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Today, DECC has launched a consultation on some big changes to the UK’s Capacity Market.  The Government needs to be sure it can keep the lights on, especially as 8.4GW of coal has decided in the last 12 months that it will close this year.  The aim of the capacity market changes is to build more gas generation, and the changes will almost certainly ensure that happens.

As a result of these measures, we estimate 4-6GW of unabated new gas capacity will be contracted in this December’s auction, and be commissioned for October 2020.  4-6GW is 8-12% of peak demand, so it is clear this is a lot to be built in one go – probably costing £2.5-4.0 billion.   This will probably never be fitted with CCS, and much could be inefficient open cycle gas, even benefitting twice from embedded benefits.  There is high uncertainty over this 4-6GW to be contracted the year (interconnectors may reduce the amount of new-build gas).  After this intitial spurt, we think there would be very little contracted in the 1-2 years after, although this, again, is uncertain.

We generally welcome these proposals – they will give investor certainty to build enough gas power stations to ensure the lights stay on, even as the remaining coal power stations are phased-out by 2025.  Also, it is important that there is now a plan to amend air quality rules to stop more new diesel being built.

However, whilst some gas power stations are needed very quickly, this needs to be the final hurrah for gas – if the Government builds much more than 4-6GW of gas needed, then customers would pay too much, and the UK puts its future CO2 emissions targets at risk. 

We recommend 3 additional measures to ensure the Government does not over-contract unabated gas capacity.  First, a requirement for CCS on new gas contracted after this year’s auction; second, a commitment to continue building zero-carbon generation to ensure the gas fleet is running only when the wind is not blowing and sun is not shining, rather than running near-baseload; and third, the encouragement of new electricity storage technologies, which hold the potential to effectively partner with intermittent renewables.

We also want to highlight the important role the carbon floor price is having in decarbonising the electricity sector, not only in terms of closing coal capacity, but also in the future to encourage subsidy-free zero-carbon generation.

 

This paper looks at how much gas plant will be built, the impact of the new-build gas on cost and emissions, and considers how new gas build will affect the Government’s coal phase-out plan, and finally concludes with recommendations on how to make sure this is gas’s final hurrah.

 

 

Assessing DECC proposals

DECC have proposed a last-minute, emergency, full capacity mechanism for winter 2017-2018, which is a knee-jerk reaction to so much coal deciding to close this year.

However, most of the changes that DECC have proposed are around the main 4-year auction process, and have big implications for new gas.  They are generally needed, and are mostly good:

  • DECC will increase the “target” capacity procured by a minimum of 1GW – most likely this will be done by “gold-plating” the system.   Previously, the capacity mechanism allowed for occasional, short-term, localised black-outs when there was a confluence of factors – e.g. zero wind generation at the same time as large power station outages and at the same time as very cold weather.  The changes are likely to result in more capacity procured to ensure there are almost never any power cuts.  Gold-plating the system at any cost is not the most cost-efficient way of running the system, so arguably this is the most controversial proposal.
  • DECC will procure all capacity 4 years in advance.  Previously, they allowed 2.5GW to be procured at only the year-ahead stage.  This will make it more likely new, rather than existing plant, will be contracted, thus helping modernise the system, and reducing the chances of coal power stations staying open.
  • DECC will – via a separate DEFRA consultation – tighten air quality limit so that the influx of diesel power stations stops.
  • DECC will increase penalty payments.  Previously, these have not been very punitive, and have led to contracted capacity reneging on their contracts – a new CCGT contracted from Oct-2018 is unlikely to be built and almost certainly not in time for Oct-2018, and SSE’s Fiddler’s Ferry coal plant has decided to pull out of a capacity contract from Oct-2019 and close this year because the penalty was not big enough to offset losses of staying open.

 

How much gas plant is likely to be built?

It is very unlikely that any gas will be built for the Oct-2017 auction, since the timescales are too short.  However, new gas is likely for the Oct-2020 auction.

If you compare the capacity to be procured in this December’s T-4 auction versus last December’s auction, another 5GW is needed

  • The target capacity will be raised by a “minimum 1GW”
  • 2.5GW will be brought forward instead of being separated into a year-ahead auction
  • 1.5GW of Fiddler’s Ferry that bid in last December’s auction will need to be replaced since it will probably not be in this December’s auction.

So who will cover the 5GW?  It is unlikely to be diesel, since hopefully tightening air quality standards will prevent it from being built; it is unlikely to be coal, since all the coal not contracted is scheduled to close in 2016.   Maybe a little will be coal, but the 1GW “minimum” increase in target capacity has the potential to turn into 2 or even 3GW if unchecked.

There is potential for new interconnectors to be built, which would reduce the amount of new gas needed.

