Financial incentives to build new gas plant may not be sufficient to encourage investors to build all the capacity Europe needs. Siân Crampsie explains
Policymakers in Europe’s energy sector are changing their views about natural gas.
Only one or two years ago the region’s dependence on imports of natural gas was a cause for alarm, but now gas is starting to be seen as the fuel that will help Europe transform itself into a low-carbon economy while keeping the lights on, particularly in a post-Fukushima world.
In March, the UK government announced special measures to address barriers to investment in new gas generation, while elsewhere in Europe the debate continues about which mechanisms would best encourage the building of flexible capacity, such as gas-fired plant.
An important role
Gas generation is set to play an important role in Europe because it is a low-carbon fuel source that can act as a flexible back-up to intermittent renewable capacity. In addition, large amounts of baseload power needs to be built in Europe to replace 180GW of capacity that is set to be retired by 2020.
The power sector is a key driver of natural gas demand in Europe, but recent analysis by A T Kearney predicts that overall growth in demand to 2020 will be weak at just 0.4 per cent a year. This indicates that levels of investment in new gas-fired capacity will be low, raising the spectre that the 27-nation bloc may not be left with sufficient generation capacity.
“The switch from coal to gas can deliver emissions reductions, and gas-fired … plant can provide system stability,” says A T Kearney partner Kurt Oswald. “There is a strong need for gas-fired power plants, but from a financial perspective there is no drive to build them.”
Part of the problem lies with the fact that renewables are pushing gas-fired power plants out of the merit order, while electricity demand growth remains low. Investors are also uncertain about natural gas prices and price volatility.
In the past two years European natural gas prices have responded to an oversupply of liquefied natural gas (LNG) caused by a fall in global natural gas demand, a reduction in US gas imports because of the shale gas boom, and new LNG capacity in Qatar.
“We have seen a major gas bubble develop during 2009 and 2010 … hub prices have been lower by around 50 per cent compared with oil-indexed price levels,” says Oswald. But things are set to change: analysis by A T Kearney shows a tightening of the European natural gas market as a result of falling production in the UK and the Netherlands. This will lead to a rise in gas prices of between 30 and 40 per cent by 2014 to around
€30/MWh.
Falling domestic production means European natural gas imports will rise by 27 per cent by 2020, met by a 65 per cent increase in pipeline capacity and a doubling of LNG import capacity in the region.
Rise in production
In addition, global production of gas will rise markedly, led by China, India, Iran and Qatar. The result will be another gas bubble, starting in 2015. “Because of the expected global oversupply of LNG, beginning in 2015, we predict high price volatility and a sharp fall in competitive gas prices – at times down to around €12 per MWh,” says A T Kearney.
Price volatility is a key barrier to investment in gas generation and the government hopes that its decision to include proposals for a capacity market in upcoming Electricity Market Reform legislation will provide investors with more certainty. The capacity market will be designed to ensure there is enough reliable generating capacity to meet peak demand.
The UK is also planning to publish a gas strategy, which will focus on ensuring security of supply by setting out government interventions needed to address barriers to gas generation investment, with a call for evidence open until 28 June.
In continental Europe, however, the idea of introducing a capacity market has been rejected the European Federation of Energy Traders (EFET) and others. EFET has warned that planning and intervention in the energy market will lead to increased costs and reduced efficiency.
“Europe needs gas … but the economic incentives in gas-to-power are not there,” says Oswald. “Capacity markets or even regulatory measures would be needed to incentivise gas-to-power in order to reduce the risk of blackouts; however we do not see that these measures will be put into place soon.”
This article first appeared in Utility Week’s print edition of 22 June 2012.
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