Should wind and solar energy producers be overtaxed if they have the bad idea of selling their production at market price? Yes, according to the French’s Energy Regulatory Commission (CRE). Selling renewable power at market price is likely to be prohibited in France by law. How did this come about and what can we conclude?
17 billion in revenue by 2023
In its November report, the CRE announces Christmas before its time. According to the French regulator, renewable energy feed-in tariffs will yield €17 billion to the State budget in 2023. This brings the total revenue for 2022 and 2023 to €30 billion. Onshore wind power is the main contributor (€12.7 billion in 2023), followed by solar photovoltaic (€2.6 billion) and bioenergy (biogas and biomass €1.2 billion). These revenues are due to the difference between the contractual purchase price of electricity from renewables and the wholesale market price. The State has to make up the difference, but as the energy crisis has driven the price of electricity on the wholesale markets to unprecedented highs, the price differential has become negative, thus in favor of the State. Before the energy crisis, the feed-in tariffs for electricity produced by wind turbines and photovoltaic panels were well above market prices. Renewables were highly subsidized. The shortfall for the State has accumulated with the penetration of renewables bringing the bill to €5.7 billion yearly for 2019. The reversal of the trend is even more spectacular as the charge is cumulative: contracts with high purchase prices before the decline in the cost of renewables in recent years are still honored.
Back to the future
Investing in a wind turbine or photovoltaic panels is a long-term decision. The profitability of such an investment is assessed over its lifetime. The return on investment is therefore dependent on the selling price of the electricity produced over a period of about 20 years. Aiming at encouraging these investments, the State has undertaken to pay subsidized purchase rates over this period. Companies or households that invest in wind or solar power are guaranteed a fixed remuneration throughout the operation of the equipment. With such a commitment from the State, the risk is low, and the return guaranteed. When the feed-in tariff was well above the price of electricity on the wholesale markets (a few tens of euros per MWh), terminating such a contract was not an issue. The situation has changed[1] significantly with average monthly wholesale prices ranging from €180 to €495 MWh in 2022, well above the guaranteed tariffs of €82 MWh for wind and €60 to €171 MWh for solar in 2017. Hence the law prohibiting the contractor from suspending or terminating the contract, and the CRE's recommendation to tax the infra-marginal rents of renewable operators who have terminated the contract. CRE justifies the taxation of these “windfall profits” by the fact that "these facilities were only able to be developed thanks to the financial support of the State from which they benefited over periods generally exceeding 10 years."
Long-term contract versus spot market
To remunerate investments in electricity generation equipment, two systems co-exist: long-term contracts and wholesale electricity markets. While in the contracts the price is defined in advance, it fluctuates according to supply and demand on the markets. The prices (set by the contract or the market) are intended to cover the costs of production, primarily the cost of equipment for renewables, including the risk taken by investors. They must be calibrated over the life of the equipment. However, it is very difficult to predict electricity prices beyond one or two years. We learned from the shale gas boom and the Ukraine war that many factors are unpredictable. The current price is a very imperfect indicator of future prices. A long-term contract that remunerates the MWh based on the market price at the time the contract is signed is likely to be disconnected from the reality of this same market years later. This error of foresight affects today the subsidized feed-in tariffs for renewables as it affects the regulated access tariff for historical nuclear electricity (ARHEN) whose amount initially set at 42 €/MWh seems ridiculously low today.
Who benefits from higher prices?
This raises the question of the porosity between the two systems of remuneration for electricity generation. Can we switch from one to the other? It is implicit in one direction: a generator that sells on the wholesale market can at any time sign a long-term contract with a buyer. Unless explicit in the contract, the reverse shift from a long-term contract to the market is not self-evident.[2] It is questioned by the French Senate and criticized by the CRE for generating windfall gains. Nevertheless, this option to exit the contractual relationship is one of the elements to be considered in the calculation of the return on investment. Changing rules afterward deprives the investor of some of the return he could expect when he signed the contract. This change is linked to another windfall gain, this one for the benefit of the State: exploiting the price differential to increase public revenues. The CRE's argument can therefore be reversed. After all, is it odd to sell a product at market price? Should this practice be prohibited because subsidies were paid for environmental reasons at a time when the equipment was not profitable? By highlighting the "loss of revenue" for the State, the feed-in tariffs are diverted from their initial purpose, which was to enhance investment into renewables. The priority is no longer that but rather to finance the “tariff shield” that caps the retail price of electricity in France.
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The current energy crisis offers a revenge to renewable energies. Once decried for emptying the pockets of consumers/taxpayers through the CSPE (see our previous post), they are now feeding the State coffers thanks to market prices higher than feed-in tariffs. The option to exit the feed-in tariffs challenged by the French authorities raises the more general question of the coexistence between long-term contracts and wholesale electricity markets. It is at the heart of the current market reform discussed in Brussels. The answer must be carefully thought out in order to avoid having to change the rules along the way.
[1] The termination requests represent 3.7 GW of generation capacity in September 2022 according to CRE, which would correspond to a cumulative loss of revenue for the State of €6 to 7 billion for 2022 and 2023.
[2] Note that this porosity is also present for the price regulated by ARHEN. Electricity suppliers are flocking to this access while they have shunned this scheme in the past when market prices were lower (see our post on the subject).
