Less consumption and lower prices
Preliminary data published last week by Terna, the Italian transmission network operator, shows that in 2014 electricity demand totalled 309 TWh, a 3% drop from 2013. This value represents the third consecutive annual decrease and is 10% lower than that observed in 2007, the year in which Italian electricity demand reached its maximum (see Figure 1). Indeed, this is one of the few times in the entire post war history that electricity demand grew less than gross domestic product (GDP) and even decreased in absolute terms.
Figure 1 – Trends in Italian gross electricity consumption (orange), gross energy consumption (purple), GDP (green) and population (red) from 1963 to 2013. The values for year 1963 are posed equal to 100. Source: Terna.
Last year electricity net production decreased even more, with a drop of around 4% with respect to 2013, reaching the amount of 267.6 TWh, more or less the same level seen since at the beginning of the past decade. Net imports filled the gap, increasing by 3.7% (up to 43.7 TWh) and covering about 14% of Italian demand.
At the same time, a sharp decrease in prices has taken place in the Italian market. Data released by the Gestore dei Mercati Energetici (GME), the company that manages the Italian electricity exchange, reveals that the average price for base-load power in 2014 shrunk to 52.1 €/MWh, a more than 10 euro reduction from the previous year and the lowest level in the last decade (see Figure 2). Data for 2014 also confirmed the progressive reduction in the difference between peak and base-load prices, something that did not characterise the Italian market before 2009-10.
Figure 2 - Italian yearly average price for peak time electricity (blue), baseload (red) and off peak (green) set on the official exchange in the last decade. Source: GME.
However, the decline in consumption and in prices has not been geographically uniform. With respect to 2013, demand in 2014 was weaker in North-west Italy, in Sicily, in Central Italy and in the South, while it was more or less stable in the North-east and in Sardinia, albeit after a strong decline that occurred also here in 2013 (see Figure 3). As far as prices on the day ahead market are concerned, 2014 was the second year in row in which convergence among all but one market zones was essentially achieved. Indeed, the only outliner was Sicily with a positive spread of 30 €/MWh, mainly due to insufficient connection capacity with the continent and the presence of few old thermal power plants that enjoyed market power for several hours each day (see Figure 4).
Figure 3 – Electricity required by the grid in different geographical areas. Source: Terna.
Several are the determinants of the observed trends in output and prices. The first one is an exceptionally weak demand due to enduring economic stagnation - GDP in 2014 declined by about 0.3% - and a mild weather that reduced heating consumption in winter and cooling consumption in summer. The second factor is represented by the reduction of coal and gas prices that allowed thermal power plants to bid lower prices in the wholesale electricity markets. Thirdly, 2014 was even more rich of rains than the already “wet” 2013, thereby allowing a very large output for hydroelectric power plants. Finally, new renewables continued to increase their supply at zero or very low marginal cost thanks to few new installations and continued support by the public authorities, displacing conventional fossil fuels especially around noon.
Figure 4 – Yearly average prices on the day ahead market in the Italian market zones. Source: GME.
A “greener” electricity mix
As a consequence of these developments in the supply side, the Italian electricity mix in 2014 looked pretty different from that of only few years earlier. According to Terna preliminary data, last year renewables generated around 119 TWh, i.e. an incredible 44.5% of domestic production (see Figure 5). Hydropower took the lion’s share with a gross production of 58 TWh, four more than the previous year. Even solar power increased remarkably by around 2 TWh, reaching 23.3 TWh and a 8.7% share of the electricity mix, whereas wind and geothermal energy outputs have remained pretty flat.
The situation for natural gas, which was used to be the main source of power in the Italian mix since the end of the 1990s, was exactly the opposite. Indeed, last year was a difficult one for gas and data from GME suggests that it contributed to less than 33% of total domestic production, i.e. around 20 percentage points less than in 2005 or 2006, when half of gross Italian output was obtained from natural gas fired plants.
Figure 5 – Italian electricity mix in 2014 (preliminary data). Thermo-electric comprises also output from the combustion of biomasses, biogases and other forms of bio-energy. Source: Terna.
A dramatic overcapacity
An inevitable consequence of reduced aggregate demand and increased penetration of renewables has been the decreasing load factor of thermal power plants, which now remain idle for most of the time and, also thanks to lower prices in moments of peak demand, are unable to recover their fixed costs and be profitable. Indeed, the Italian electricity system is today badly affected by oversupply. At the end of 2013, total installed and efficient net power capacity was 124.7 GW, more than double the level of peak demand observed in 2013 and in 2014 (51.5 GW). Gross installed efficient capacity was obviously bigger than that, slightly more than 128 GW (see Figure 6).
Figure 6 – Gross efficient power capacity expressed in MW in Italy from 1963 to 2013. Total capacity is in black, thermal is in red, hydro is in light purple, geothermal is in bright green, nuclear is in dark green and wind and solar in blue. Source: Terna.
To be more accurate, not all this installed capacity was available for production. According to data provided by AEEGSI, the Italian regulator, in 2013 available maximum capacity of relevant plants was on average about 75 GW, still 50% higher than peak demand. The significant gap between installed and available capacity was due to planned maintenance, technical outages, refurbishment activities or simply because producers mothballed some of their unprofitable capacity in moments of weak demand.
Indeed, due to particularly bleak perspective for oil and gas fired power generation, energy companies have reduced almost to zero investments in new capacity and have begun to decommission some of the least efficient or poorly-located plants. Data from the Ministero dello Sviluppo Economico, the Italian ministry in charge of overseeing the electricity industry, confirms that no big new power plant (more than 300 MW) has been commissioned since 2012 and that companies that got authorisations in the past for building new capacity are asking for time extension and do foresee the commissioning of only 430 MW in 2016 and 800 MW in 2017. At the same time AEEGSI refers that in 2013 and in 2014 a significant amount of capacity has been withdrawn, both definitely or temporarily.
