The European power sector is facing a capacity and investment crunch which could jeopardise its security supply and derail its low-carbon agenda.
That is the stark warning in a report which puts a €1 trillion ($1.3 trillion) price tag on the new infrastructure needed to maintain Europe’s energy supplies.
Analysts at US-based consultancy IHS CERA say the investment climate deteriorated over the last year as several countries faced a double-dip recession, while the financial strength of utilities weakened due to higher debt levels and weaker credit ratings.
“Europe’s energy sector faces a large and pressing investment challenge,” says Michael Stoppard, co-author of the report ‘The Energy Investment Imperative: Toward a Competitive and Consistent Policy Framework’.
“Today the required investment is lacking. However, because of the long lead time to develop energy assets, it is imperative that the right investment framework be put in place as soon as possible to ensure long-term stability of Europe’s energy system,” he added.
IHS has calculated that investment of around €750 billion is needed over the next ten years for power generation, €90 billion for transmission lines and about €150 billion for new gas supply and transmission capacity.
This, it argues, means that “new approaches to corporate and project finance will be needed to attract institutional investors, and regulators will need to take major steps to reduce uncertainty for these investors”.
IHS CERA states that four fundamental factors underpin this investment need:
- Power plant retirements. Europe’s ageing capital stock of power plants – notably coal and nuclear – need replacing. Moreover, the environmental provisions of the Large Combustion Plant Directive and the Industrial Emissions Directive will require early closures. Up to 110 GW of plant is due for retirement by 2023 under the two directives, out of a total of 465 GW of conventional power generation capacity.
- Renewable integration and backup. High-capital spending on new renewable generation will need to continue, but it will increasingly need to be supplemented by attention to both full integration into the current power systems with backup supply and improved system flexibility.
- Infrastructure. All of that new renewable generation also requires connecting to the grid and increased grid interconnection. The report notes that Europe’s energy strategy relies on an aggressive expansion of domestic and cross-border transmission infrastructure, “but many projects are plagued by significant delays”.
- Secure gas supply. IHS CERA says there is a growing need for gas imports as the EU’s production declines. Securing this supply requires investment upstream, and in long-distance transmission pipes or liquefied natural gas facilities. It adds that domestic shale gas extraction – should it take off – will also require investment if it is to meet its potential.
IHS CERA says that Europe’s “weak economic performance and the consequent stagnation in gas and power demand have won some precious time”.
However, it stresses that because of the long lead time to develop energy assets, “it is imperative that the right investment framework be put in place as soon as possible to ensure long-term stability of Europe’s energy system. Indeed, it is important to prepare now for beyond the current 2020 targets.”
The report argues that the combination of factors across all areas of power generation have caused the current dearth of investment.
Europe is due to close around a quarter of its fossil fuel capacity by 2023 to meet tighter environmental rules, while the rapidly expanding renewables sector needs back-up supply and better grid interconnections.
New thermal plants have all but dried up, with some unprofitable plants being shut, and investment in transmission lines “lags well behind projected needs as a result of delayed permitting and regulatory constraints”.
The report states that activity across all areas of renewable power has slowed, mainly as a result of support cuts and financing constraints.
|Many countries could fall back on an extended use of coal, warns IHS CERA
“Onshore wind additions have passed their peak, offshore wind is exposed to grid connection decisions and an as-yet immature supply chain, and solar photovoltaic additions are slowing as support schemes tighten, despite falling costs.”
IHS CERA says Europe is failing to attract vital investments in new sources of gas from outside the European Union, and getting much-heralded domestic shale gas industries off the ground is proving to be very slow.
The report underlines that Europe’s overall economic performance in the last year has been weak as many countries struggled with double-dip recessions, and it warns that “without the motor of growth, the traditional draw on the balance sheets of Europe’s major utilities to finance energy build can no longer be relied upon”.
“The financial strength of most utilities has weakened dramatically because of higher debt levels and weaker credit ratings. And what investments the utilities can countenance are increasingly directed toward global diversification away from Europe. Traditional sources of project finance – the commercial banks – remain constrained, and Europe is failing to provide a competitive value proposition for investment in a globally competitive market for investment and finance.”
This, stresses IHS CERA, “is not the landscape upon which plans were laid back in late 2009 when, with Europe expected to emerge from a severe but brief recession, the European Council set the target to reduce carbon dioxide emissions by 80-95 per cent below 1990 levels by 2050”.
Indeed, the report states that the European Commission’s Roadmap scenarios published in December 2011 do not address the impact of the extended economic crisis of 2011-12.
