Market environment

The cost of electricity is made up of the following:

• cost of investment, i.e. construction of the power plant. This cost is amortised over the plant’s lifecycle.
• fixed costs, i.e. on-going maintenance: employee wages, repairs, equipment, etc. These costs are incurred regardless of whether the plant is producing electricity or not.
• variable costs, i.e. how much it costs to generate each additional MWh of energy. The level of variable costs directly depends on the level of production. The main component of variable costs is the cost of fuel.

For different types of power plants, the relation between these costs varies. For example, for wind farms or photovoltaics, the cost of investment and its share in total costs are high. However, operating, fixed and variable costs are relatively low. In the case of conventional plants, variable and fixed costs are more balanced, largely depending on the cost of fuel.

This is why in Poland the levelized cost of electricity per 1 MWh is still higher for renewable energy than conventional. However, at PGE we are also forecasting a gradual decline in the cost of generating energy from renewable sources.

The price on the wholesale market is driven by variable costs, and more precisely – by the marginal cost to produce 1 MWh of electricity. Based on the level of these costs, from the lowest to the highest, a supply curve (merit order) is created. The point where the demand curve crosses the supply curve is the current market price of energy.

Fixed costs are incurred regardless of whether a given plant operates or not. Therefore, they have no present impact on the price of electricity.

High costs of investing in renewable sources (i.e. sources with low variable cost) are financed outside the electricity market, from subsidies that all consumers pay for.

Not all capacities are always available on the market. Therefore, the price is driven by their availability and by demand for electricity – lower at night, higher during the day, and seasonally shifting – higher in the winter, lower in the summer.

In Poland, we have limited water resources and limited capability of using solar energy, which translates into a limited number of plants fuelled by these forces of nature. This is why the most important renewable source is wind energy. It is wind conditions that largely determine the level of available capacity.

The most important factor in capacity availability is thus the weather. Therefore, the level of the availability of renewable capacities is variable, and there must always be an appropriate conventional capacity reserve, ready for immediate use whenever weather conditions make it impossible to generate energy from wind.

It is because variable costs have an impact on the price of electricity. For conventional plants, the main costs are: cost of fuel and cost of CO₂ emission allowances.

Wind farms, hydro plants and photovoltaic units do not incur these costs. Therefore, they are always first in the merit order. CHP plants are similar – their primary role is to produce heat, while electricity is generated in addition to that. Given the cost of fuel (coal, gas) and CO₂ allowances, conventional plants are further out in the merit order.

In Poland, lignite plants usually have the lowest variable costs, followed by hard coal plants, with gas-fired plants being the most expensive.

The production cost, of course, depends on the efficiency of fuel processing at the plant. Therefore, new units will offer cheaper electricity than existing ones.

The mechanism for setting prices based on variable costs was effective in a free market situation, undistorted by the subsidising of select technologies.

Subsidising the costs of investing in renewables has distorted the energy market, worsening the economics of conventional unit operations because these cannot operate at full capacity. In many markets, the operation of permanently or temporarily unprofitable assets is being limited. This may not be allowed on the market for electricity, which is one of the basic human needs. In disadvantageous weather conditions (e.g. no wind), there would not be enough energy, which would cause a blackout. This is destructive for the economy and for the regular life of people.

This is where the concept of capacity market comes in – as a market supplementary to the electricity market, offering the certainty of electricity supplies irrespective of the weather or time of day.

The need to support the operational readiness of generating sources results directly from market distortions caused by non-market support for uncontrollable renewable energy sources. This is not additional support – this is really just levelling the playing field. Thanks to this, stable generating sources may receive partial compensation for declining wholesale prices (which until now covered variable costs and fixed costs). This will allow plants to be maintained and modernised so that they can be cleaner and more efficient – for uninterrupted and reliable supplies of energy to our clients.