Moving Forward on Reverse Auctions: 7 Things to Know

I participated in a workshop in Tanzania on reverse power auctions July 26-29, organized by the US Energy Agency (USEA) on behalf of USAID’s Power Africa initiative. A developing country with ambitious goals for its energy sector, Tanzania is pursuing reverse auctions (RAs) as a low-cost way to bring on additional energy, including significant renewable capacity. Well-designed RAs can help countries develop renewables or other power sources. Here are seven things you should know about them:

1. What RAs are.

Whereas a live auction, or one on a website typically involves an item, a seller, and several potential buyers bidding up the price, in a reverse auction there is a single buyer, and several of bidders competing to sell them the item they want, aiming to offer the lowest price (or the bid most aligned with a specified set of criteria), either through submission of offers in advance (“sealed-bid”), or during a live bidding process (e.g. “descending clock” auction). This is a common procurement practice for many goods, but has become popular for renewable energy in recent years.

2. RAs are currently among the most popular policies for renewable energy.

Though few countries used RAs for renewables following their start in the 1990s in the UK, they have recently gained popularity. According to the International Renewable Energy Agency (IRENA), the number of countries using renewables auctions increased from nine in 2009 to 44 in 2013, of which 30 were developing countries. China has used RAs to vastly expand its use, and manufacture, of renewables, and RAs have allowed Uruguay to vastly expand its wind capacity over the last 10 years and achieve a nearly 100% renewable grid. Even Germany, one of the countries most closely associated with Feed-in Tariffs (another renewable-promotion instrument), is transitioning to a competitive process going forward.

3. RAs are effective at driving down prices. Sometimes too effective.

Competitive bidding programs generally lead to lower prices. Over several rounds of the UK’s Non-Fossil Fuel Obligation prices for wind energy fell nearly 75%, to approximately half average European prices. Brazil’s auctions too saw dramatic price reductions for wind, sometimes in excess of 20%.

However, RAs can also lead to underbidding – participants submit excessively low bids to win contracts, with thin margins that are vulnerable to unexpected delays or costs. In the UK, underbidding led to failed projects. To prevent this, organizers adopt safeguards to prevent underbidding – deposits, penalties, and bidding pre-requisites (land access, environmental permits, etc.). Though effective, these elements increase transaction costs, and make it more difficult for smaller players to participate.

4. They can be tailored to a country’s needs and support a variety of policy goals.

While people typically think of auctions as a least-cost means of promoting renewables, decisions on aspects like criteria, bidder qualifications, eligible technologies, can support a variety of policy goals. For example, South Africa’s auction not only evaluates projects on the basis of price, but also on the basis of job creation, local content, and socio-economic development, while Peru has used a tender approach to provide electricity access and maintenance to remote areas with solar energy.

5. It is critical to consider transmission as well as generation

RAs are typically employed to increase generation capacity. However, expanding transmission infrastructure can be more onerous and time-consuming. One workshop participant noted that typical build time for an energy generation project might be three years, but expanding the grid accordingly could take five or six, due to the number of processes and actors involved. Site-specific or joint generation-transition auctions can help with this challenge.

6. Careful design can support market growth.

If a country wishes to attract investors in renewable deployment or manufacturing, there must be confidence in the sustained existence of a market. Unlike a Feed-in-Tariff, auctions do not inherently provide continuous demand for renewable energy projects, but create particular moments of demand. Auctions should thus be held regularly, and in conjunction with a long-term energy strategy to encourage long-term investment.

7. The RA doesn’t end with the gavel.

While much emphasis is often placed on auction design, post-auction contract management is a very important part of the process. Actively monitoring projects can support compliance and achievement of goals. As one presenter at the workshop said, “if the auction is the wedding, the contract management is the marriage.”

Furthermore, auction process design is an iterative process. Competitive bidding can drive competition, but over time bidders can learn to game the system. RAs should therefore be reviewed periodically.