(The author is a Reuters market analyst. The views expressed are his own.)
By Gerard Wynn
LONDON, Aug 21 (Reuters) - The variability of renewable energy is raising additional issues for European governments as they grapple with carbon emissions targets and the growth of wind and solar power.
Regulators in several countries are preparing to contract gas-fired electricity generation capacity to provide back-up for renewable energy on still and cloudy days, when wind and solar power are in short supply.
That adds to efforts in countries including Britain and Germany to increase transmission capacity, also to smooth intermittency by allowing wind farms to access as wide an area as possible.
Ideally, companies that generate wind and solar power should help pay for these balancing services, such as by installing battery storage, but they are already struggling to compete without subsidies, and so the extra cost will fall on consumers.
In Europe, the new capacity payment schemes for gas-fired back-up will draw attention to these costs, previously unreported, for maintaining fossil fuel power plant capacity that will be idle much of the time.
That will only add to economic and political pressure for renewable energy to compete without subsidies.
A so-called capacity payments system is planned in Britain and France, under consideration in Germany and already in use in Spain and Ireland, as EU members strive to meet binding targets collectively to get a fifth of all energy from renewable sources by 2020, compared with about 11 percent now.
Back-up is necessary because of the intermittency of renewable energy.
In addition, most European countries operate under a "merit order" system in which they dispatch power to the grid based on lowest marginal cost to keep wholesale power prices to a minimum.
Because wind and solar have zero marginal cost - their fuel is free - they always get priority access.
That helps keep power prices down at times of peak demand (lunchtime and early evening), which is great news for consumers but is increasingly undercutting the profitability of gas-fired power.
Furthermore, most EU countries support renewable power by guaranteeing firms a premium, or feed-in tariff, which means they are insulated from wholesale power prices. They will continue to generate power even if this means dumping so much electricity into the grid that wholesale prices drop close to zero.
If the market were left to its own devices, power prices could rise to extremely high levels at times of peak demand when renewables are not available, to allow fossil fuel plants to recoup their fixed costs.
Britain's Department for Energy and Climate Change (DECC) has estimated that prices would have to rise to as high as 10,000 pounds ($15,700) per megawatt hour (MWh) for short periods, from an average of around 45 pounds. Prices in Britain have historically never exceeded 938 pounds per MWh.
Power generators would expect regulators to intervene before prices could rise to such levels, which makes them reluctant to invest, and so creates the need for a capacity mechanism.
Britain will publish detailed plans before year-end, and has made sketchy proposals to hold auctions four to five years in advance of delivery. Companies would bid simply to make capacity available, regardless of whether the power is used.
An advantage of such a capacity payments system is its transparency, giving suppliers several years' notice of what the regulator wants.
One difficulty is calculating how much capacity to contract. Risk-averse bureaucrats with imperfect information are likely to contract for too much.
Analysts of a similar U.S. scheme say, however, that bidders also have tended to be conservative because the system includes penalties for failing to honour contracts - at the rate of tens of thousands of dollars of lost deposits per under-supplied megawatt.
Generators tend to underestimate how much capacity they can provide, leaving a potential surplus that policymakers could take into account when estimating needs.
In Europe, there is also the political problem of focusing attention on back-up costs, as already seen in Spain which introduced capacity payments in 2007 to help gas plants stranded by the rapid expansion of wind power.
The payments have been unpopular partly because Spain's system does not penalise gas plants if they are unavailable when needed, besides depriving them of their capacity payments.
It is harder to justify, in such circumstances, payments of up to 28 euros per kilowatt of capacity per year.
However, penalties will not remove the impression that renewable energy is more expensive than previously thought.
As a recent report for Britain's DECC found recently:
"(Centralised capacity markets) Can create a political backlash because clearly visible capacity prices draw attention to the high cost of ensuring reliability at current target reserve margins."
Capacity payments will only put further pressure on renewable energy to stand on its own feet without subsidies, which have been falling rapidly in Europe in line with plunging equipment prices.
When renewables are competitive without subsidies they can then bid alongside gas in technology-neutral auctions, leaving their social benefits implicit. (editing by Jane Baird)