Government announcements on 27 June provided further detail on the Energy Bill, including draft feed-in tariff contract for difference (FIT CfD) strike prices, as well as the launch by National Grid of a consultation on additional measures to encourage reserve capacity on the power system. Taken together these could, if implemented, support new opportunities, business models and routes to market for existing market players, including those outside the big six, as well as new market entrants.
A key component of the FIT CfD is the requirement for intermittent generators to sell their power on the wholesale market at the market reference price (MRP). Power purchase agreements (PPAs), which were available from suppliers under the previous Renewable Obligation regime, are subject to less attractive terms with steeper discounts and low or no floor prices (to the extent they are available anymore at all). Alternative routes to market are therefore becoming more competitive, including generator aggregators, direct PPAs and direct wholesale market trading.
In recent years the big six have already faced strong competition from new entrants in the industrial and commercial (I&C) market, which are competing strongly on price. These and other new players could provide generator aggregation services via direct PPAs with I&C consumers. Asset optimisation and balancing services could be provided by asset-backed or proprietary traders, in combination with enhanced output forecasting ability, and strategies to sell ahead contracted firm volumes and trade surplus or shortfall energy closer to delivery. Generators could also co-market (including through auctions) their output through blended products with combinations of fixed and market-indexed pricing, different tenors and product shapes.
The adoption of an MRP index under which all strike price top-up payments to generators are calculated will, by definition, result in winners and losers. As an average market price index, half the transactions will be above and half below the MRP. It can be expected that generators slow to invest in, or sub-contracted for access to, advanced forecasting capabilities, forwarding selling strategies and 24/7 trading and control capabilities will be in the bottom half of MRP transactions, hence placing MRP revenues at risk.
Based on the draft CfD strike prices of £155/MWh and £100/MWh in 2015/16 for offshore and onshore wind, respectively, and assuming wholesale prices of around £50/MWh, MRP revenue could be between a third and a half of total revenue under a CfD. Based on the experience of generators in Germany and elsewhere, renewable portfolios above about 100MW, depending on a number of factors including location, can reduce costs sufficiently to make direct wholesale market trading economic.
The second set of recent announcements concerned further details about the proposed new capacity market. As well as the capacity market proposed under the Energy Bill, two new measures are under consultation: demand-side balancing reserve (DSBR) for half-hourly customers and supplemental balancing reserve (SBR) for generators over 50MW. For DSBR products, the challenge will be to aggregate and combine the large numbers of small-scale distributed assets at sufficient volumes to generate economies of scale.
With proposed products potentially offering prices up to £15,000/MWh for embedded generators, solutions and business models developed in other markets could become more widespread in the UK. Elsewhere, business models have emerged following two characteristics: those which are spatially bound (local
level), and those which are non-spatially bounded (system level).
In the spatially bound category, there are three broad models:
· Distributed generation and storage systems create a new business model with the purpose of providing dispatchable levels of power and heat. Typical configurations are combinations of photovoltaic and battery systems, or micro-combined heat and power with thermal storage heaters or oversized boilers. By the use of electrical or thermal storage elements, production and demand can be optimised to maximise revenues from exporting additional energy during peak wholesale power market times. Energy can be stored during low wholesale market times to boost production and capacity in anticipation of prices rising again. Additionally, network usage fees can be avoided and, by compensating for the forecast errors, balancing costs are minimised.
· Energy management services business models target the energy and economic optimisation of individual production and consumption units by using intelligent measurement and control technology. An integrated view of various forms of energy (electricity, heat, cooling) is important, as is a structured procurement and optimal marketing of self-generating capacity.
· Micro-grid business models combine many of the above factors at the local or regional decentralised level (such as residential neighbourhoods, industrial zones or councils). Generating units and storage portfolios are bundled, with the interaction optimised by intelligently controlled consumption. Micro-grids are built on smart grid infrastructures on which the necessary communication and control information is transported.
In the non-spatially bound (system level) category, there are also three broad models:
· Virtual utility business models combine multiple decentralised consumption and production units which are non-spatially bound, thereby realising geographical aggregation and combination portfolio effects. The combination of different production technologies (wind, solar, combined heat and power) in flexible operational modes can act to dampen the fluctuating component of intermittent generators, thereby stabilising energy supply to the virtual utility customers.
· Virtual storage business models combine storage capacity distributed across the network. Through realisation of geographic, technology and load shifting capability, a virtual storage element can be optimised against wholesale power and capacity markets.
· Demand-side management business models focus on the control of consumption, in particular for large consumers such as industrial customers. Through the combination of control and metering devices enabled by a smart grid, time-shifting power consumption using disconnectable loads (such as ventilation, cooling, heating) can reduce network peak loads. The focus is on combining many decentralised units across multiple distribution networks: the more units and types of consumption and larger geographical area included in the optimisation, the greater the revenue potential.
The lesson from similar developments in the German market under the 2012 Renewable Energy Act’s direct marketing initiative shows that the process of price discovery for these new products and services is rapid, and convergence on standard products and terms tends to happen quite quickly. The potential for success for nimble new entrants to import business models and processes from other markets is high, but which models will be most successful depends on which of the options currently being consulted on will be chosen.
Jim Fitzgerald is an associate partner in London, and Jochen Schneider an associate partner in Munich, for The Advisory House
This article first appeared in Utility Week’s print edition of 19th July 2013.
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