Therefore, we estimate that 4-6GW of new CCGT will get contracted to be built in this December’s auction, which would need to be commissioned by October 2020.   This is a huge amount of capacity to be built in one year, representing 8-12% of UK peak electricity demand.  However, it is unlikely that the changes would mean more new gas would be built year-on-year, as the changes are all envisaged as a one-off adjustment.

The gas plants that bid into last year’s capacity mechanism also give some clues to the type of gas that will be contracted:

  • Unlikely to be ever be capable of carbon capture and storage (CCS) – there are currently no requirements to have CCS, and none of the gas plants bidding into the last capacity auction have CCS plans, or are located in areas where CO2 could be easily buried.
  • Possible that much of it will be cheaper, inefficient open-cycle OCGT technology – and some of that may claim embedded benefits, which are double-rewarding new capacity.

 

How will the new gas plant impact the coal phase-out?

The UK’s 2025 coal phase-out is likely to be reinforced be these proposals – i.e. that there is a robust plan to replace the coal capacity that will come offline.

However, it is likely that the winter 2017-2018 emergency capacity auction will increase coal emissions.  We think it is likely coal plant will run harder, because the coal power station can decide when to run in the capacity mechanism, whereas if it is in the SBR then it would only run when needed to keep the lights on.  We also think it is likely that coal plant will stay open for longer, because it is now operating normally with a transmission connection in the capacity mechanism until September 2018, ready to get a year-ahead contract from October-2018, in the T-1 auction crowding out demand side response.

We do question whether the emergency capacity auction is necessary? The Government must keep the lights in winter 2016-2017 by making heavy use of the UK’s winter reserve (the Supplemental Balancing Reserve, “SBR”).  This is a messy way to keep the lights on, and may result in spiking prices.  So the Government wants to implement a full capacity mechanism in winter 2017-2018.  But it is unlikely that this would be any less messy than keeping the SBR for an extra year, and it is also likely to be a lot more costly since all power stations would get paid a contract, not just those in the reserve.   Surely it is better to fix the flaws of the SBR, so both winters 2016-2017 and winter 2017-2018 can operate with a bloated SBR, instead of setting up a one-off emergency capacity market?

 

How much will the new gas plant cost?

It is impossible to know exactly what will happen around costs, but we think the cost will be high, but not too high.  The most likely scenario is for a high cost in this December’s auction, followed by cheaper year-by-year auctions in the future.

  • The clearing price for the cheapest gas is likely around £25/KW, but if 4-6GW is procured this December, the price is likely to be much higher – probably £35-55/KW.   This would mean all 50GW of plant would get paid a one-off £1.8-2.8 billion windfall in Oct-2020 to Sep-2021.  The payments to 5GW of gas over the remaining 14 years at this clearing price range would be an additional £2.5-4.0 billion.
  • However, this might be the cheapest option under the current framework, since all the gas gets contracted in one year, so the clearing price for subsequent years should be low.

 

How much will the new gas plant impact UK emissions?

The aim of the coal phase-out should be to replace coal generation with renewables generation, so that gas generation is no different in 2025 than it was in 2015.  New gas capacity is required to operate as back-up, and the load factor of existing gas capacity will also fall.

Therefore, an increase in gas capacity does not mean an increase in gas generation or an increase in gas CO2 emissions, so long as sufficient renewables is built, and there are question marks over DECC’s desire to do this.

The Climate Change Committee have made clear that there is little room for unabated gas plant after 2035.  Perhaps the new gas plant will not have much of a life after 2035, but some will still be needed to generate on days of no wind and no sun.  It is fair to say that the new gas capacity will be required to run less often and to close earlier than fossil generation is used to.

 

Conclusion: how to make sure this is the final hurrah for gas?

We estimate 4-6GW of unabated new gas capacity to be built as a result of this year’s December auction, to be commissioned for October 2020, although there is a high degree of uncertainty.

4-6GW is 8-12% of peak demand, so it is clear this is a lot to be built in one go – probably costing £2.5-4.0 billion.   This would probably not be CCS, and much could be inefficient open cycle gas, even benefitting twice from embedded benefits.

We think even if 4-6GW of new capacity gets built, then the UK can phase-out coal power stations by 2025 without increasing gas CO2 emissions, so long as the Government continues building renewables, so that overall gas load factor continues to fall.

However, if we build more gas than 4-6GW, we do start to risk our UK climate targets, and risk ending up with an expensive glut of gas power stations.

Therefore, we end with 3 final recommendations to try to ensure that this December’s auction is the final hurrah for gas:

  1. After this year’s auction all new gas would require CCS.
  2. Ensure 2025 renewable generation offsets all coal generation, so that gas generation in total does not rise from 2015 to 2025, even with new gas capacity built.
  3. Ensure the framework sufficiently encourages upcoming electricity storage technologies.