By Gerard Wynn
LONDON, May 9 (Reuters) - 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 announced.
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.
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.
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.