Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
Issue link: https://fhpublishing.uberflip.com/i/589314
UTILITY WEEK | 23RD - 29TH OCTOBER 2015 | 19 Finance & Investment Analysis T he key energy question for policy- makers is whether the lights will stay on this winter and in coming years. National Grid's Winter Outlook Report 2015/16 suggests there is sufficient capacity in place to meet demand this winter and that the risk of blackouts is low. However, PA's analysis suggests there are some major bar- riers to securing supplies in the immediate future and this winter it could be more chal- lenging than normal if it gets very cold. The outlook sets out a detailed analysis of the supply and demand picture for both gas and electricity for this winter. From this, National Grid concludes that the electricity margin above peak demand will be tight at 1.2 per cent. This capacity will be increased by an additional 2.4GW of supplemental bal- ancing reserve, which National Grid has pro- cured to boost the margin to 5.1 per cent. The challenge comes from the fact that, given the limited margin, the uncertainties in supply and demand could put the UK elec- tricity system under pressure. For example, a cold period without much wind power gener- ated in western Europe could result in higher than expected demand and lower than expected available generation. This would make the system vulnerable, even with the extra reserves procured by National Grid. However, there should be much bigger concerns about security of supply for next year and beyond. PA's analysis of the sup- ply outlook for 2016/2017 shows that actions will have to be taken to minimise the risk of the lights going out. Our forecast, based on National Grid's future energy scenario "Slow Progression", shows that the reserve margin, excluding any system balancing reserve and demand response measures, will be negative at -5 per cent. This reflects the announced closure of 5.7GW of coal capacity (Longannet, Eggbor- ough, Ferrybridge, Fiddler's Ferry). These closures arise from the GB market's high emissions price and cheap imports via conti- nental interconnectors. These plant closures more than offset the expected increase in renewable and gas generation capacity. As a result, to achieve the same reserve margin as this year (5.1 per cent), National Grid would need to procure over 6GW of supplemental balancing reserve capacity. This would be a challenge, given that for this winter it has been able to secure only 2.4GW, which is below their initial procurement target. National Grid is aware of this issue, as it has applied to Ofgem to extend the supple- mental balancing reserve scheme beyond this winter, although the scale of the short- fall has not been publicly acknowledged yet. Looking further ahead, PA analysis shows an increase in the reserve margin to around 5 per cent by 2020. This will depend on new capacity coming on stream from gas and wind and new electricity interconnectors. The results of our analysis highlight the need for a serious and objective review of the effectiveness of the measures introduced last year in the context of Electricity Market Reform (EMR). One of the pillars of EMR, the capacity market, is aimed at securing the future of UK electricity supply by incentivising new power plants to be built and existing plants to stay online. The current insufficiency in capacity indicates that EMR is failing and our analysis indicates three clear reasons. First, the hiatus involved in establish- ing the capacity market has delayed invest- ment because of the market uncertainty. Second, the initial capacity auction last year cleared at a low price and only included a single new generation project, which has recently announced that it will not be online in time for winter 2018 as it has been unable to secure investment. Third, the structural imbalance between the GB market and the European markets makes investment in Brit- ish capacity unattractive once the proposed new interconnectors come online. Our recent study showed that far from improving gen- eration capacity margin, with the current market arrangements, greater interconnec- tion could lead to increased dependency on foreign capacity and further closures. Piergiorgio Chelucci and Duncan Steen are energy experts from PA Consulting's energy markets modelling and analytics team optimistic on wholesale market revenues", Cornwall Energy said. "So we are not partic- ularly surprised Trafford is struggling." The failure of the capacity auction to ensure that investment will come forward by the end of the decade has already prompted action from the government. Under proposed changes to the auction it will now be harder for developers to drive the price down lower than a level they can truly afford in the hope that investors come to their rescue later. Large-scale developers will be required to tell the government ahead of the auction what their lowest possible price is, to prevent them from bidding lower on the day. If they are still able to compete for long enough to secure a contract, they will face post-agreement tests at the five-month and 11-month marks, where they will be required to show evidence of investor support. Fail- ing these targets will come at a steep price. Under the government's plans, developers that fail the post-auction tests will lose their contract and will be banned from future auc- tions for a period of three years. This will apply to both the development company and any person responsible for the project at director level. The prospects for CCGT So what hope for new gas-fired power capac- ity in the upcoming auction this year? The answer, in short, is bleak. Cornwall Energy says new-build gas plants could struggle because existing capac- ity continues to exceed the total sought by the government. Although there have been capacity closures announced in both gas and coal since the last auction, Cornwall says "these have come from plant that did not trouble the auctioneer in the last auction". In addition, 2.4GW of cheaper intercon- nector capacity and 3GW of smaller embed- ded plant has pre-qualified, with 7.5GW of existing coal plant still remaining. The government may be betting that eventually the UK's remaining coal fleet will follow the 6GW about to close their doors, which could allow market auction prices to maintain levels high enough to make gas investment viable. But even this gamble might only pay off in the early 2020s ahead of a planned new nuclear revolution by the middle of the decade. National Grid may well be ready to weather the coming winter. But without a clear, workable road towards securing invest- ment in much-needed thermal capacity the operator could find itself faced with a steady succession of increasingly difficult winters to contend with. Dependency culture An analysis by PA Consulting makes grim reading for future UK security of supply. By Piergiorgio Chelucci and Duncan Steen.