By Gerard Wynn
LONDON May 9 European consumer electricity
bills will have to rise over the next decade.
Current wholesale prices are not sufficient to cover the
capital and operating costs of building new gas, nuclear or
renewable energy to replace the looming closure of a raft of
coal and nuclear power plants.
The need for higher wholesale prices is not yet evident in
the forward power curve, which remains flat or at most rising in
line with interest rates.
That curve shows no sign of a looming gap in power
generation, even though many gigawatts of coal-fired capacity
must shut by 2015 to meet European Union pollution rules (the
"Large combustion plant directive"), while ageing nuclear plants
will shut over the next decade.
In Britain alone, a quarter of the present capacity is
expected to be decommissioned by 2020, according to the grid
operator, National Grid.
The flattish forward curve instead reflects the economics of
unsubsidised coal, no longer an option given CO2 targets, and
appears to assume the generation gap will not be met by the
market, but by new or existing government programmes supporting
reserve gas capacity, efficiency measures and renewable energy.
But given how far present wholesale prices trail the
required incentive, such programmes must come at a big premium,
implying electricity bills will rise as utilities pass this on.
Britain confirmed on Wednesday planned reforms of the energy
market, to guarantee prices for renewable and nuclear power
("contracts for difference"), and for idle gas power plants to
step in when renewables are not available ("capacity payments").
The proposals seem sensible, but the tricky part is
calculating price levels for the guaranteed contracts, yet to be
Those contracts will probably represent a lower bar,
regarding cost, given that such government-funded programmes may
not meet their aims.
For example, renewable energy can only largely replace
fossil fuels if an incredibly expensive supergrid linking whole
regions is built, in order to overcome the inconsistent supply
of wind and solar power. However, such extra costs are not yet
incorporated by EU governments.
The cost of an offshore grid linking the North and Baltic
seas, and the wind power across many northwest European
countries, would be about 90 billion euros ($116.95 billion),
according to the European Commission.
Recent precedent, meanwhile, suggests that the most
efficiency measures can achieve is to stall consumption, and
certainly not replace lost capacity.
ECONOMICS OF NEW GAS
The economics of a new German gas plant are a good
illustration of how far wholesale power prices are trailing
economic reality, as gas is cheaper than other non-coal
alternatives - nuclear power and renewable energy.
The capital cost of a new gas plant is around 0.6 million
euros per megawatt (MW) or, depreciated over ten years, 60,000
euros per MW per year.
Assuming the plant runs at 80 percent of capacity, it will
generate power for 7,000 hours per year, implying a capital cost
of about 9 euros ($11.70) per MW per hour (MWh).
Additional, variable costs include the gas fuel, where
European import prices are around $9 per million British thermal
unit (mmBtu), which converts to around 44 euros per MWh for a
new plant burning at extremely high efficiency.
The purchase of carbon emissions permits adds a further 3
euros or so per MWh in costs. And there are additional,
operating costs of around 3 euros.
That means costs are around 59 euros per MWh, far above
potential power generation revenues of 50 euros, as shown by
German and French year-ahead wholesale power prices, leaving
even the most modern plants imaginable (60 percent efficiency)
out of the money.
U.S. gas-fired power plants face much cheaper gas prices
(about $2.3 per mmBtu) and no carbon price. That completely
turns the tables on gas economics, which explains why a dash for
gas is very much on the cards there, but not in Europe.
COAL AND NUCLEAR
The same problems exist for nuclear, magnified because of
the far greater capital cost (six or seven times gas) which when
depreciated per MWh already exceed the German wholesale power
price, before allowing for additional operating, fuel,
decommissioning and waste disposal costs, illustrating why
nuclear power has to be supported.
Meanwhile, the capital cost of a new, advanced coal plant is
about 22 pounds (27 euros) per MWh, according to consultants
Parsons Brinckerhoff. Additional, variable costs allow a new
coal plant to break even at present wholesale power prices -
suggesting coal is still the marginal power plant in Europe.
The big picture therefore is that the forward curve for
wholesale power prices sends an incorrect signal for driving new
power generation to replace high-carbon coal.
Governments must support prices, therefore, at a substantial
premium to wholesale prices.
Whether or not those prices, when they're announced, are
reflected in wholesale prices is a moot point.
It may be that wholesale power prices will continue to
reflect the clearing price for unsubsidised coal.
Regardless, the government support price premium will be
reflected in consumer bills given that utilities will pass these
on, storing up possible surprises ahead.