A double-edged sword

A double-edged sword

Deregulation of energy markets is encouraging industrial consumers to develop on-site generation facilities. Electricity price is a key driver in this market, yet uncertainty over deregulation and its impact on prices could damage market volumes in the near term.

Andrew Evans,

Energy Consultant,

Datamonitor, UK

Between 1993 and 1998 it is estimated that 10.6 GW of new industrial capacity was ordered across the EU, which equates to well over $10 billion in investment, even if a conservative estimate of equipment costs is used. However, the current market situation is one of uncertainty for potential investors in industrial power, which led to lower market volumes in 1998.

Although these low order volumes are not expected to continue over the next six years, it is likely that the market will become ever more polarised in terms of both the countries and products that will see investment, and the state of uncertainty in the market will remain.

The deregulation of electricity markets in particular is proving to be a double-edged sword for autogeneration. On the one hand, it is encouraging manufacturers to adopt on-site generation with the prospect of generating extra revenues by selling excess power to the grid; on the other it is creating uncertainty due to a lack of knowledge about the future cost of electricity.

There are currently large differences in the penetration of on-site power between different EU member countries. Six EU countries passed the 1 GW order mark for the last six years, and those that feature in this group are perhaps not surprising (see Figure 1). Germany was the EU`s largest market with orders of 2 GW, followed closely by the Netherlands. The size of industrial production in the EU`s six leading countries is one clear reason for the size of the industrial power market. But, as a comparison of Belgium and the Netherlands proves, markets with similar-sized industrial activity do not necessarily have similar-sized industrial power markets.

A propensity to invest

In the spring of 1999, Datamonitor carried out a survey of over 450 large industrial companies across the 15 member states plus Norway, to gauge the level of interest in autogeneration across the region. Companies were initially asked whether they carried out autogeneration activities and then, depending on their response, were either asked to provide more detail on the activities they carried out or what factors would lead them to establish such activities. Companies from a wide range of industries were interviewed, including iron and steel, paper and pulp, and food and chemicals.

Of the companies contacted, just 24 per cent stated that they presently autogenerated electricity. Of these, the largest proportion, 33 per cent, autogenerated between one and 20 per cent of their electricity demand. Sixty-one per cent of those companies that autogenerated electricity said that they autogenerated between one and 40 per cent of their demand, while 18 per cent autogenerated between 81 and 100 per cent of their total demand.

The broad range of responses suggests that there does not tend to be an optimum proportion of demand which autogeneration will produce. While some prefer to use autogeneration only for peaks in demand, or for about one third of their demand, others prefer to rely on on-site power for all, or virtually all, of their demand.

A key driver

Examining the markets for industrial power equipment against the aver- age industrial price of electricity shows that the average industrial electricity price is a key driver for investment in industrial plant, as shown in Figure 3.

There are some markets (those enclosed by the dotted line), where electricity price is the clear driver for industrial investment. Austria, Germany, Italy and Belgium in particular have generating utilities of immense market power, in general a recipe for high electricity prices.

In other markets where electricity price is less of an issue, but the industrial power equipment market is still large, such as the Netherlands, France, Spain and the UK, there are other factors that have driven investment. In the Netherlands, France and Spain, the factor is beneficial regulation, whereas the UK market has been driven by the offerings of contract energy management companies.

Of those survey respondents which autogenerate electricity, only 31 per cent, sold any of the electricity they autogenerated to the country`s electricity grid. It is interesting to note that there was no particular correlation between the share of demand which was autogenerated and how likely a company was to sell electricity to the country`s grid.

Although one might assume that those companies which autogenerated between 80 and 100 per cent of their demand would be more likely to have a surplus to sell, companies which autogenerated as little as 15 per cent of their demand, were just as likely to sell excess electricity to the grid. This is expected to be because of opportunities to sell excess power during times of peak demand, when electricity prices will be higher.

This situation has arisen in Spain, where many respondents stated that they had set up autogeneration facilities purely to sell electricity to the grid. Respondents in this country stated that it was cheaper to buy electricity off the grid and make a profit on selling their own generation at times of peak demand. It was for this reason that many companies had autogeneration facilities that accounted for zero per cent of their demand, since all electricity that was generated was sold to the grid.

Plant specifications

Of those companies in the survey that autogenerate electricity, it appeared that the most common technology by a large margin was CHP (combined heat and power), which accounted for 42 per cent of autogeneration plant. The second single most popular option was steam at 27 per cent, while hydropower plants accounted for 11 per cent of total plants.

The most popular type of equipment that is used in these plants to autogenerate is steam turbines, followed by gas turbines and gas engines. Natural gas is popular as an autogeneration fuel – a fact that is not entirely surprising considering its low levels of emissions and relative low cost.

Convincing issues

Of those companies which did not autogenerate, only 17 per cent stated that they were considering doing so. Of the 83 per cent who claimed to not be considering it, 55 per cent said that they would only be encouraged to autogenerate if they could achieve electricity savings of over 20 per cent. Only 23 per cent of these would be willing to turn to autogeneration for less than 15 per cent electricity savings, while seven per cent of respondents claimed that savings in electricity price could not convince them to change to autogeneration.

This would suggest that most companies that do not currently autogenerate have little interest in starting such operations. Only significant reductions in electricity prices would be enough to convince most of them to change their minds.

