Interview: Mark Somerset, Vice president & general manager, Intergen

“New gas plants need a counterparty buying the power or a capacity mechanism covering the fixed costs – or both”

The past five years of accounts for Intergen make for grim reading. Turnover almost halved from €1.2 billion in 2008 to €600 million in 2012 and the bottom line is red throughout.
As a business almost exclusively based on gas generation, it has been at the sharp end of the power market. An excess of power capacity combined with high gas prices have put the squeeze on Intergen’s three plants in the UK and two in the Netherlands. These power stations have dropped down the merit order and run just 15-20 per cent of the time.
Mark Somerset, vice president and general manager, admits conditions have been “very tough”, but appears calm and focused on the future. Intergen is a global company and the UK had previously been a “very profitable” market. “We do believe that markets are cyclical in nature. We have gone through a tough time and we will go through a better time.”
As old coal power stations retire faster than new forms of generation replace them, that better time could be imminent. Intergen is “front of the queue” to build new gas power stations, says Somerset – if government gets the incentives right.
We meet the fortnight after Intergen signs a £1 billion exclusivity contract with Siemens to build two gas-fired power stations. Somerset thinks Intergen has got a good deal. “It is a buyers’ market. [Siemens] are not building much in Europe, for obvious reasons. We hope we’ve caught it at a very good time,” he says. The agreement includes a “firm offer” on price, performance guarantees and a schedule for building and maintaining the stations.
The proposed facilities, totalling 2.1GW of capacity, adjoin two of the company’s three UK power plants at Spalding, Lincolnshire and Gateway, Essex, and will be able to take advantage of existing gas and electricity transmission links. “They should be very competitive,” says Somerset.
This puts Intergen at an advantage over other would-be gas power station developers, he says. “They will say they are ‘shovel-ready’, because they have planning consents, but they don’t have construction agreements like we do. We want to capitalise on that.”
Intergen still needs to secure finance before it can break ground, however. The world has changed since the late 1990s, when one of Intergen’s UK plants was financed without so much as a power purchase agreement (PPA). Now, Somerset expects even new, efficient plant to run only half the time, picking up the slack after nuclear and renewables have maxed out. That means it will be “very expensive” unless there are some income guarantees. “New projects today need a large creditworthy counterparty buying the power or a capacity mechanism that covers the fixed costs – or both,” he says.
Somerset is calling for action from the government on both fronts. The Department of Energy and Climate Change in June committed to creating a capacity market, through which gas generators will be paid for being available, whether they generate or not. The first auctions are due in the second half of 2014. The idea is to make sure there is enough back-up plant for when the wind doesn’t blow. The consultation period runs until Christmas and independent generators like Intergen are keen to get their message across.
As it stands, the ten-year contracts proposed for new gas power projects are “just too short” for institutional investors, Somerset says. “Although you could finance, it would add a big refinancing risk. If you stretch that loan out to 15 or 20 years, that would reduce the annual risk considerably.” He points out that the government is proposing 15-year contracts for renewable generation. “I don’t think we are being unreasonable,” he says.
He is also concerned about the penalty regime, which imposes fines on generators if, for one reason or another, their capacity is not available when the system most needs it. “At the moment, we have a proposal on the table from government that if you fail to meet your ‘stress event’ when called, you could lose the entirety of your capacity payment for the year.” Somerset and other would-be capacity market participants are keen to propose less punitive alternatives. “We have already made these points – it is a question of reiterating and coming up with a proposal ourselves. We are hard at it and it is absolutely critical for these projects.”
As for the wholesale power market, Somerset is starting to look for a long-term buyer but says the structure of the big six makes it difficult. “We can’t rely on the existing PPA market, because the vertical structure is essentially flawed. Under the vertical structure the large companies will self-build and they will look for pricing signals, but because liquidity is so poor, they are hard to see. When they do see signals, they will start to act, but that might already be too late… What we are trying to do here is break through that. All we are interested in is the most competitive generation deal we can get.”
He is looking ahead to a future Labour government for his preferred solution: break up the big six. That does not necessarily mean legal separation but a strongly policed self-supply restriction, he says. “What we are very supportive of is a reinforced separation of generation from supply, which is one of the points that [shadow energy secretary] Caroline Flint is talking about. We are supportive of a pooling arrangement, where generators have to sell their contracted volumes through the market.”
The other plank of Labour’s energy manifesto, a 20-month price freeze for consumers, sent shockwaves through the industry and sparked widespread warnings that it would scare off investors. Somerset’s response is understated: “We don’t think it is a good idea.”
He acknowledges that the idea has played well with the public. “It provokes a wider debate about what the energy market is for… In the old days, the state-owned industry was not a perfect beast. It had a lot of costs attached to it. It was not commercial but, yes, it kept the lights on.” Nowadays exposure to market forces, coupled with increasing government intervention and subsidy has made energy prices “a mish-mash which is quite hard to control”. He adds: “We would say as an independent generator, the best way to keep prices down is competition and that means much greater definition of your horizontal structure. That is our counter to any price freeze.”
That competition means Intergen’s gas power plants will continue to take their chances in an “increasingly volatile” UK market. There are a lot of variables. Intergen is “scrabbling about in the gas space” left by low-carbon generators. Somerset thinks next year “will continue to be challenging for us” but clean spark spreads – the difference between the power price and gas and carbon prices – will start to pick up towards the end of 2015.
He accepts that the technology has a diminished place in the merit order (“I know we are signed up, we have certain [climate change] obligations”), but he warns that if gas is crowded out, the sector could become “incredibly unbalanced”. He notes the high cost of some low-carbon technologies. EDF’s new Hinkley Point C nuclear power plant is to get a guaranteed “strike price” of £92.50/MWh, nearly twice the current wholesale price. “Wow, that is not a bad deal for EDF,” says Somerset. “Offshore wind is north of that. Even onshore is a hundred [pounds a megawatt-hour] and these are big sums of money.”
The real competition is coal, however, for the diminishing part of the market not taken up by low-carbon providers. Coal generators must shortly decide, in response to Europe’s Industrial Emissions Directive, whether to convert to biomass, upgrade to continue running on coal, or close by 2023. These decisions “will have a big impact”, says Somerset. “These investment decisions are major. What happens to coal is fundamental to our business.”
On the gas supply side, Intergen will continue to deal on the exchanges rather than seek direct contracts, he says. “We have not looked into sourcing a supply of gas specifically for the UK business. But it is very interesting to see the development of fracking in the UK. As long as it is responsible, I am very supportive of it… It seems to me, if you can source a large deposit of shale gas in the UK, which brings jobs and is reasonably remote from communities, it is worth doing. Gas is going to be with us for decades.”
When Utility Week interviewed Somerset in 2010, he talked about diversifying into renewables. Intergen is not investing yet, but he insists it is still on the cards. “We have looked very seriously at a couple of wind opportunities,” he says. “Strategically, that is the way I would like to take the UK business, there is no question about that.” It has been delayed by a couple of changes of shareholder, he says. “You need consistency to make such a step away from your core business. We have that consistency now and that is exactly what we are doing.”