Why is credit so important in this sector?
Credit is a very sensitive topic, especially for wind operators. While a solar plant very often is backed up by a less stringent finance contract, a wind farm is often funded with project finance type packages, in which the bank is more involved. This gives us a greater competitive advantage because in addition to the strong basis of the company, we can offer guarantees to financial institutions which come from triple-A rated Scandinavian banks.
We have seen how banks in general are fairly “conservative": they initially considered wind generating plants simply as assets, and not as industrial operations.
Have you thought about “covering” yourself and capitalizing with a customer base or production assets?
Our strategy is to be simple traders, and this is the value for which the market recognises us. In our view, holding production assets is a different job, as is selling energy to a portfolio of consumers. The latter business in particular carries many challenges for operators, not just in terms of margins (falling all the time), but also because of payment delays by customers during these critical years.
And what is the risk in managing renewable resources where a good credit level helps?
It is the counter-party risk. The producer always has to pass on energy to a third party, who then goes to the market on its behalf. The market pays the trader and has to trust the trader's reliability to respect the agreement and pay the producer for the energy. This is why guarantees are required.
This situation plays out in favor of Danske Commodities (dc). As we have had a market presence for many years, our stability is well-known to many international financial institutions, so we can operate without having to issue guarantees on plants that they finance.
What does an Italian producer typically ask of a trader?
A very simple price plan for a renewables plant in Italy, from which a trader is authorised to go and sell the energy on the market, often at market prices. It is in fact a mandate to operate on the market. PPAs (Power Purchase Agreement) are normally taken out for short periods, between 12 and 18 months. So from this point of view, Italy is still a young market, with banks and producers sometimes reluctant to abandon the GSE to trust a trader with long-term contracts. In actual fact, both parties prefer not to commit themselves for a long period, so that they can take advantage of any developments on the market in terms of the legislative and regulatory framework.
So in this sense, the “end” of incentives is a move in your favor.
Absolutely it is. In a report on trading from Elemens, published a couple of months ago, there was a clear increase in the proportion of renewables on the free market. This is a natural process which we have already seen in Denmark and Germany in a similar way. When the bank recognises the unforeseen rise in balancing costs, the problem of how to reduce these costs arises at once. It is not easy to find a solid, “bankable” counter-party like GSE. Only a few of the traders operating in Italy meet the stringent requirements demanded by the banks. The use of a trader is often seen as an extra, a bit on top, since the incentive and price of energy guarantee the value of the investment - and obviously the services the trader provides were not taken into account when the business plan was drawn up. But at the point where a change in regulations imposes an extra cost, and there is an easy and bankable solution to deal with it, that's when the trader comes on the scene.
What does it mean in practice to determine the value of energy produced from renewables?
It starts essentially from an analysis of the current situation around valuation of energy, that is the set-aside agreement with GSE or the upcoming PPA contract. Generally, the first thing a producer (especially a newcomer) has to ask itself is if it wants to set a fixed price value for the energy, that is if it intends to take a position on the market remembering that prices may fall over the next 1-2 years, or if it wants to look for a trader that will value the energy at market price, but reduce the balancing costs. Normally renewables producers try to copy the set-aside scheme. At the time of moving from GSE to a trader, the producer prefers to find a solution that is immediately comparable to the old one, but with some benefits.
Why should a producer of renewables go to the trader?
Use of a trader should be seen in terms of risk management: while a set-aside scheme has balancing costs of between 1.5 and 4€/MWh, varying monthly, the open market can fix these costs, and that at a realistically lower level.
Are there other areas where Germany is further on than us?
Let's say that in Germany, deregulation of trading in renewables was done with both the carrot and the stick. In Italy it began by loading the balance costs onto renewables, while in Germany, for those who decided to go onto the free market and take on balancing costs, there was an extra subsidy available, in the order of a few euros per MWh. This incentive was designed as a catalyst, since in going onto the market the renewables producer relieved the TSOs of the burden of selling the energy they produce on the market. Over two years, 90% of German wind energy producers moved onto the open market, along with the great majority of solar energy producers. The German approach meant a faster transition and in the end, the benefit for the system is comparable overall. In Italy, there is still some inertia.
Would greater participation in market demand also be significant?
We hope that the standards framework takes stock of a number of outside experiences, which would obviously be adapted to the Italian market. dc is prepared to contribute to the definition of a stable, regulatory structure, to deal with demand as well. Demand-side participation would allow us to do in Italy what we already do in other countries: “dynamic asset management”, optimising management of acquisitions on production and consumption portfolios.
Can you give an example?
