Auction programmes are now officially the preferred procurement method for contracting renewable energy capacity globally, and are set to grow in prominence.
There is thus an important need to learn from and distil current experiences with these auction programmes for the African context, writes Prof Anton Eberhard and Wikus Kruger from the University of Cape Town, Graduate School of Business, South Africa.
An analysis of auction programmes in Latin America, Europe, Asia, and the Middle East and North Africa region has shown that renewable energy auctions can be effectively implemented in various contexts, but require a specific combination of auction design and implementation factors to ensure the achievement of low prices and high project realisation rates. These factors include measures to ensure bidder capacity and commitment, project de-risking and credit enhancement by the procurer, and adequate institutional capacity within government.
Independent Power Projects (IPPs) – built, financed, owned, and operated by the private sector – have become one of the fastest-growing sources of investment in the region’s power sector (Eberhard et al., 2016). Recent data show that a rapidly growing portion of these IPPs is renewable energy-based (Figure 1), many of which have been competitively procured (Kruger and Eberhard, 2018).
These three trends – the surge in private power investment, the growth in competitively priced renewable energy projects, and the use of competitive procurement (auctions) for IPPs – represent important departures from the status quo in the sub-Saharan region.
Auctions, although quite recent, have already delivered more investment in renewable energy at lower prices than any other procurement or contracting method for the region. Many African countries have struggled to successfully address the risks and costs involved in renewable energy auctions, resulting in potentially poor outcomes. Additionally, there is a desperate need for affordable power generation investment, yet many countries cannot afford the ‘school fees’ involved in a poorly designed and implemented auction programme.
The Energy and Economic Growth Applied Research Programme is therefore supporting the University of Cape Town in conducting research on this matter, which will help improve the design and implementation of renewable energy auctions in sub-Saharan Africa in order to accelerate investment in clean energy technologies and ultimately mitigate climate change. This programme is managed by Oxford Policy Management and funded by UKAID.
Findings, results, and policy implications
The rising prominence of auctions is primarily due to the introduction of competition into the procurement process, causing significant downward pressure on renewable energy project prices. The result is that the least-cost new-build electricity generation capacity options in many developing countries are now renewable energy based (McCrone et al., 2017; CSIR, 2016; Dezem, 2016).
Our analysis of renewable energy auction programmes has revealed seven major trends with important implications for sub-Saharan Africa, which we will now outline.
Seven major trends
1: Renewable energy auctions work in many different market contexts with various renewable energy technologies. Auctions have been able to secure large volumes of privately financed, built, owned, and operated renewable energy capacity while at the same time reducing prices – often to levels below a power system’s average cost of supply or below the cost of new-build conventional power sources. Auctions have been shown to work in numerous types of electricity markets with various types of technologies (although onshore wind and solar PV dominate).
2: A coherent, clear integration of energy policy, electricity sector master planning, and procurement is essential for achieving successful auction outcomes. Auction volume and rounds need to be clearly linked to renewable energy targets as well as sector planning frameworks (including transmission planning). This provides predictability to investors and enables the procurer to implement auction rounds with some regularity, which has proven to consistently drive down prices and develop a pipeline of strong projects. It might be wise to start relatively small to test the auction framework.
Sub-Saharan African governments and regulators are advised to develop renewable energy auction programmes based on least-cost, dynamic integrated resource plans. Overall auction volumes, technology specific tranches and frequency of rounds should be established by these plans. Given the relatively small and weak grids in most sub-Saharan African countries, it is also imperative that auction design takes into account transmission capacity and planning.
3: Auction participants need to not only have the capacity (financial, technical) to stand behind their bids, but more importantly should be committed to realising auction outcomes. The use of stringent qualification criteria, right-sized financial guarantees (e.g. bid and performance bonds), and effective penalty mechanisms has ensured high project realisation rates. In the absence of these mechanisms, auction programmes have been subject to speculative bidding and underperformance.
Sub-Saharan African auctioneers would be well advised to use an effective combination of qualification criteria, bidder guarantees, and penalty mechanisms to ensure adequate bidder capacity and commitment to project realisation.
4: Most renewable energy auctions tend to favour simpler, more intuitive design options such as, for example, capacity-based volumes (MW), energy-based payment (MWh), and sealed bid processes with pay-as-bid pricing rules.
A simple, straightforward auction is likely to not only be easier to implement but will probably also attract greater bidder interest. Given the relatively high transaction costs of auctions for bidders and auctioneers, it is suggested that at least the first few rounds of auctions be implemented using tried-and-tested auction design options.
That being said, the need for auction innovation around potential additional products such as energy storage might prompt some sub-Saharan African auctions to introduce auction design elements that have not been used in other contexts.
5: It is important to decide on clear auction objectives beforehand, since there tends to be a trade-off between different objectives. Policymakers need to be aware that objectives such as local industrialisation and community ownership requirements will affect auction pricing. Local content requirements in particular need to be realistic.
6: Project de-risking and credit enhancement have proven to be important for achieving lower prices, and for ensuring project realisation. Various auction programmes have used payment and loan guarantees, offered concessional financing, and provided other fiscal incentives to drive down the cost of debt for projects.
Some offtakers have even provided substantial amounts of equity. One of the most frequently used risk mitigation measures has been the provision and preparation of the project site, along with the relevant infrastructure, permits, and data.
For many sub-Saharan African countries, the only way to ensure that private power projects are bankable is by providing guarantees and other credit enhancement mechanisms. An auction makes it possible to provide these benefits at a programmatic level (as opposed to a case-by-case basis), and to ensure that only the best (winning) projects benefit from scarce government resources.
7: Effective renewable energy auction implementation requires substantial institutional capacity and commitment at various levels of government. It is important to have a credible, capable procurer (often the sector regulator or system operator) that is able to coordinate multiple institutions; a credible (if not creditworthy) and committed offtaker; and high-level political support. Auction rules and procedures should be clear and evaluation needs to be done transparently. A well-designed auction programme that is poorly implemented will struggle to realise effective outcomes. ESI