Behind the scene of energy: electricity production

We continue our series on energy markets with a look at the costs involved in electricity production. Return on investment, differences between fixed and variable costs, the impact of the crisis, and more. A review with Christelle Wynants, Head of global market analysis at ENGIE Global Energy Management & Sales, our entity specialized in energy sourcing, risk management, and asset optimization on markets.

What are the different types of costs involved in producing electricity?

Christelle Wynants: There are three principal costs for investors and producers:

• The cost of investment, which is obviously high when you talk about production infrastructures, and which needs to be repaid over the whole period of operation;

• Fixed operating costs, representing the payroll of teams in place or equipment maintenance, and which must be paid whatever the amount of electricity produced;

• And variable operating costs, which depend directly on the level of production. So, in a gas-fired plant, you need to buy fuel to produce electricity, which comes at a cost. Inversely, if you produce nothing, this variable cost is zero.

​​​​​​​Is generating electricity always profitable?

C.W.: Not always. For a production infrastructure to be financially viable, the revenue generated over its lifetime must cover the variable costs and fixed costs, and repay the investment, along with the rate of return expected on these investments. Financial viability also depends on the quantity of electricity produced and the sale price, but also on the technologies used and local regulations in countries where energy is produced (taxes, revenue cap, etc.).

For example, support mechanisms for renewable electricity production such as guaranteed tariff, tax credit, minimum revenue guarantee, etc. are deployed by public authorities to facilitate or guarantee the payment of fixed costs and repayment of investments. This mechanism enabled the swift development of wind and solar systems in several European countries.

The financial viability of thermal electricity production resources has been in jeopardy for many years, which has severely limited investment outside of renewables, even though thermal resources remain necessary today to ensure the security of supply.

How do you explain price variations in a period of crisis or calm?

C.W.: Whatever the context, the same principle applies: the price of electricity depends on supply and demand. In a “normal” period, several factors may impact prices, including weather conditions which affect both demand and the level of production of renewable energy, maintenance needs or possible failures at thermal (nuclear, coal, gas, oil) power plants, or the availability of grid access which impacts energy exchanges between countries.

These variables can cause prices to vary immensely. In the same day, it is possible to switch from a negative price, in some ways a sale at loss, to sky high prices! For example, the volatility of prices was recently exacerbated by several factors, such as grid constraints at French boarders with eastern neighbors, high levels of rainfalls in Western Europe, the conflict in Ukraine and ongoing tensions in the Middle East. When high risks impact production, buyers are ready to pay steep prices for electricity.

Read “Behind the scenes of energy by GEMS” on electricity markets

What is a fair price and how do you obtain it?

C.W.: A price is only fair if it is fair for everyone, from investors to consumers. Let’s be clear, an investor who can’t recover their initial outlay will stop investing! In a similar vein, if a price is much too high for an industrial operator or a business consumer, they will cease their operations. It is therefore essential to ensure that the balance is maintained over the long term, which should be the whole aim of market design, the regulation mechanism used in Europe. In the short term, imbalances are inevitable.

For flexible and programmable production, it is essential to support investment not only in renewables, but also in other technologies (low-carbon gas, batteries, and more) which are needed when solar and wind cannot satisfy demand.

To this end, several European countries have set up a capacity market: the principle is that a power plant is not only remunerated when it generates energy, but also because it is available if the grid requires it (e.g., poor weather conditions or unavailable infrastructures). The mechanism enables countries to guarantee their security of supply by ensuring that sufficient production resources are present and available to meet demand during peak consumption periods. The widespread adoption of this mechanism is one of ENGIE’s proposals to make positive reforms to market design.