Utility Week

UTILITY Week 6th November 2015

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Markets & Trading 28 | 6TH - 12TH NOVEMBER 2015 | UTILITY WEEK Market view T here are clear benefits from increased interconnection but conventional gen- erators in Great Britain will lose out because they cannot compete on a level play- ing field with generators on the continent. In 2002, the European Union, as part of its aim to build "the most integrated, com- petitive and sustainable common energy market in the world", set a 10 per cent tar- get for interconnection between member states. This policy direction was reinforced in October 2014 when the European Council decided that this 10 per cent target needed to be achieved "as a matter of urgency" by 2020, and that interconnection levels should increase to 15 per cent by 2030. Levels of interconnection in the GB mar- ket currently stand at 5 per cent of installed capacity. So the 10 per cent target, in con- junction with structural market differences between Britain and the continent, has incentivised the development of a number of new interconnector projects. These could provide 9.7GW of interconnection capac- ity by 2025 and link GB with neighbouring markets in France, Belgium and the Nordic countries. It is clear that this level of inter- connection will have significant implications for the GB electricity sector. Consumers will benefit because cheap electricity imports will help to maintain 2025 wholesale electricity prices at around today's levels (despite assumed increases in infla- tion-adjusted commodity and carbon prices). These cheaper supplies would primarily be sourced from nuclear electricity from France and Belgium, as well as hydro electricity from the Nordic countries. However, this downward pressure on prices will have a detrimental impact on domestic thermal generation capacity. GB's thermal capacity is already operating at a disadvantage relative to capacity from the continent because of the significantly higher carbon price and other system charges. This means that, as the level of interconnection capacity increases, fewer new thermal plants will be built and the closure of existing ther- mal generation capacity will be accelerated. A highly interconnected system would also substantially change the way that GB electricity demand is met. If all the potential projects come to fruition by 2025, a quarter of total GB electricity requirements would be met by imports. This high dependency on imports will have a profound impact on security of sup- ply. In particular, it will decrease our domes- tic de-rated margin (calculated as the sum of generators declared as being available during the time of the peak demand less the expected peak demand with reserve require- ments) to negative levels. As a result, the UK will be heavily dependent on neighbouring countries to maintain adequate margins and keep the lights on. Another effect of increased interconnec- tion is that the associated CO2 emissions emitted abroad from imported electricity will not be included in UK-specific carbon calculations. So while the replacement of local coal-fired capacity with renewable and gas-fired capacity is the primary driver of decarbonisation, increased interconnection provides a further boost to decarbonisation efforts. Sourcing more electricity through interconnectors provides a direct mechanism to reduce CO2 emissions. In addition, the replacement of local coal-fired capacity with renewable and gas-fired capacity will act as another primary driver of decarbonisation. As a result, the UK's CO2 emissions from the electricity supply industry could be almost halved in 2025. There is also a clear first-mover advan- tage for interconnector developers because incremental increases in interconnection will reduce the price spread between GB and the continent. Those projects that are delivered earlier will see the shortest payback periods and therefore a longer period of profitability. Despite this incentive, current projects are not sufficiently developed to meet the 2020 target. With a 250 per cent increase in intercon- nection capacity relative to today's levels, the ambition to create an integrated Euro- pean electricity market would have a pro- found impact on the GB energy landscape and will have major implications for the business models of all those involved. Policy- makers face a double-edged sword and need to think carefully about how they balance the attraction of meeting their carbon reduc- tion targets and the benefits of cheaper elec- tricity with the increased risk to security of supply. James Wang and Samuel Ebohon are energy experts from PA Consulting's energy markets modelling and analytics team Damaging connections? Access to cheap European power via more interconnectors will benefit consumers but put homegrown thermal generation under severe pressure, say James Wang and Samuel Ebohon. Key points The EU set a target in 2002 of 10% inter- connection of system capacity; in 2014 a target date for this was set of 2020. Current UK interconnection stands at 5%. If projects are completed as forecast, the UK will have 9.7GW of interconnection capacity with mainland Europe by 2025. By 2025, a quarter of UK demand could be met by imports. By 2025, emissions from UK generation could be almost halved. Interconnection will benefit UK consumers with cheaper prices but put UK thermal plant will suffer. "An integrated European electricity market would have a profound impact on the GB energy landscape"

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