Power imbalance: extremes of European power industry
October 25, 2013
Published in corporate Gazprom Magazine Issue 10
The global financial crisis, energy market metamorphoses, liberal reforms being in progress for more than fifteen years already and many other factors have brought the European Union (EU) power industry to the crossroads. Being in a state of constant turbulence, the EU power market has accumulated the maximum of contradictions which cannot be eliminated until the authorities and regulatory bodies propose a sound long-term development strategy for this industry. Such a situation alarms the potential strategic investors whose participation could have allowed for settling some of these contradictions.
At present, the installed capacity of power plants in the EU totals some 900 GW, thus being a bit behind the USA and the People’s Republic of China, but surpassing Russia about fourfold. Thermal generation accounts for more than a half of the capacity, nuclear power plants – for some 15 per cent and power plants running on renewable energy sources (RES) including hydropower plants – for around one-third. The share of alternative energy sources is rapidly growing in the Old World. For instance, out of some 200 GW of new capacities built by Europeans in the 21st century, 120 GW are based on RES, with more than a half of it (70 GW) being wind farms. Alongside with this, the installed capacity of gas-powered thermal power plants (TPP) has considerably grown in the new century – by almost 50 GW. Coal-fired and oil-fired power plants, on the contrary, have been gradually removed from service (between 2000 and 2010 their capacity decreased by 45 GW).
Last year the EU countries produced 3,260 TWh of electricity, which is 7.6 per cent more than in 2000. The buildup was mostly due to RES and gas-powered generation, whereas coal- and oil-fired power plants, even those still remaining in the system, substantially cut down the electricity output. Moreover, even before the Fukushima accident the amount of electricity produced by nuclear power plants was being reduced under the influence of the environmental lobby.
It may appear as if in Europe gas-fired generation and RES go hand in hand with each other, and this seems only logical at first glance. On the one hand, there is the most eco-friendly fossil energy source; on the other hand, there is renewable energy free from any air emissions. That is why in terms of securing air purity the triarchy of gas, wind and sun looks like the optimal model of the power industry development. In reality their union turned out to be fragile, and after a while gas-based power generation and RES got into confrontation. This was caused by the economic crisis as well as a specific situation in the European power market provoked by a long-drawn liberal reform.
The power industry reorganization (Directive No. 92 of 1996 and Directive No. 54 of 2003) followed a liberal scenario similar to that implemented in the gas industry, but with due consideration for specific features of the industry, of course. It consisted in dividing vertically integrated holdings into independent legal entities by types of activities (generation, transmission, sales) and creating conditions for the non-discriminatory access of third parties to the networks. This was followed by the wholesale market liberalization (all major ‘generators’, selling their volumes either under long-term agreements or at nine EU power exchanges got access to it) and the opening of retail markets (major consumers acquired the right to choose the supplier). The stated goals of all these reforms were price reduction, promotion of competition and formation of a single European power system.
Even the first few years after enactment of Directive No. 54 showed that this reform was not carried out as smoothly as its authors thought it would be. Power prices (excluding the price increase in global energy carriers) grew in 17 out of 25 EU countries for industrial consumers and in 14 out of 25 countries – for households. One should also remember that in most Eastern European countries as well as in Italy and France there are still state-regulated power rates for the population. At the moment, according to Sergey Kondratiev, Deputy Head of the Economic Department of Institute for Finance and Energy, “though end electricity prices differ a lot from a country to a country depending on types of generation and market structure, the highest prices are observed in the countries with liberalized power industry”.
As for the market competition sought for by reformers, it led to flushing out small- and medium-sized generating companies in favor of power majors swallowing up the generating assets across Europe. Today half of the electricity produced in the EU is controlled by seven major companies. By the way, this fact was accepted by the European Commission too, as it figured that the majors would invest money into new technologies and, therefore, winked at consolidation processes in the generation sector.
