Stroll for gas? Project investment in the UK

The UK’s Sizewell B nuclear power plant. Gas fired plants are the short term fix of choice for European governments needing to build new infrastructure, but there is still a lack of confidence in their long term future when the push for renewable energy is currently so strong Source: British Energy

Simon Harrison, director of energy at global engineering, management and development consultancy Mott MacDonald rubs his crystal ball to see how current issues may affect investment in gas, CCS, nuclear and renewables in the UK.

Simon Harrison, Mott MacDonald, UK

Simon Harrison, Director of Energy at UK consultants Mott MacDonald
With shale gas coming on stream in some parts of Europe and the United States in particular, the long-term outlook for the gas price across Europe and the energy security issues about gas have eased. Overall that’s positive.

Where people are perhaps nervous about gas is in its future role in a renewables-heavy electricity system. Gas power plants can be constructed and generating electricity in a couple of years and the market can have a high level of confidence about short-term load factors and, therefore, revenues.

But no one’s really quite sure what will happen in 15 years and with assets like a gas fired power plant there is a bit of a confidence issue there. The other issue is about what Europe will do regarding carbon capture and storage (CCS) for gas fired plants.

These issues aren’t dealbreakers, but looking forward they are concerns. Gas is everybody’s short-term fix, but across Europe, governments will be looking at their renewables targets and their carbon pathways for 2050.

RENEWABLEs TARGETS UNCERTAINTY

How difficult the European renewables targets are to obtain is a very interesting question. It varies from country to country. It is unclear what the sanctions are for non-achievement of the targets. There has been talk of fines and the indication is that these fines will be very large. In the end it will be a question of how the pack behaves and whether there will be any countries that end up as outliers.

If we end up in a situation where the vast majority are within sniffing distance of the targets and a few countries are miles off, then one can imagine there being some pressure for sanctions of some sort. However, if we end up in a position where most countries are not going to get there, then it seems to be highly likely that the target date will be shifted.

If that were to happen that would be significantly bad news in a climate change context. There’s still quite a long time until 2020 and one must wonder what may happen in terms of international agreements, climate events around the world that change people’s attitudes, and political and spending priorities towards decarbonization.

MAKING RENEWABLES HAPPEN

There are all sorts of challenges in developing renewable energy projects. Each country has a different set of circumstances, different tariff regimes and different complexities. There are a different mix of players who require project finance and those who may not need it.

I joke with Mott MacDonald’s solar power team that solar is a travelling circus. They don’t disagree. One country will open up a feed-in tariff for solar power and the industry will come to town. They will build out rather more quickly than the politicians would have expected and then the politicians will look at the costs for the electricity consumer or taxpayer and shut it down. The UK’s decision to drastically reduce feed-in tariffs for large solar projects is just another example in a line of such decisions in Europe.

There is huge potential for solar power once costs have come down but it is currently an expensive technology. One can understand that governments wish to achieve the right balance of creating the basis for a solar industry when the costs do come right on the one hand, and keeping costs down for the consumer on the other. Given the potential for solar it is key that work continues on cost and performance improvement and that these discontinuities do not destabilise investment in the industry overall.

There is work to do with every aspect of renewables. Delivering offshore wind and finding enough people to invest equity and dealing with all the logistical and supply chain challenges remain big issues. For onshore wind, dealing with planning consent is also a big challenge. Network reinforcement and associated planning consents also remain challenging. None of these issues are new and all can be solved, but consistent effort is needed across the board.

For the third round of the UK’s offshore wind programme, the major challenge is finding enough equity players to invest and the right mechanisms to mitigate risk. The UK’s Green Investment Bank is promising in this respect, but we don’t know yet whether it will be able to deliver at the required scale. While the UK’s electricity market reform (EMR) proposals have not yet set out how the new feed-in tariff scheme to replace the outgoing Renewables Obligation subsidy in 2017 will actually work, the government has set out its thinking on transitional arrangements and is trying hard to avoid a hiatus. But inevitably changes to market arrangements introduce uncertainty into the industry.

It is safe to assume that UK policy will remain focused on building out offshore wind and that a tariff regime will be put in place that is sufficiently satisfactory for developers to take an interest, though it cannot be denied that offshore wind is an expensive way to make electricity at the moment. There remains a not insignificant set of risks to building out offshore wind projects. The Green Investment Bank has a significant role to play in the de-risking of such projects, as does the industry, with innovations in design and construction already demonstrating the learning that has been taken from early projects.

The role for coal

Coal with CCS appears to me to be potentially a very significant option and I suspect that once the demonstration projects under the European Union NER300 programme and other mechanisms have actually proven the concept it will be pushed forward.

The 885 MW Langage CCGT plant near Plymouth, England, one of several new large gas fired plants in the UK Source: Alstom

The environmental proposition of coal becomes much stronger once carbon capture has been demonstrated at scale. Even looking only on a financial basis, unabated coal plant is seen as an investment with a lot of uncertainty because of emissions legislation and carbon trading.

