Why a perfect storm awaits UK power

Credit: Hernan Pinera

Urgent government intervention is required to ensure that current uncertainty in the UK market is replaced by developer confidence, writes Paul Webber

The recently confirmed closure of all large UKà‚ coal-fired plants by 2025, along with the planned closure of older and less efficient gas-fired plants, means Britain should be investing in large-scale replacement capital power. Yet the ongoing delay in constructing the new nuclear plants that will replace the advanced gas reactor (AGR) nuclearà‚ fleet, which is nearing the end of its life, means the UK will become more and more reliant on building additional modern and efficient combined cycle gas turbine (CCGT) plants to meet its electricity needs.

Lack of certainty in the regulated power market has meant that private developers, including the so-called ‘Big Six’ utilities, are currently struggling to build new large-scale gas-firedà‚ power plants. Meanwhile, existing coal plants and some gas plants must close in order for the government to meet its commitments to environmental targets.

Urgent government intervention is required to ensure that the current uncertainty in the market is replaced by developer confidence, and that a realistic timeline is established that will deliver the necessary construction of newbuild capital generating capacity.

A recent paper by the Institution of Mechanical Engineers points to a potential UK electricity shortfall, as existing coal-firedà‚ power plants are phased out by 2025, existing nuclear plant is decommissioned and newbuild nuclear continues to be delayed. The UK potentially needs up to 30 new CCGT power plants to fill the gap, but the problems in achieving this target are numerous.

Auction issues

The government’s ongoing strategy for Electricity Market Reformà‚ has a number of mechanisms to drive reform. One of these places National Grid in the role of the Delivery Body administering the Capacity Mechanism (auction) which was first introduced in 2014.

The annual Capacity Market Auctions of 2014 and 2015 were each designed to ensure that adequate generating capacity will be available four years from the auction date, by awarding agreements to existing and refurbished power plant operators and newbuild power plant developers. The mechanism is designed to help balance supply and demand, and maintain adequate reserve capacity for periods of high demand, for example during severe winters.

The viability of investment in new CCGT plants is dependent upon obtaining agreement through the Capacity Market Auction at a clearing price which provides an acceptable return on the investment for developers and lenders.

However, the results of the 2014/15 and 2015/16 Capacity Market Auctions provided little encouragement to developers of large CCGT power plants. According to National Grid’s Transmission Entry Capacity (TEC) Register, there are 13 large new-build CCGT projects that have been consented and have a grid connection agreement, which is the minimum entry requirement to the Capacity Market Auction, with a combined capacity of around 12 GW. Another two large CCGT projects are in the scoping and consenting phase, with a combined capacity of 3 GW.

In fact, there are only two large-scale newbuild CCGTs that have got through the Capacity Market Auction to date. In the 2014 auction, Wainstones Energy (1656 MW) was awarded a 15-year agreement at a clearing price of à‚£19.4/kW/year, ($28/kW/year) and in the 2015 auction Carrington Power (810 MW) was awarded a 15-year agreement at a clearing price of à‚£18/kW/year.

In 2014, a total of 15.7 GW of capacity exited the Capacity Market Auction above the clearing price; only 8.8 GW (35 per cent) of which was newbuild CCGT capacity. In 2015 the figure was slightly better at 11.4 GW, of which 5.5 GW (47 per cent) was related to newbuild CCGT.

The story isn’t much better if we look solely at newbuild capacity, rather than CCGT. The 2014 Capacity Market Auction resulted in 2.6 GW of newbuild capacity awarded; just 5 per cent of the total awarded capacity.

2015 was slightly worse, with 1.9 GW of newbuild capacity awarded, equating to around 4 per cent of the total. The two newbuild CCGT plants with capacity agreements make up approximately 55 per cent of the total awarded newbuild capacity to date. The remaining awarded capacity was made up mostly of a large number of sub-20 MW diesel and gas plants.

