How do we deliver new investment in gas?
Martin Pibworth is today [Sept 27th] addressing a security of supply debate at the Energy Institute in London. Here he sets out the path to encouraging fresh investment in gas generation.
SSE’s operational gas fleet currently stands at just under 4GW. But the question for many of us in the energy industry is how can we deliver new investment in gas?
It’s been clear for some time that many of the UK’s older coal and gas stations would close by the early 2020s and would need to be replaced by, amongst other things, new gas fired capacity.
Yet the UK has built just one large-scale gas fired power station since 2012 – and given the time it typically takes to deliver new capacity it is unlikely we will see any more before the end of the decade.
There are a number of reasons for this. Firstly, due to a number of structural changes in the electricity market over the last few years, gas has gone from an attractive investment opportunity to a loss-making business in the space of a few years.
These structural changes included reduced customer demand, changes to market price signals, and an increasing amount of renewables coming onto the system. The result was that gas ran less, and earnt less when it did run.
Secondly the Electricity Market Reforms (EMR) introduced to address these structural changes have delivered investment in existing gas stations, but have not yet delivered investment in new capacity.
The two key planks of EMR for gas investors were the Carbon Price Floor (CPF) and the Capacity Market. In theory the CPF allows gas to run more by making coal generation more expensive. This provides a strong signal that gas has an enduring place in the electricity mix, and helps to mitigate against swings in commodity markets.
For new build investors it also provides an economic benefit over existing gas plants, because new build is more efficient. Alongside it the Capacity Market auctions are meant to underpin investment by paying power stations to be available at peak times.
Some have criticised EMR for not bringing forward investment in new gas capacity. However it is important to make a distinction between investment in existing gas and investment in new gas. Before Electricity Market Reform there was no investment in either and existing stations were closing and being mothballed.
Since Electricity Market Reform however there has been a stronger signal to return mothballed capacity, and to continue to invest in operational plant. At SSE we’ve returned over 1GW of mothballed gas since 2015 on the back of the Capacity Market and Carbon Price Floor signals – so these have definitely brought forward investment in existing assets.
And I believe the portents for new gas investment are now much more positive. This is because the main reasons the Capacity Market and CPF have not encouraged investment in new build gas capacity are now being addressed. The UK Government has introduced a number of reforms to the Capacity Market, including a new auction for next year which is a very positive move, and Ofgem is looking at the issue of ‘embedded benefits’ which have been distorting the Capacity Market auction results.
Alongside this there was an extension of the current Carbon Price Floor arrangements in the last Budget to April 2021. The more the Carbon Price Floor is left untouched, and the more visibility investors can be given on its time horizon, the more effective it will be. A robust carbon support mechanism provides confidence to the market, enhancing liquidity and allowing gas station owners better opportunities to hedge their output. This reduces risk and makes investment cheaper.
I know that Brexit means there is some uncertainty about the future of our participation in the Internal Energy Market and the EU ETS. But I think in a time of uncertainty providing a clear signal that the Carbon Price Floor is here to stay until at least 2025 would be extremely positive. I would therefore ask the Chancellor to consider this as he looks forward to the Autumn Statement.
Indeed SSE is one of several signatories of a letter recently sent to the Chancellor from firms who own and operate coal, gas and renewable electricity generation, who believe putting a price on carbon emissions, through the UK’s Carbon Price Floor, is a critical part of the UK’s energy policy. I hope he will consider our message that the CPF is one of the most important policy tools the government has to help industry continue to deliver reliable and lower carbon electricity cost-effectively.
So overall the direction of travel is positive. The mechanisms introduced under EMR are the right ones – they have already delivered investment in existing assets, and I believe the changes that have been put in place to improve them can deliver investment in new build capacity as well.
There is more work to be done, most notably on the CPF and embedded benefits, but I believe there is cause for optimism.