Going more into detail, we can see that in 2013 the net reduction in available capacity was of 1.7 GW and that it was mainly due to the retirement of relevant thermal power plants qualified for the participation to the market for dispatching services. The value of those plant closures is rather significant, about 2.3 GW, but still much smaller than the withdraw of capacity, again mainly composed of large fossil fuels fired plants, estimated for 2014. Preliminary data by the AEEGSI talks about 9.3 GW.
Such reduction, for the most part due to the mothballing of several now unprofitable but relatively new and not fully depreciated fossil fuels fired power plants, is coherent with the fact that electricity companies did not record good revenues and profits in 2014 and do not expect any strong recovery in market conditions in the years ahead. Consequently, some firms are planning or already implementing divestitures: Enel, the market leader, talked in October of 23 possible closures for 11 GW of capacity, and E.On, the fifth largest producer, decided last year to leave Italy and sell its thermo-electric assets to Eph, a central European company with interests in gas, coal and electricity.
The inevitable downsizing
Such decisions by generators could in the medium term alleviate the present condition of overcapacity but pose several challenges to the reliable and safety management of the electricity system. Indeed, we are witnessing a reduction in the more reliable and flexible generating capacity, exactly at the time when the larger participation of intermittent renewables increases the reserve margins required by Terna for ensuring a constant balance between supply and demand of electricity.
Nevertheless, the strategies implemented by firms like Enel or E.On seem to be pretty rational also because, despite the already mentioned price reductions occurred in the past couple of years, Italy has still difficulties in exporting its excess capacity in neighbouring markets. In 2014 the country was a net exporter only to Greece and to the island of Corsica, while importing much larger net amount of electricity from Switzerland, France, Austria and Slovenia (see Figure 7).
Figure 7 - Electricity flows expressed in TWh among market zones and with neighbouring countries in 2014. Blue encircled numbers represent local electricity requirements. Source: Terna.
The reason for that is simple: average prices in neighbouring markets are still lower than the Italian ones and Italian production becomes convenient only in moment of very cold weather or in period of little rains (see Figure 8).
Figure 8 – Monthly prices for baseload power in a sample of regional markets (Central-west Europe, Central-east Europe, Nordpool and UK) plus the European Power Index of Platts. Source: European Commission.
In conclusion, as a good observer of the Italian market recently stated, Italy has today an oversized electricity system – a dress too large - that needs to be reshaped and restructured. Some companies are aware of that and are trying to reduce investments or directly write-off some of their assets. The Italian government should be aware of this as well and take coherent decisions that do not foster investments in additional generating capacity.
Indeed, at the moment Italy does not need any further power plant but a better use of its existing capacity. This could be achieved through a) the further development of the domestic grid and of the interconnections with neighbouring countries; b) a regulatory regime and a market design that allow an efficient integration of renewables (responsibility for imbalances, participation to the market for dispatching services, etc); c) the coupling of the Italian market with the North-west European market in order to use at best existing or future interconnection capacity; d) the introduction of more cost-reflective tariffs for final users – like a regressive one - that do not penalize a larger use of electricity for heating/cooling or even for transportation.
In any case, do not expect a thriving year for power producers in Italy.
 Electricity demand is equal to total domestic production, plus net import, minus electricity consumed by power plants, energy used for pumping water in hydropower plants’ reservoirs and power losses due to electricity transportation and voltage transformations.
 In 2014 the Italian government approved some amendments to legislation, further weakening renewables support mechanisms and it is highly probable that new investments in the industry will be, and indeed already are, very small (also because of the new lows reached by wholesale prices). ANEV, the association of firms that produce and/or operate wind turbines, has recently declared that only 107 MW of new wind capacity was installed in 2014, i.e. 76% less than in 2013. Preliminary data from Terna about new photovoltaic plants talks about 400 MW of new installed capacity in 2014: it is also in this case a relevant reduction (-72%).Finally, in 2013 only about 400 MW of incentivised biomass/biogass/waste capacity was awarded for new projects and it is highly likely that not all of them were completed before the end of 2014. However, the vast majority of renewables still preserve dispatching priority and enough subsidies to keep production highly profitable.
 In the preliminary report by Terna, output from biomass, biogas and waste is put together with that of plants burning fossil fuels. However, since in 2013 output from the combustion of those renewable resources was around 17.1 TWh and there is no strong reason for imaging a significantly different value in 2014 (a sharp decline in capacity addition occurred), we have added such 17.1 TWh to the 101.9 TWh reported by Terna as the output of hydro, sun, wind and geothermal resources. Therefore, the estimate presented here should be conservative.
 The value reported by GME refers to sales on the day-ahead market and not to effective production. Between the two quantities there could be a small discrepancy, both positive or negative, depending on modifications in the infra-day market and on the actual dispatching of power plants by the system operator for real time balancing (gas fired, hydro and pumped hydro stations are the technologies usually exploited for real time balancing: only in extreme cases is Terna allowed to disconnect wind or other renewables power plants).
 According to the Grid Code of Terna, a relevant production unit is a unit with a generation capacity of at least 10 MVA. Non relevant plants had in 2013 a total capacity of about 24.5 GW. A large part of this amount represents the so-called “distributed generation”.
 A solution to the problem of thermal power plants and the lack of flexible and reliable generation capacity has been identified in the adoption of a capacity mechanism. At the moment in Italy there is a capacity payment that should be substituted by a competitive capacity market based on auction by 2017. The UK has already it but debate over its desirability is still on.