Too much uncertainty

The Capacity Market Auctions of 2014 and 2015 clearly favoured existing generation, refurbishments and relatively low-CAPEX plants, such as small-scale diesel and gas plants. This provides limited headroom for newbuild large-scale capital plant until existing coal and nuclear plants are scheduled to shut down. The clearing price is currently too low to make large newbuild CCGT plants viable.

Additionally, the Capacity Mechanism currently offers no guarantee to developers on the amount of electricity the plant will be required to produce in its working life (load factor). Developers typically require a payback period of at least 15 years at a relatively high load factor. When added to other uncertainties, including the future cost of fuel, electricity price and demand, and environmental legislation, there is great uncertainty for developers and lenders wishing to make a viable long-term investment.

Capacity constraints

Worryingly, the 2014 and 2015 capacity agreements for coal-fired generation showed a drop in capacity from 9.2 GW for 2018/19 to 4.6 GW for 2019/20. This is going to be further exacerbated by the impact of The Industrial Emissions Directive (IED), which came into force on 1 January 2016 and will force the closure of virtually all existing coal and a number of gas plants on or before 31 December 2023 under the ‘Limited Life Derogation’ option. The total capacity of coal-fired generation with agreements for 2019/20 is just 7 GW, approximately.

As a result, the UK may need many more newbuild CCGT developments to replace this capacity. Given a typical four-year period to design and construct a CCGT plant, these newbuild projects must start now if they are to be completed in advance of the coal station shutdowns.

Addressing the shortfall

To ensure security of supply beyond the next few winters, the Department for Energy and Climate Change (DECC) stated in its Single Departmental Plan for 2015-2020 that it intends to review the operation of the Capacity Mechanism to ensure it provides the right investment incentives for new gas plants.

The urgency for action was exacerbated in February 2016 when SSE announced that it is proposing to end commercial operations at three of the four units at its Fiddlers Ferry coal-fired power plant from April 2016. This is despite SSE having secured a capacity agreement for 2018/19 under the 2014 Capacity Market Auction. This leaves a potential generating shortfall that the government will need to address.

An additional factor is the timing of the shutdown of existing AGR nuclear plants, and their replacement by new nuclear capacity. The timing of the new capacity coming online will be key to determining how much new CCGT capacity will ultimately be required.

There is currently around 9 GW of existing nuclear capacity in the system, with approximately 17 GW nuclear newbuild planned. It is uncertain when existing capacity will drop off and when new replacement capacity will be connected, but currently we don’t expect new nuclear capacity to be connected until at least 2025.

However, positive news came in February when EDF announced it planned to extend the life of some of its existing nuclear plants beyond 2025. If this is achieved, it would mitigate the scale of the potential energy gap.

Which CCGT plants go ahead and when they start is wholly dependent on the individual project economics related to the clearing price at future Capacity Market Auctions, along with the cost of risk associated with the uncertainties. There is broad industry anticipation that government will make the necessary changes to the Capacity Mechanism to remove some of this uncertainty and to encourage newbuild CCGT.

The future for UK power

A revitalized power plant construction sector in the UK would generate significant employment, but may be constrained in the short-to-medium term. As a result of the prolonged lack of investment, multiple simultaneous CCGT projects underway in the UK would be required to compete for the same scarce design and construction resources. Similarly, the numbers of original equipment manufacturing organizations active in this market have reduced and the manufacturing capacity of their plants has fallen.

The pace of newbuild CCGT implementation is currently being driven by supply and demand economics through the Capacity Market Auction – the lowest price wins – as opposed to designing a balanced mix of technologies as was done in the past.

The Capacity Mechanism has been designed with the intention of helping to ensure that ‘the lights don’t go out’, and new-build CCGT should play an important part in that. However, the buffer provided by the infrastructure that was previously built, in the main, by the nationalized Central Electricity Generating Board (CEGB) has all but come to an end. This and the other factors have combined to create ‘a perfect storm’ of uncertainty for developers of and investors in large CCGT projects.

The Capacity Market Auction needs to change to support CCGT, and it needs to change now.

Paul Webber is Partner at Arcadis, a global design and consultancy firm for natural and built assets.

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