Technologies be technologies, but in order to support the reliability of power supplies, peak shaving capacities are required, meant to secure additional power and heat supplies to consumers during abnormal temperature periods. However, a permission procedure for commissioning new capacities, approved under the reform, for obvious reasons could not possibly encourage the investors to channel money to the construction of power units known to be inefficient beforehand to stand idle most of the time. Technically, within a well-balanced system peak shaving power plants may be required once in seven or ten years, but the European power system cannot be referred to as well-balanced in any case.
The case with integration was even worse. From the administrative point of view it all seemed decent: 34 system operators were created and united into the ENTSO-E association which under the Third Energy Package fulfilled the following functions: Europe-wide planning and coordination of operating parallel power systems. In reality, the European power network infrastructure was not ready for integration into a single system. Nine members of the European Union are able to use the imported electricity in the amount not exceeding 10 per cent of the demand in their domestic markets, for ten more members it is 25 per cent and only for four countries it is 50 per cent and more. Finally, Ireland, Malta, Cyprus and Greece are not linked to the power infrastructure of the rest of the EU at all.
Currently the European power market is represented by a conglomerate of regional markets connected to each other. One of the key problems of the single market formation lies in congestions at transboundary sections between the regional markets. Europeans were going to resolve this problem through promoting investments into the network infrastructure and complete the formation of a single market by 2012. Naturally, this didn’t happen and now the deadlines are moved to 2015, but again success is not guaranteed.
Green and blue
There was also a conceptual problem that presented itself, namely, the absence of a single European power industry strategy. The European Commission tried to correct this flaw in the so-called Green Book issued in 2006 (the real name of the document was European Strategy for Sustainable, Competitive and Secure Energy Supply). It is hard to call this work a complete strategy but it has set a general trend: Europe should transit to RES not only for environmental reasons but, perhaps, to a greater extent for the purposes of energy security. The reasoning here is roughly as follows: the most part of fossil energy sources in the Old World is imported, whereas the sun, wind and water are indigenous (excluding the dependence on rare earth metals supplied from the People’s Republic of China and required for producing the equipment for RES). So why don’t we place a bet on them along with protecting the air, especially since some EU countries started encouraging the construction of facilities running on RES long before the release of this document. Out of all the conventional fuels only natural gas was favored in the Green Book, due to its environmental friendliness and positive long-term experience of its reliable supplies from Russia, Norway and Algeria.
It resulted in the previously mentioned construction boom of gas-fired thermal power plants and RES-based power plants. There were certain nuances, though. Gas-fired generation was developing first of all due to such market mechanisms as lower capital costs and more appropriate construction time for gas power plants (2 to 3 years) compared to coal-fired ones (4 years), as well as intense introduction of gas turbine units, i.e. technologies allowing for a high efficiency of power units and optimal fuel consumption.
RES are a whole different matter, as the prime cost of electricity they produce is considerably higher than in the conventional power industry. That is why the governments of most Eurozone countries established preferences in the form of special long-term (up to 20 years) rates for power supply from these sources to the network as well as tax benefits. Therefore, investors saw RES as a serene harbor in the rough sea of the European power market, and massive amounts of money flooded this sector, sometimes at the expense of infrastructure projects more necessary for Europe. And it were the consumers who paid for this pleasure as RES allowances were included into the final cost of electricity. All this sorted ill with the announced aspiration for competition and lower prices, but amidst the economic upturn everyone somehow agreed to spend money on water and sun.
And then a crisis broke out. The incomes of national budgets, companies and households slumped, power consumption declined dramatically causing the excess in capacities. In such a situation it would be logical to cut down or even stop providing investment support to RES and stimulate the long-standing process of removing oil- and coal-fired power plants from service. But it was not to be. The environmental lobby together with the investors demanded that the show had to go on, and national governments didn’t dare to object them. At the same time, the US shale revolution dumped slightly cheapened American power plant coal to the European market, thereby reducing the prime cost of power at coal-fired TPPs. In the wholesale market where the biggest margin is given to the cheapest electricity, coal generation (it should be added that in some EU countries it received state support) proved to be rather profitable, thus inaugurating an era of the so-called Coal Renaissance. As for gas-fired generation, it was on the receiving end as a decline in demand and a lack of state support put it at a disadvantage.
