How should SA approach the procurement of least-cost power?

31st May 2019 By: Tobias Bischof-Niemz

How should SA approach the procurement of  least-cost power?

ENERGY & CAPACITY Today there are two different asset classes delivering two distinctly different services: kilowatt-hours and kilowatts
Photo by: Dr Tobias Bischof-Niemz

In the previous Transition Talk column (Engineering News May 17–23, 2019), I explored what it would take to depoliticise the process of drafting a rational Integrated Resource Plan (IRP) for South Africa. Such a plan will outline what investments need to be made in the electricity sector. The next step, which is the topic of this Transition Talk, is to procure the generation assets required in the plan in an efficient manner.

In regulatory terms, where prudence and efficiency are the two key objectives, the IRP stands for prudence (doing the right things), while the implementation of the IRP represents efficiency (doing things right).

Less than a decade ago, a least-cost IRP would have selected coal-fired power generators as the energy workhorses. Under this scenario, the coal plants provided both the bulk energy, or kilowatt hours, as well as firm capacity, or kilowatts (together with a few diesel-fired peaking plants to fill the gaps). The two largest cost items in the power system, energy and firm capacity, were hence provided by one technology, in the form of coal-fired power stations.

Today, there is a separation of tasks. The cheapest way for South Africa to produce new electricity is now through a combination of solar photovoltaic (PV), onshore wind and flexible generators. The variable renewable-energy plants are the energy workhorses, providing the bulk kilowatt hours for the system. The flexible generators, such as gas-fired power stations, battery storage units and pumped-hydro schemes, provide the firm capacity required to keep the system operating reliably all the time. That means, today, there are two different asset classes delivering two distinctly different services: kilowatt hours and kilowatts.

As I discussed in a previous Transition Talk column (Engineering News 

February 8–14, 2019), it creates a lot of stringency and efficiency to structure power generators along power-station-specific contracts for electricity delivery using power purchase agreements (PPAs). Existing power stations can be transitioned into such a setting, while new power station PPAs should be procured through competitive auctions.

To date, South Africa’s electricity auctions have not distinguished between assets that deliver kilowatt hours and those that should provide firm capacity, or kilowatts. In future, distinctive processes, with distinctive evaluation criteria, will be required if South Africa is to strike the procurement balance necessary for the operation of a least-cost and reliable electricity system. Crucially, upfront acknowledgement is required from those who craft and implement energy policy that two very different asset classes, delivering two very different products, will have to be procured, using payment structures that are appropriate to both.

For both asset classes, the payments under the PPA naturally have to cover the full cost of building, owning and operating the plant. Otherwise no investment will be made. As implied by the name, fixed-cost components are incurred whether or not the plant is in operation (investment and fixed cost operations and maintenance cost).

Variable costs, meanwhile, are incurred only when the system operator dispatches the plant – that means when energy is produced (burning of gas in a gas turbine or engine, burning of coal in a coal-fired power station, or the discharging of a battery). The payment terms under the PPA should, firstly, reflect the underlying service that is provided and, secondly, be performance based (payment is made only on delivery of the promised service, whether that is energy or firm capacity).

Wind and solar PV provide predominantly energy (very little firm capacity), and their cost structure is fixed cost only (no fuel, no other variable cost). Gas-fired power stations on the other hand provide mostly firm capacity (very small amounts of energy), and their cost structure is such that the fixed costs of building and owning the plant are relatively low, while the variable costs per energy unit if and when they are dispatched (fuel is burned) are high.

Taking cognisance of the underlying cost structures and the lifetime of the assets, the following procurement approach is advisable for wind and solar power generators:

• Competitive auctions for long-term PPAs.

• Lifetime of the PPA linked to the lifetime of the asset (duration of fixed-cost lock in).

• Bid evaluation based on price per energy, or rand per kilowatt hour.

• Payment is based on actual energy delivered (only when the solar or wind plant is able to produce energy).

For new gas-fired power stations or existing coal-fired power stations, the following structure is appropriate:

• Competitive auctions for long-term PPAs.

• Lifetime of the PPA linked to the lifetime of the asset (duration of fixed-cost lock in).

• Evaluation based on price per firm capacity (rand per kilowatt per month) and on price per energy (rand per kilowatt hour).

• Payment based on actual firm capacity delivered (only when the power station, is reliably available to be dispatched and supply power on demand).

In addition, payment per energy produced if and when the power stations are asked to generate actual kilowatt hours as a result of cost-optimal dispatch decisions at the Eskom system operator, and therefore burn gas or coal fuel.

In such a setting, all technology-performance risks will be vested with the owner of the assets. If the technologies do not perform (no energy generated from wind or solar, or no firm capacity available from gas- or coal-fired power stations), there is no payment.

The offtake risk, which relates to whether or not energy or firm capacity is indeed required at a certain point in time, lies with the power system planners and operators.

Hence, all payments will be based on performance (output) for the specific service requested from the different asset classes, and all risks will be allocated to the entities that can best manage them. As a result, this setting will deliver the lowest-cost power system for the wider economy to benefit.