Out of those companies considering autogeneration, 64 per cent of respondents said that having more control over costs was their primary reason. The potential to generate heat and power and concerns over possible increases in electricity prices were also cited as important considerations. It is interesting to note that government incentives came last in the list of considerations and was only ever mentioned in conjunction with other factors, such as more control over costs. This suggests that governments are either not interested in supporting autogeneration or they are not going about it in the correct manner. The UK and Sweden were the only countries where government incentives were even mentioned

Of those companies considering autogeneration, there is a fairly divergent view as to the size of plant that should be built, with a fairly even split between those who favour plant of between 1 and 3 MW in size, 25 per cent, and those who favour a much larger plant of over 20 MW, 21 per cent. One would suspect that the larger the demand, the larger the plant being considered. This, however, was not the case, with some large companies considering small plants and vice versa. The demand of a company would only be a guide as many may wish to sell excess power to the grid, while others would only wish to generate a small proportion of their power.

Eighty-three per cent of respondents stated they were not even considering commencing autogeneration activities, with 45 per cent of respondents giving the high initial investment as their primary reason. This suggests that there could be a rise in autogeneration should technological improvements help to reduce initial investment costs.

It is also significant to note that many respondents said that they were not considering autogeneration because they were happy with their existing electricity suppliers and felt that they did not know enough about autogeneration to switch. This suggests that there is also a large degree of inertia among these companies, preventing them from considering changing their electricity supply system. It is possible that this could change as companies become increasingly aware of the opportunities presented in liberalizing electricity markets.

Of those that stated that autogeneration was not being considered, half stated that autogeneration would only ever be used in over ten years time or never at all. This suggests that most companies not considering autogeneration now are unlikely to reconsider in the near future. In fact, only one per cent of respondents stated that use of autogeneration would be reconsidered in less than one year.

Impact of deregulation

Although deregulation will bring new opportunities in the EU`s power equipment markets, the industrial market is likely to be affected by the uncertainty surrounding the process.

Datamonitor`s view is that many potential investors in industrial power do not know how industrial electricity prices are going to develop, affecting their planning for capital intensive projects. It is this lack of information, rather than any inherent weakness in the industrial power industry, that will damage market volumes.

But uncertainty will not stop investment in industrial power altogether: there are too many other factors such as process steam and deployment grants that will inevitably drive investment.

Look at the UK experience: despite being almost ten years post-privatization, industrial electricity prices are not the cheapest in the EU, and are only just lower than countries with state-owned power assets such as the Netherlands. Also in the UK, the impact of the pre-moratorium `dash-for-gas` on the utility market tended to overshadow solid volumes in the industrial sector. Despite no real regulatory support and a competitive supply market, investment in industrial cogeneration is increasing in popularity.

The reduction in volumes brought about by uncertainty will also be tempered by increasing utility involvement in cogeneration and other industrial on-site power projects. In order to protect their revenues, many major European utilities are expected to help rather than hinder some on-site development projects. This is already happening in the Belgian market, where Electrabel is positioning itself as the cogeneration champion, and has been the major force behind the size of the industrial power equipment in the Netherlands.

This said, Datamonitor`s forecasts do show a fall in industrial order volumes over the next five years compared to the last five years. Total orders between 1994 and 1998 were 8340 MW. In comparison, forecasted volumes over the period 1999 to 2003 amount to just 7357 MW.

On the product front, the next six years are expected to bring substantial investment in the large power plant market sector, reduced investment in the middle tier and strong activity in the smaller market. The large industrial on-site power plant market should benefit significantly following deregulation as large manufacturing companies make moves to reduce their electricity costs and improve revenues via sales to the grid. In some of the EU`s smaller markets, on-site industrial power plant operators are expected to provide the most competition for incumbent utilities as the total market may be too small to attract IPPs and foreign utilities.

Joint ventures between domestic utilities and industrial manufacturers are also likely to spring up with the utility aiding the industrial company to construct and possibly operate the on-site facility rather than risk losing its business altogether.

In the small industrial power plant market, volumes are also forecast to be healthy. It is the small industrial power user that is least likely to benefit from electricity market liberalization as the utilities target the largest spenders first with attractive supply offerings. Small users will therefore be pushed to invest in on-site power as a way to reduce costs and continue to compete with their larger competitors.

It is in the middle tier of the market where liberalization could really bite. In this sector of the market, the largest by a considerable distance, potential investors will be large enough to obtain competitive utility pricing but too small to have any serious ambitions in the electricity industry. This is the primary reason that volumes will be smaller over the next six years than the last six years.

Competition and deregulation is developing at different speeds across the EU, and in many markets its effects will be offset by the regulative situation in the industrial power market. But these effects will be felt throughout the region to a greater or lesser extent until more is known about the future of competition and electricity price.

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Figure 1. Volume of the industrial power generation equipment market in the EU by country, 1993-98 Source: Datamonitor

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Figure 2. Share of companies which autogenerate electricity and the proportion of demand which is autogenerated, 1999 Source: Datamonitor Autogeneration Survey, 1999

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Figure 3. Industrial power generation equipment market volume vs. average industrial electricity price Source: Datamonitor

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Figure 4. Type of plant and type of equipment used in each plant, 1999. Source: Datamonitor Autogeneration Survey, 1999

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