“If Europe is to continue toward a competitive low-carbon economy, cost-efficient investment is needed more than ever.”
While Europe grapples with its economic woes, and in turn energy companies struggle with the knock-on effect on their balance sheets and investment plans, activity elsewhere in the world is compounding the pain for power firms – and it could get worse.
The effect of the shale gas boom in the US is well known – the production bonanza generated around 150,000 direct jobs in 2010 and multiples of this indirectly, and it has pushed down gas prices, stimulating a revival of industrial and manufacturing activity.
The shale revolution has boosted the energy competitiveness of North America. Volumes of US shale gas production now account for one-third of US gas production, and are equivalent to over half of total EU gas demand.
|The shale gas boom in the US could result in ‘industry migration out of Europe’
Credit: Cuadrilla Resources
IHS CERA warns that “the risk of industry migration out of Europe may be limited in the short term, but will intensify if a wide energy cost gap is maintained over the longer term”.
“Energy-intensive industry accounts for around 10 per cent of industrial jobs in Europe. A reformed carbon trading system can and should be developed that does not further weaken the global competitiveness of trade-vulnerable and energy-intensive industries.”
IHS CERA has identified four policy enablers that it believes are vital to meeting the investment imperative:
- Carbon market reform. Without reform, the EU ETS risks being pushed into a mere backstopping role to assess the progression towards the EU emissions reduction targets, rather than acting as an agent of change.
- Clean technology support. Current support frameworks need to be critically reviewed to keep costs affordable to consumers. Support costs for renewable generation alone will reach at least €50 billion by 2020, an increase of 40 per cent over today’s €30 billion, which calls for clear trajectories and thresholds for subsidy removal as technologies mature. Additional costs arise from accommodating intermittent renewables in the system.
Power market reform. Short-term challenges need to be met for conventional power plants, to address the need to reward better operating flexibility as well as dependable capacity through reforms of ancillary services and the introduction of capacity mechanisms. IHS calculates that wind and solar generation will require around 60 GW of additional conventional backup generation by 2035, and adds that this capacity will not be delivered under the current market designs.
It stresses that “today, 110 GW of flexible gas-fired power generation is at direct risk of retirement”, and adds that this is backup capacity that is needed as a complement to further renewable expansion. “If the investment framework is not adjusted adequately and investments are not forthcoming, many countries could fall back on extended use of coal plant as a default option.”
- Infrastructure investments Few would argue that infrastructure development provides the backbone of the pan- European power system, and IHS CERA says “delays in the authorisation and permitting processes for transmission projects need to be remedied”. It believes that to effectively interconnect the European power system, more than €200 billion investment is needed between now and 2035. “Interconnectors will require more funding through regulated revenues as price differentials between markets will not support merchant commercial investments,” it states.
The IHS CERA report concludes that it is critical that new approaches to corporate and project finance are adopted to attract institutional investors. “The current market structure is unlikely to attract the necessary risk-bearing investment, and insofar as it does, premiums to cover significant regulatory and market risks threaten to drive up the cost of capital in an already capital intensive industry,” states the report.
Concluding that today’s European power sector is ill-equipped to address the present investment needs, IHS CERA calls for “a compact policy package that contains a number of enablers”. These enablers are all closely interlinked, and the report draws up four guiding precepts for them:
- Liberalised market principles should be maintained wherever possible. Moreover, national policymakers need to work together and co-ordinate their measures to limit further market distortions.
- Current market arrangements need to be adapted to take into account the change in context. The changes include the impact of the recession on power demand, the growing share of intermittent renewables, and the increasing capital intensity of power generation investments.
- The focus of market reform should turn to the investment incentives and should value better operating flexibility. Power system flexibility and backup for intermittent generation and peak supply need to be valued appropriately in the market. It should include other elements such as capacity mechanisms needed to ensure a fair return on new investment.
- Renewable power generation needs to be exposed to short-term market dynamics. This will help renewable generation become more “dispatch-conscious” in its operation and achieve integration, at least cost in today’s wholesale markets.
Fabien Roques, the report’s co-author, drives home the gravity of the dark clouds sweeping across Europe’s investment landscape: “The current market structure is unlikely to attract the necessary risk-bearing investment. Premiums to cover significant regulatory and market risks threaten to drive up the costs of capital in an already capital-intensive industry,” he warns. “National reforms to implement capacity mechanisms risk undermining progress so far with market integration at the European level.”
And he stresses: “Unless the investment framework is fixed urgently, Europe will fail to deliver on its low-carbon agenda.”
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