Capacity market: interconnectors beat new gas

Every capacity market auction so far has seen new combined-cycle gas turbines undercut by rival technologies. In the T-4 auction, it was interconnectors that stepped in, reveals Tom Grimwood.

Four years in and the capacity ­market has secured just a few new ­combined-cycle gas turbines (CCGTs). Every auction so far has seen them undercut by rival technologies. First it was gas and diesel-fired reciprocating engines (recips). Then batteries and demand-side response (DSR) piled in. Now it is interconnectors.

The latest four-year-ahead (T-4) auction saw 7.6GW of coal generation drop out. According to the provisional results, all but 2.6GW of coal capacity exited the auction, with the only exceptions being two units at Drax and three at Uniper’s Ratcliffe.

“Even though large amounts of coal-fired capacity have not won a contract and the traditional thinking was that would all be replaced by new CCGTs or reciprocating engines, that’s not the case,” says Tom Edwards, senior consultant at market intelligence firm Cornwall Insight. “It’s actually been replaced by interconnectors.”

All interconnectors successful

All of the interconnectors to enter the auction won contracts. They included three new build projects – Eleclink, Nemo Link and IFA2 – with a combined capacity of 2.2GW. By comparison, just 762MW of new build ­generation was successful.

Nemo entered the previous T-4 auction but failed to win a contract, despite the much higher clearing price of £22.50/kW. Eleclink dropped out shortly beforehand, while IFA2 is a completely new entrant. Edwards says Eleclink and Nemo probably decided to stick it out in the latest auction because they “both have certainty that they are going to be built”.

According to Stephanie Zhang, project manager at Aurora Energy Research, the committed participation of these interconnectors helps to explain the record-low clearing price for a T-4 auction of only £8.40/kW. She says interconnectors are price takers not only under the rules of the auction – meaning they cannot drop out at above £25/kW – but also in terms of their economics.

Both Nemo and IFA2 will have a guaranteed minimum income under the Ofgem cap and floor regime, meaning they are not reliant on the capacity market to be viable. “They are not like normal new build,” says Zhang. “They will be bidding in at a few pounds per kilowatt and that basically crowds out other new build generation.”

There are numerous additional projects in the pipeline, meaning interconnectors will likely continue to drive down prices in future auctions.

Following their previous success, recips and batteries took multiple hits to their business models, partly in the name of levelling the playing field with other technologies. The triad avoidance payments available to distributed generators were slashed, new emissions limits were introduced for mid-sized generators, and the de-rating factors for shorter range batteries were reduced.

There will now be questions as to whether interconnectors will and should see similar changes, and not without reason. As well as being subsidised through the cap and floor regime, they have exemptions from transmission and balancing charges and do not face the same carbon price as domestic generation. Aurora has estimated these exemptions to be worth around £10/MWh.

Importing coal power

Zhang says the presence of interconnectors means Great Britain is “basically importing power generated by coal plants in Europe and that means, at an EU level, emissions are actually going up”.

Arguing for the removal of the UK-only top-up to the European carbon price, the carbon price support, Tom Glover, chief commercial officer for RWE Supply and Trading, previously said: “I optimise power stations across Europe and I know that when I turn down my gas station in the UK, we turn on a coal station in Europe because of the carbon tax. If that is sensible carbon reduction, then it doesn’t make any sense to me.”

Dieter Helm’s cost of energy review argued instead that the carbon price support should be applied to imports, a recommendation that was also backed by a recent report from University College London.

However, the exporting of emissions is not the only concern. The Centre for Policy Studies has warned a growing reliance on interconnectors will leave Great Britain exposed to supply disruptions and price spikes led by developments in the rest of Europe.

Although she concedes it is “quite difficult” to measure the level of security of supply interconnectors can offer, Zhang says it may be worth reviewing their de-rating factors to ensure they are not being overcompensated.

Prospect for CCGTs

But without changes, will CCGTs continue to struggle in future auctions? Not necessarily, says Zhang: “People will be asking if the price will stay so low. We think that is not really the case. We think that every year’s auction is different. You have different sets of uncertainties and you’re looking at different levels of demand and supply.”

This year’s auction was hugely oversubscribed, with more than 74GW of capacity bidding for around 50GW of contracts.

Cornwall’s Edwards says CCGTs will only find success when there are substantial closures of existing generation: “We didn’t think that was going to happen this year and probably won’t next year either because we’ve got to wait for a large exit of capacity.”

First on the horizon is coal. The Ratcliffe and Drax units that secured agreements are all compliant with the Industrial Emissions Directive, and Edwards thinks they are likely to remain open through to 2025 – the year by which the government has pledged to phase out all unabated coal generation.

Although Aberthaw, Cottam, Fiddler’s Ferry and West Burton A all failed to secure agreements in the latest auction, they all also have capacity contracts for future years, several of them running through to 2020/21. Edwards says he sees “no reason” why they won’t attempt to extend their lives further by bidding in future year-ahead (T-1) auctions.

Aside from coal closures, he says the next “big pinch point” will come in the mid-2020s, when existing nuclear plants start to close. “That’s when gas really should come into its own and be able to capture the market.

“However,” he warns, “if there’s a bunch of new interconnectors sitting around, there’s going to be no market for them to capture, and then it will be a price fight between them and smaller reciprocating engines who are just cheaper.”

Exodus of capacity

The “big exodus” of capacity from the latest auction at around the £40/kW mark suggests this is the clearing price that most new build CCGTs require to be economically viable.

Edwards says they are not only likely to be undercut by other technologies, but also by refurbished gas plants.

“The older gas fleet is also ageing, and they will also start coming to the end of their lives in the 2023 to 2025 period,” he explains. “But they’re prime sites. They’ve got transmission connections. They’ve got gas ­connections… King’s Lynn proved it could refurbish at £22.50/kW and that’s not anywhere near the price that a new build is going to need.”

Aurora’s Zhang argues some new builds will be able to bid lower than Edwards ­suggests: “Our analysis shows that CCGTs can break even at around the high twenties – so £25/kW and above.”

She says some plants will face more favourable transmission charges due to their location, while prices for CCGTs ­themselves are falling, with capex cost now coming in at under £600/kW.

Whether this will be low enough to fend off the stiff competition from a growing list of rivals remains to be seen. CCGT developers will now have their sights set on interconnectors as they fight for their place in the future energy system.