group. for practitioners inside Professional printing can and outside the Bank. Each Live Wire delivers, in 3–6 attractive, highly readable pages, knowledge that is immediately also be undertaken on relevant to front-line practitioners. 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Once a year, the Energy Practice takes stock of all notes that appeared, reviewing their quality and identifying priority areas to be covered in the following year’s pipeline. https://openknowledge.worldbank.org 1 U n d e r s ta n d i n g C O 2 e m i s s i O n s f r O m t h e g lObal energy seCtOr 2014/5 A KNOWLEDGE NOTE SERIES FOR THE ENERGY PRACTICE THE BOTTOM LINE Understanding CO2 Emissions from the Global Energy Sector the energy sector contributes about 40 percent of global 2014/4 emissions of CO2. three- Why is this issue important? xas The Case of Te renewable ene rgy T o T h eof quarters r i d : emissions gthose Mitigating climate change requires knowledge of the Figure 2. energy-related CO2 1 TransmiTTing come from six major Figure 1. CO2 emissions sources of CO2 emissions by sector emissions by country economies. although coal-fired LICs plants account for just Identifying opportunities to cut emissions of greenhouse gases 0.5% requires a clear understanding of the main sources of those emis- 40 percent of world energy Residential Other were Esions. N E R Carbon G Y P R A C T dioxideICE(CO2) accounts for more than 80 percent of 6% sectors Other MICs production, they S FOR T H E LEDGE NOTE SERIE 10% 15% A KNOW total greenhouse gas emissions globally, primarily from the burning 1 China responsible for more than Other HICs 30% of fossil fuels (IFCC 2007). The energy sector—defined to include Energy 8% 70 percent of energy-sector Energy to the Grid: fuels consumed for electricity and heat generation—contributed 41 Industry 41% Japan 4% emissions in 2010. if warming is Transmitting Renewable 20% Russia to be limited to two degrees percent of global CO2 emissions in 2010 (figure 1). Energy-related 7% USA THE BOTTOM LINE CO2 emissions at the point of combustion make up the bulk of such Other transport Road India 19% Celsius, therefore, steep 7% EU The Case of Texas emissions and are generated by the burning of fossil fuels, industrial 6% transport 11% states reductions will have to be made Texas leads the United 16% waste, and nonrenewable municipal waste to generate electricity with 9,528 mw of installed in the use of coal to generate face? and leakage emissions What challenge did they and heat. Black carbon and methane venting Notes: Energy-related CO2 emissions are CO2 emissions from the energy sector at the point wind power capacity—a electricity in the larger bunkers, domestic note. of combustion. Other Transport includes international marine and aviation ? are not included in the analysis presented in this level exceeded by only four Why is this case interesting economies. t was contingent on aviation and navigation, rail and pipeline transport; Other Sectors include commercial/public Transmission investmen yet needed to precede it tion, and other emissions not specified elsewhere; Energy = fuels consumed for electricity and and heat genera- services, agriculture/forestry, fishing, energy industries other than electricity countries. The state needed and accelerate more infrastructure to transmit Texas needed to prioritize Where do emissions generation come ents commitm from? HIC, MIC, and LIC refer to high-, middle-, wind sites tremendous needs for trans-heat generation, as defined in the opening paragraph. electricity generated from development of remote EmissionsTexas are faced the challenge of meeting concentrated in a handful of countries from and low-income countries. producer of generation renewable sources, but the century, Texas was a major e triggered by the scale-up Source: IEA 2012a. During much of the twentieth is now taking advantage and primarily mission come infrastructur from burning coal infrastructur e can take longer to regulator could not approve States. The state of petroleum in the United Vivien Foster is sector renewable sources. Transmission projects wind.for the Sus- leads It currently The geographical pattern of energy-related CO2 emissions closely transmission expansion a major renewable energy resource:manager only 0.5 percent by all low-income of power capacity middle-income countries, and in the absence of financially 9,528 MW of installed wind Depart- tainable Energy mirrors the distribution of energy consumption (figure 2). In 2010, To solve the United States with ment at the fifth World rank in wind Bank two zones energy with the countries put together. committed generators. were a country, would almost half of all such emissions were associated competitive renewable a (ERCOT 2011) and, if it (vfoster@worldbank.org). Figure 1. Texas’s five Coal is, by far, the largest source of energy-related CO2 emissions the problem, Texas devised largest global energy consumers, and more than three-quarters quickly generation worldwide. Daron program in 1999, it vowed to were associated with the top six emitting countries. Of the remaining Bedrosyan globally, accounting for more than 70 percent of the total (figure 3). planning process that When Texas reformed its energy works energy mix. It now uses a energy-related CO2 emissions, about 8 percent were contributed for London This reflects both the widespread use of coal to generate electrical connects energy systems increase the role of renewables in its Toronto. to increase Economics in utilities power, as well as the exceptionally high CO2 intensity of coal-fired to the transmission system. portfolio standard to require energy by other high-income countries, another 15 percent by other the renewable Previously, he was renewable sources. an To minimize power (figure 4). Per unit of energy produced, coal emits significantly The system is based on their energy generation from eligible energy analyst with the energy program created more CO2 emissions than oil and more than twice as much as natural designation of “competitive the state’s renewable Practice. Greenhouse Gas Inventory costs to the taxpayer, World Bank’s Energy rely on the private sector United Nations Framework Convention 1 on Climate Change, gas. renewable energy zones. energy zones that Data—Comparisons By Gas (database). http://unfccc.int/ghg_data/items/3800.php competitive renewable and trans- e and operations for generation to provide infrastructur and regulation provides planning, facilitation, mission, while the state (figure 1). electricity pro- standard mandated that The renewable portfolio by 2009. 2,000 MW of additional renewable energy viders generate and was followed Marcelino Madrigal met in just over six years (mmadrigal@worldbank This 10-year target was and mandated 20, which raised the targets .org) is a senior energy up in 2005 by Senate Bill reach 5,880 energy generation must specialist in the World that the state’s total renewable Furthermore, the 2015 and 2025 respectively. Bank’s Energy Practice. MW and 10,000 MW by energy target 500 MW of the 2025 renewable With Rhonda Lenai Jordan legislation required that sources other than wind. (rjordan@worldbank.org) be derived from renewable in is an energy specialist Source: ERCOT 2008. the same practice.