Blow to UK energy plans as new gas plant in doubt
By Paul Homewood
As you will recall, Amber Rudd acknowledged this week that we needed an awful lot of new gas power capacity to be built in the next few years. Given market conditions, it is extremely unlikely that much of this will arrive in the timescale she hopes for.
The government, however, is pinning its hopes on the Capacity Market Mechanism, which pays generators to provide a certain amount of standby capacity. This is fine in theory, but the first auction held last December, to supply capacity for 2018, resulted in most of the contracts being awarded to existing generators.
The reason for this is simple – as they are already operational, they don’t have to worry about covering their capital and fixed costs; it is only marginal costs that matter.
Only one new build CCGT won a contract, Carlton Power’s 1520 MW project at Trafford, Manchester. The auction process is a reverse one, with all successful bidders receive the same contract rate, decided when the government has the requisite amount of capacity bid.
On this occasion, all applicants, including Trafford, received £19.40/KW @2012 prices.
The Government’s plans to keep the lights on have suffered a fresh setback after it emerged the only new large gas power station due to be built in coming years is now in doubt.
Energy firm Carlton Power was awarded a subsidy contract by the Department of Energy and Climate Change last year to build a new 1.9 gigawatt plant at Trafford in Greater Manchester – big enough to supply power to 2.2 million homes.
The £800 million plant was due to start generating in October 2018, but Carlton Power told the Telegraph it could no longer meet that date – and had so far failed to secure financial backers for the project to go ahead at all.
Mike Benson, Carlton Power’s business development director, said securing investment had proved "more difficult than we would have hoped" due to a combination of long-term policy decisions that had skewed the market, and uncertainty caused by recent cuts to wind and solar subsidies.
The Trafford plant had been supposed to begin construction this summer after getting a subsidy contract through the Government’s ‘capacity market’.
The scheme is designed to ensure there will be enough power plants to keep the lights on by paying their owners to guarantee they will be available.
Carlton Power signed up to build the Trafford plant in return for subsidies of more than £30 million each year for 15 years. On top of the ‘retainer’-style payment, it would then get revenues from selling electricity into the wholesale market.
Mr Benson said long-term political intervention through "continuing direct subsidies for low carbon technologies such as wind, nuclear and solar" skewed the wholesale power market, making the price artificially low and making it harder to invest in gas plants.
"Despite the widespread acceptance of the need for new gas fired generation, there is no market signal to support that investment," he said.
Industry experts have been questioning for some time whether the Trafford plant would be commercially viable with the level of subsidy it agreed in the capacity market.
Last week the Telegraph reported warnings from Alan Whitehead MP, Labour’s shadow energy minister, that some 20 gigawatts of new gas plants were needed by 2025 under the Government’s own plans, and that much higher subsidies – totaling billions of pounds – would have to be paid through the capacity market to secure them.
There are more than a dozen proposed gas-fired plants with planning permission, but many have been on hold for years.
Richard Howard of think tank Policy Exchange estimated that gas plants could need subsidies at up to double the level secured by Trafford in order to go ahead.
Many existing gas-fired power plants are losing money currently.
A look at the numbers confirms these fears, and suggests that even a doubling of subsidies may not be enough.
Energy consultants, Timera Energy, have looked at costings in depth, and have concluded that capital costs for CCGT are around £500/KW. This looks realistic against capex for Trafford, the under construction Carrington and potential Knottingley projects. Therefore, a 1000 MW plant could be expected to cost £500 million.
Capacity auctions are only available for a maximum of 15 years, and given the apparent political determination to virtually decarbonise electricity during the 2030’s, nobody is likely to plan on a longer economic life than that. Depreciation alone would therefore amount to nearly 7% a year. With a profit margin added in, an investor would be looking at something like a 15% ROC.
Based on our theoretical 1000 MW plant, therefore, our investor would need to see £75 million a year coming in. On top of this, the operation would need to cover fixed and maintenance costs, which Timera estimate at £20/KW, or another £20 million a year.
The plant will of course earn some revenue from the electricity it sells, but whether this covers variable costs, particularly in the face of a rising carbon floor price, is not something that can be banked on.
There is, needless to say, much competition for capital, particularly when it can attract generous and guaranteed returns in the subsidised renewable energy sector, so there is little incentive to risk investing in a CCGT plant, which may well be subject to political whims in a few years time.
Consequently the only certainty any potential investor would have is the contracted standby payment, which would therefore need to be at least £95 million a year to cover capital and fixed costs, equating to £95/KW. This is five times the rate auctioned last year of £19.40.
If we are to attract 20 GW of new CCGT capacity therefore, we could be looking at standby payments of £1.9 billion for these alone. At the last auction, DECC bought capacity of 49 GW at £19.40/KW, so we can assume that the remaining 29 GW could still be bought from existing operations at that rate in future years.
This would give an overall cost of £2.6 billion a year. The auction last year cost £955 million.
This is a far cry from the Office for Budget Responsibilty’s projections, only published in March this year. They forecast a cost of £600 million.
It would appear that Amber Rudd is going to have to put her hand in her pocket, or, more to the point, George Osborne’s!
This all leaves open the question of just how new build CCGT can be attracted into the bidding, when they are easily undercut by existing capacity, such as nuclear, CCGT and coal. The suggestion made by Gummer’s CCC is that there needs to be two separate auctions, one for new and one for existing.
One problem with this is that some existing capacity will be squeezed out, with the consequence that it may shut down. It is, however, not easy to see any other solution.