But the generation landscape in the UK is massively out of kilter. Renewables attract a level of subsidy that allows them to operate profitably at negative power prices. Nuclear will benefit from the carbon support mechanism and the feed-in tariff (FIT). The big challenge for operators of gas plant is adapting their business model to enable them to make economic returns that are at best highly uncertain and at worst unattainable. In particular, growth in wind generation means gas plants having to move from traditional baseload operations to operating only when there is insufficient wind. For gas plant economics, this means a double hit of compressing earnings into shorter periods and incurring greater maintenance costs when plants start and stop more often. For new plants, such a running regime makes planned investment economics highly challenging and risky.
The penetration of subsidised low-carbon technologies is already having a demonstrable impact on planned investment in new flexible gas plant – over the past 18 months, a significant volume of new combined cycle gas turbine capacity has either been cancelled or significantly delayed. The government’s own projections show capacity margins tightening in 2016 if offshore wind growth is slower than expected and planned energy efficiency measures do not reduce demand. InterGen believes this is a highly realistic scenario, in which case new flexible gas plant will need to be operational by 2016.
InterGen is concerned that a tightening of capacity in 2016 without a mechanism in place to support new and existing gas plant could result in relaxing Large Combustion Plant Directive restrictions on coal plant, because the government would have to choose between keeping the lights on and adhering to EU law – it is easy to see which would be preferable in the eyes of voters. This would undermine existing gas plant investments and would be disastrous for the UK in terms of its attractiveness as a place to invest, as well as being detrimental to the UK’s carbon targets.
All is not lost. To address these issues, the government has identified that all gas plants require support to bolster the investment signals to ensure security of supply, and has proposed the introduction of a capacity mechanism as part of its Electricity Market Reform. Government is now grappling with how this would be best implemented. The key questions still unanswered are about what the capacity mechanism should look like and when it should be introduced.
A well-designed capacity mechanism will promote essential investment in gas plant and will provide support for independent generators, whose survival is necessary to provide competition in the market and thereby ensure affordable energy bills for consumers. The mechanism should not reward generation that already receives support through the Renewables Obligation or proposed FIT. On timing, the capacity mechanism should be implemented in late 2012 to give companies one year to agree construction contracts and raise finance, and then three years to build the plant.
The capacity mechanism should be designed to provide different terms of support for existing and new gas plant. For existing plant, the payment period should cover at least one outage/maintenance cycle (three to five years) to ensure that there is sufficient return for companies to have the confidence to invest and keep their existing plants efficient, flexible and available. For new plant, support needs to be in place for up to 20 years, otherwise the mechanism will not offer shareholders or banks sufficient certainty to enable them to invest. This contract period for new plants is in line with existing long-term support for renewable generation.
In addition, it is essential that the payments provided are from a credit-worthy counter-party so that they are “bankable” and count towards the raising of finance.
The capacity payment mechanism represents a significant opportunity for the government to encourage new investment in UK gas-fired generation at the right time and promote competition in the market. If implemented successfully, the mechanism will offer certainty to banks and shareholders, allowing independent generators such as InterGen to continue to invest in UK plc. By introducing a capacity mechanism now and not taking our foot off the gas, the lights will stay on, consumer bills will be minimised and carbon emissions will be lowered. It’s time to shout about it.
Mark Somerset, European general manager, InterGen
This article first appeared in Utility Week’s print edition of 20 April 2012.
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