Among our larger customers are some European steelmakers, who have very high levels of consumption and often also their own electricity generation assets. So these are operators who can decide whether to produce their own energy or buy it on the market. Now we are not energy sellers, so this lets us buy energy from anyone selling it on the market. We intervene at a second stage, on the intraday market, to optimise load management. It may happen that a decision is taken to purchase energy on the day-ahead market for consumption from 8.15 to 8.45 in the morning, but seeing the market change, this is “delayed” to another time slot, meaning it is then sold on the market if the energy price on the intraday market is high, and the same amount bought at another time when the price is low (obviously moving consumption as well from one period to another).
Similarly, if the price of energy at one period is very high, it may suit to sell energy previously purchased on the intraday market and generate it oneself, or sell the self-generated energy directly on the market instead of consuming it internally, thus also reducing consumption. So basically, it’s a lot of fun. This is all only possible if there are continuous intraday markets, gate closure close to the time of consumption or production and a trading desk organized to take advantage of the opportunities offered by the market. So at dc we have the largest intraday trading desk in Europe and we work with at least two people in front of the screens 24/7.
Do you also have a role in commercial development of battery storage?
We have some experience in battery storage, and we are ready to meet with the Italian regulator if it wishes to know more about our experience abroad. In this area, we manage one of the first standalone battery facilities in Germany, connected only to the network and not to a generation plant. We are talking about a plant of 5 MW and 5MHh, in which a private investor has put 6.5 million, with 40% financed by public subsidy. The investor relies on a trader to manage the energy, that is, on a party who can go to the marketplace and identify the most appropriate opportunities that will ensure a return on investment. This is certainly a more complex task than the commonly-held idea of storing energy at night and selling it during the day.
That rule did apply once, for hydroelectric and pumping, for instance …
It was actually a golden rule for hydropower basin plants. Not everyone who talks about battery storage is concerned with finding out how much the volumes used to play this “game” have fallen since 2000. It continues to be talked about as a golden rule, but the point is that the cost of battery storage is not definitely worthwhile, given the time-shift: it needs a trader who can understand the best opportunities offered by the markets. In Germany for instance, it is primary regulation that is the most suitable operation for use of a battery facility, as unlike Italy, this operation is mainly rewarded on capacity and not on the energy exchanged for this service.
What is the reward?
We are talking about some 3000 euros/MW/week. While Hollywood movies offer to the collective imagination the character of the purely speculative “trader”, someone who takes value from the community, in this case, the importance of the energy trader should be properly understood in the role of ensuring not just a return on asset investment, but also providing the TSO with tools suitable for ensuring network security.
For some years now, renewable producers have been heard asking for long-term contracts …
England is an example of this, where the average PPA is long-term. We recently signed a PPA for 15 years, for an offshore windfarm of 600 MW, so for 15 years we undertake to buy the energy and set the balancing costs. As for fixed price contracts, these last up to 5 years in England. And often investors who have plants in both Great Britain and in Italy ask us for similar terms in Italy, for example, a fixed price contract for a Sicilian plant in market parity. This would be too risky for us.
Why is that?
Normally, the one asking for a solution is a producer who has a risk for which it wants cover. A trader such as Danske Commodities does not hold all the risk “on the books”: so it has to have market tools that provide cover for risks, to hedge at least partly. On a market like that in Britain, we are more comfortable offering 5-year fixed prices. In Italy, present market conditions do not offer sufficient cover for the trader.
What is missing?
First and foremost, market liquidity, then the structure of products on the market. European markets have forward products with flat peak, off-peak and baseload profiles. This leaves the trader exposed in terms of profile. The particular feature in Italy is that PUN products are exchanged on the forward market, and if a producer wants to set the zonal price, apart from the profile risk (the bell curve), the trader also has the CCT risk, that is the difference between the zonal price (paid to the producer) and the PUN.
The intelligent, stable trader does not hold all the risk on the books, but transfers some of it to the market: if it is all held on the books and things go badly, they will really go badly. So, to conclude, the trader is happy to support the consumer or producer to seek greater efficiency and lower risk, provided it has the appropriate market tools.
One of the tools the trader has is weather forecasting …
For every country, we use two or three different weather forecast providers. It is vital for the trader to have meteorology models for every single renewable plant, not just with temperatures for predicting consumption or rainfall for hydropower, but giving sunshine figures in a particular part of Jutland or wind strength in a particular remote part of the Apennines. There are often meteorologists included at the trading desks of the major companies to answer these questions.
And speaking of Hollywood movies again, on very windy days, our trading desk can really seem like Wall Street, as we try to balance 7 GW of renewables so that we don't incur heavy sanctions. It should be noted that the professional meteorologists are always supported by computer-based learning models. Finally it is important to have accurate, up-to-date information about the plants, using live data systems. If the trader had to wait for actual production data to be published by the TSO each month, there would be no way of correcting any forecasting errors until the following month.