As a result, this summer alone two power majors – RWE generation and E.ON – announced their intention to shut down some of their gas power plants, and other players of the generation sector are ready to join them. In short, the pages dedicated to the blue fuel were torn out of the Green Book and cast far away. There is still a hope, though, that it is not for ever.
Stefan Wenzel, Lower Saxon Environment Minister and Member of the Greens party recently stated that the German power industry plan was ‘schizophrenic’, because it promoted the use of coal at power plants at the expense of more eco-friendly natural gas.
In the recent months the opinions of those who criticize EU energy policy, especially in terms of gas generation, have been voiced more and more loudly. There is Aurelio Regina, Vice President of the Confederation of Italian Industry (Confindustria) who says that it is unacceptable that subsidized power plants producing very costly electricity should oust state-of-the art gas power plants from the market. There is also the French Court of Auditors publishing a report that criticizes the increase in costs on state support of RES.
Even the environmentalists preoccupied with the Coal Renaissance are discontented. Stefan Wenzel, Lower Saxon Environment Minister and Member of the Greens party recently stated that the German power industry plan was ‘schizophrenic’, because it promoted the use of coal at power plants at the expense of more eco-friendly natural gas.
Finally, this September nine European power majors, including Eni, GDF SUEZ, RWE and E.ON presented in the European Parliament their strategy for the European energy policy reorganization. Commenting on this decision, Paolo Scaroni, Head of Eni stated that subsidies for renewable energy sources amounted to some 18 per cent of electricity bills and that these bills should be cleared of such charges to close the gap in competitiveness.
But it’s not just about the finance – technical problems related to the reliability of power supplies are also growing. Sergey Kondratiev points out that the development of some RES involves certain technological risks. For instance, he gives the following example. In Denmark where 20 per cent of power is produced by wind farms it is a common practice that on windy days a system operator has to unload almost all the heat generation and considerably enhance the flow to neighboring countries. A similar problem exists in Germany where on sunny and windy days power export to neighboring countries shoots up causing the destabilization of their power systems. Or, on the contrary, there might be windless calm and no sun, and then the output of RES-based and solar plants drops to the minimum. It is hard to call such power supply uninterrupted and, hence, reliable.
RES proponents are repeating in all sharps and flats that it is not a big deal and TPPs may operate as reserve capacities. But it somehow escapes them that when coal-fired power plants operate in the ‘now take off, now landing’ mode, it quickly leads to the boiler equipment failure which will demand substantial expenditures on replacing it. For gas TPPs such a process is less painful (still unpleasant, though), but this brings up a question – who will pay for their forced outage and for maintaining their instant operational readiness? If it is up to consumers again, they might not be able to manage another cost load increase, not to mention how absurd the situation itself is, when first you are taken toll for the RES projects to pay off and then you’re required to pay more, so that you don’t have to sit in the dark every now and then because of the wind turbines have been built on your hard-earned money.
Policy of cautious optimism
In this situation Gazprom, which doesn’t make a secret out of its intention to act as the strategic investor in the European power generation market, has to take a break and wait for a more favorable course of events. There are hopes for that, as we see. Gazprom, however, doesn’t confine itself only to watching, it already starts implementing certain projects.
For instance, this summer an agreement was concluded with Italian company Enel for Gazprom to acquire in Belgium the Marcinelle combined cycle power plant (CCPP) with the installed capacity of 420 MW. In addition, Gazprom Energoholding (which controls the Group’s generating assets) together with NIS (Gazprom Neft being the major shareholder) are planning to construct a gas-fired TPP for auxiliary needs in the Serbian town of Pancevo to supply power and heat to the oil refinery and petrochemical plant owned by NIS.
The involvement of Gazprom as well as other potential investors in European gas generation will depend on the market situation and behavior of national regulators; on whether European power industry will be able to come out of the turbulence and find the optimal balance between different energy sources, giving preference to the most efficient ones, and between the cost of power and reliability of its supplies.