While the public focus of governments around the world has largely been on climate change and emission reduction, with almost all energy-related media headlines now taking the climate angle, there is a far more pressing issue, namely supply security: and central to securing supply is investment in generation to replace ageing and inefficient (both economically and environmentally) plant and meet year-on-year demand growth with a more sustainable energy mix.
Most of the current and forecast global demand growth is in the rapidly emerging Asian economies, and in particular those of China and India, but it is in the more developed economies of the West where potentially the greatest challenges lie for investment in generation. The UK, which has been an innovative force in energy market liberalisation, is a particular case in point.
Within the next two decades the UK could be experiencing an energy gap of up to 25 GW, which will be caused by various factors including the decommissioning of ageing nuclear plant, the shutting down of economically and environmentally underperforming coal plant, and strong year-on-year energy demand to fuel economic growth. Clearly if the UK is to plug this gap it needs to be investing in new generation plant now.
For much of the past decade the generation push has been on renewables, as the government seeks to achieve its target of 10% of electricity being generated from renewable sources by 2010. The major part of renewable generation is from wind power and last month the UK reached the milestone of 2GW of operational wind capacity. But this achievement has to be placed in perspective. The UK’s wind capacity is a tenth of Germany’s wind capacity and less than a fifth of that in Spain.
Moreover, it may have taken just 20 months to build the second GW of wind power (it took 14 years to build the first GW) but it will be harder to build the third (and subsequent) GW as planning problems and local opposition remain a potent obstacle in further expanding the UK’s wind farm portfolio. And if the government wants wind power to provide the backbone of the UK’s renewable energy, say 5% of UK supply, then at the current rate of development it will take the best part of seven years, or until around the middle of the next decade, which is significantly beyond the government’s self-imposed deadline. Even if wind power is only to provide a third of the country’s renewable energy capacity, with the bulk of the balance provided by wave and tidal power, then to reach 3.5% of total capacity at the current rate of development will take the best part of five years. And this assumes that the development of other renewable energy sources will come on stream at a similar rate to that of wind power, which is unlikely as most of the momentum in terms of investment is with wind power, and is assisted in part by a Renewables Obligation that seems to be unfairly biased toward wind power projects, seemingly regardless of the load factors.
While wind power is important, its cost and intermittent generation will always undermine its contribution to UK energy supply security and as such it will always play a largely supporting role.
While the UK has looked to beef up its environmental credentials since the turn of the century through renewable investment, the 1990’s ‘dash for gas’ and its consequences has tended to take more of a back seat. The recent additional gas imports through the Langeled and BBL pipelines might have allayed current gas supply concerns and pushed wholesale prices down by almost 50% in the near curve, but these imports only serve to mask the reality of Britain’s gas supply insecurity, namely that just 40% of the country’s gas now comes from St Fergus compared to 70% five years ago: or that, according to Ernst & Young, the average distance a molecule of gas will travel to reach Britain will increase from 200 miles today to nearer 1,000 miles by 2015.
Given the potential for increasing gas supply insecurity and reliance on politically unreliable energy suppliers such as Russia, the UK Foreign Office is now in the process of setting up a dedicated team to look at the strategic security of Britain’s energy supplies, with the government saying that energy security will be at the forefront of the next election campaign, which is expected in 2009.
The UK experience is not markedly different from that of other European economies, except that it has eschewed the protectionism stance of some EU member states. All these states share, in varying degrees, a sense of gas supply insecurity.
This month the Commission will seek consensus on a raft of energy policy proposals at the Spring Council, but the lack of agreement at the preceding Energy Council in February suggests a long slog for the Commission in developing the new energy policy legislation that it wants in place before the end of the decade. Notably there was no agreement on a minimum renewable generation target of 20% by 2020, nor did member states endorse ownership unbundling. Both will influence future generation investment decisions, with the unbundling stand-off perhaps the most influential. The failure to develop a more competitive, liquid and transparent European energy market, a failure that is more likely in the absence of unbundling, impairs price discovery and creates investment uncertainty.
Of increasing importance to investors is not so much the energy forward curve but that of carbon. For fossil fuel generation, regardless of any financial support for new clean coal plant and carbon capture and storage, the key issue for investors will be the long-term price of carbon. But there is no such price. While there are carbon prices beyond 2012, any contracts beyond the end of the first Kyoto commitment period have no legality.
The market will probably have to wait until the summer for the Commission’s ETS Review to report. But as with the January’s Strategic Energy Review the Commission will probably release much of its thinking in briefings ahead of its publication. Already, environment commissioner Stavros Dimas has outlined his preference for a mandatory allowance auctioning level, but the key issues as far as the market is concerned are the sectors constrained and the length of the third phase from January 2008.
With the EU proposing renewable and emission reduction targets for 2020 it makes sense for the next phase to run for eight years (from 2013) with a commitment to run successive phases for ten-year terms. In doing so there will be a more structured long-term carbon market with ten-year strips cascading back into annual, quarterly, monthly and spot contracts. It will also assist generation investment decisions as economies look to put in place long-term energy security policy.