The direction of travel is for tighter legislation and it is hard to see that direction changing. However, there are energy security concerns across Europe and too much tightening would make it too expensive to keep some of the existing generation capacity running. This capacity has a very important role for some while and this would be a concern.

There is a lot of money forthcoming for carbon capture in Europe in order to get it proven. I would expect that within five years there will be a number of demonstrator projects proving that it works. Beyond that, establishing an appropriate commercial regime that makes it worthwhile for all stakeholders investing in their part of the value chain is going to be significantly challenging, especially at the offshore disposal end.

The oil companies, who have the skills and many of the assets, will have to make some really quite significant investments, but they are much more used to the type of reward and risk profile from extracting oil and gas. The utility function of CO2 disposal is going to have a much more stable revenue profile, which may be less attractive to them.

There is a lot of work to be done with CCS but it needs to be done. If we are going to continue to burn fossil fuels and believe in climate change then CCS has to be there. There will be ongoing developments which will reduce costs but we need to go through the learning curve to do that.

There will need to be a reward for the disposal of carbon dioxide under the seabed. That will be dollars/euros per tonne storage charge, but it’s a question of being able to guarantee volumes and whether that charge is set at the right level to make it worthwhile. The tricky bit seems to me to be the equivalent of oil exploration, the characterization of reservoirs and devoting upfront investments to the development of storage sites to the point of being able to sign a contract.

In the UK, the CO2 pipeline network seems to me likely to develop eventually as a regulated monopoly, offering a transit charge, and the power generation companies could sign commercial deals with a CO2 disposal company. Essentially the disposal of CO2 would become another cost of generation, just like ash disposal, to be recovered through the sale of electricity and avoided emissions.

But really, beyond the demonstration projects carbon capture and storage is going to need a revenue model in terms of avoided emissions to drive the whole thing forward.

Nuclear power: Delayed or derailed?

It is too early to say that costs have risen for nuclear power. We don’t yet know that the various governmental nuclear reviews around the world will require nuclear plants to have this or that system bolted on, which would increase costs.

All we know at the moment is these reviews will cause delays while people work out their responses. How different financial institutions view nuclear may change. How insurers view nuclear may change. How nuclear regulators look at the degree of redundancy and security of plants may change, and of course public acceptability may change.

On the other hand, some of those things may not change and it may be a perturbation that settles. But it is too soon to draw conclusions. At the moment we don’t even know what the endgame is at the Fukushima Daiichi plant itself.

EDF spent à‚£12.5 billion ($20.6 billion) on British Energy fairly recently and is clearly keen to become a dominant nuclear player in the UK and elsewhere. I think it wants to crack on and build here as fast as it can, but any delays will at least mean that lessons from the two EPRs being built in Finland and France at the moment can be learned.

But EDF, Horizon and the others still have to make the value equation add up. They are large companies and might at least contemplate building nuclear plants on balance sheet and refinancing them upon completion, but their balance sheets are not infinite. It will be interesting to see what happens from a project finance point of view.

Pre-Fukushima there were nuclear plant project finance discussions in other parts of the world – Mott MacDonald have been involved in some of them – but it is a tricky area and it needs the public sector sitting behind it in many countries. In the UK, the carbon price floor could work. A mechanism that provides certainty of a revenue stream can help hugely – if it is set at a level that genuinely provides support and in a way that gives confidence against regulatory resets in the future. A factor being given renewed focus will be the implications of an early shutdown on decommissioning funding.

Another area of uncertainty for nuclear is the out-turn construction cost. Getting a true turnkey fixed-price contract for nuclear power plant is not really something that the market will support at the moment. In fact EDF is going the other way and intending to architect engineer nuclear plant projects themselves to take advantage of their in-house expertise.

So we don’t quite yet know where we are going to come out in terms of out-turn construction costs, post-Fukushima. Everyone is going to want clarity from nuclear regulators as to what’s exactly needs to be provided ” before construction starts. One of the biggest issues with the past generation of US nuclear plant was that the regulations were changing on-the-fly, often halfway through construction.

There is also the possibility of new governments overturning previous commitments to nuclear power. In the UK, the politicians have been doing a good job communicating clarity of cross-party consensus on the need for nuclear. That said, this does now seem to be fragmenting, though this may be more for political than any other reasons. Where it could get crunchy is if there are significant upfront cost increases for new build nuclear and industry stakeholders go back to the government and ask for a higher carbon price floor and other support mechanisms.

USING LESS ENERGY COULD HELP A GREAT DEAL

It’s clear that delivering secure reliable low carbon energy requires massive mobilization of resources of every kind. All technologies will have a part to play. But the real elephant in the room is energy efficiency.

All the studies show that using less energy through improving buildings, increasing equipment efficiency, integrating power, heat and cooling solutions, and making the most of available natural resources, is far cheaper than building more low carbon power plants. Governments are making the right noises now about these issues but there is a long way to go for this to become commonplace.

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