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20/02/2019

The NEMO-link: impact on the Belgian market

Elia, the Belgian Transmission System Operator (TSO), faced challenging conditions to keep the light on in November and December 2018. Decaying concrete at the Tihange nuclear power plant, combined with planned outages of three reactors at Belgium’s second nuclear plant in Doel knocked out 6 out of all 7 Belgian nuclear reactors at the end of October 2018. In a country where up to 50% of generation capacity comes from nuclear reactors (with a total capacity of 5761 MW compared to a peak demand of 14000 MW), Belgium had a substantial risk of a blackout. In order to cope with the situation, various sources of additional generation capacity were sought, including the re-commissioning of old gas fired power plants and especially the record-breaking import of power from neighboring countries.

Data from Elia shows that on a given moment on the 26th of December 2018, Elia was importing at a power capacity of 5234 MW, close to the 5500 MW maximum import capacity reported by Elia. With import capacity reaching its limits, there is good news for Belgium: the NEMO–link – a submarine power cable connecting the UK and Belgium – has become operational on the 30th of January 2019. As the NEMO-link increases the Belgian interconnection capacity by 1000 MW, Belgium will surely benefit from the NEMO-link in the short run as it increases the security of supply. But what will be the long-term effects of this cable? This paper explores both short- and long-term consequences that NEMO-link, and by extension, increased interconnection, will have on the Belgian electricity market and its consumers and producers.

Main consequences for the Belgian market

Effects on generators and commodity price

Power commodity prices are determined by supply and demand. In markets with high levels of renewable energy sources (RES), generators often face low prices for their renewable power due to the mismatch between demand and supply of RES. RES with a marginal production cost close to zero push other technologies out of the merit order. For example, PV panels mostly produce during the day (when there is much sun), while higher prices typically occur when demand is highest during a small portion of the day (in the morning and evening when consumers are at home). Generators are increasingly exposed to the risk of lower prices in markets with high penetration of RES.

In the worst-case scenario, this supply demand mismatch could lead to negative prices - a phenomenon sometimes observed in German market when there is high penetration of RES – where power suppliers have to pay their wholesale customers to buy power. Even though the idea of cheap energy prices and receiving money to consume power seems appealing, it also means generators and suppliers generate less revenues which are compensated by higher subsidies or consumer prices.

The NEMO-link will ensure gains both for generators as consumers by increasing the match in supply and demand:

  • Differences in wholesale prices: cross-border trade maximizes welfare by allowing increased trade between areas with higher prices and areas with lower prices which makes power prices converge. As prices in the UK are generally higher, the first market results of the NEMO-link show that power mainly flows from Belgium to the UK – during 95 % of the time BE exported to the UK during the first week of the NEMO-link operation, as illustrated by figure 1. Consequently, UK consumers will benefit from more competitive prices whereas Belgian and other European producers can scale up revenues from increased market opportunities on the UK market. The increase also leads to side effects for the Belgian consumer as well. While converging prices decrease UK consumer prices (that are generally higher), it also causes wholesale prices to go up for Belgian consumers.
  • Meteorological differences between the Belgian and UK market lead to differences in prices.  For instance, at times when there is much wind generation in Nord-England (leading to lower power prices in the UK) and little wind in Belgium (causing higher power prices), Belgian consumers can benefit from lower prices whereas UK generators can increase their revenue and vice versa. This makes the Belgian and by extension the European grid more resilient towards local meteorological conditions.
  • Differences in consumption peaks: Due to different time zones, there is also a shift in peak consumption between the two zones. As peak consumption goes hand in hand with peak prices, NEMO-link will allow consumers to benefit from lower peak power prices on both sides of the Channel.

Effects on security of supply

In the Belgian Energy Pact, Belgium policymakers have expressed the intention to decommission the Belgian nuclear park by 2025 and increase the share of renewable energy sources (RES) in the power mix. In order to make that happen, new investments in gas-fired power plants are needed to replace the nuclear park (baseload capacity) and complement intermittent renewables (flexible capacity). These flexible gas-fired power plants are also vital back-up generation when a power plant fails or during extreme weather conditions.

However, the large-scale deployment of RES, with low marginal costs, tends to push conventional gas-fired power plants out of the merit order, decreasing their revenues and overall utilization rate. Therefore, investors currently remain reluctant to invest in gas-fired power plants due to low return on investment. To ensure investment, the Belgian Government is considering to introduce a capacity remuneration mechanism – a subsidy mechanism that supports investors. Previous Sia Partners analysis showed that these capacity renumeration subsidies would attain around 39500 €/MW/year for CCGTs and 27300 €/MW/year for OCGTs. The NEMO-link will reduce the need for subsidies, and avoid costs for society, for two main reasons:

  • Reduce the need to build plants: By increasing interconnection capacity Belgium can forego some of the investment in additional back-up generation capacity as it can leverage additional UK capacity in times of need. Assuming that the NEMO-link – which has a capacity of 1000 MW - will reduce the need for back-up generation by 500 MW, cost savings between €20-10 million a year could be attained. As there is a time difference between the UK and BE, peak demand occurs one hour earlier in Belgium than in UK, which amplifies the decrease in need for back-up generation even more.
  • Reduce the subsidies needed per operational plant: Power prices in the UK are generally higher than in Belgium, consequently the NEMO-link will be mostly used for export. Belgian gas-fired generation plants thus will be activated more frequently and generate more revenues. Therefore, less subsidies will be needed to ensure profitability for gas-fired generations plants

Effect on balancing costs

In order to keep the balance between electricity production and consumption, Elia relies on Balance Responsible Parties (BRPs) such as producers and suppliers. These BRPs are responsible to maintain balance - between their injections, offtakes and trades - on their own perimeter on quarter-hourly basis. In case BRPs do have imbalances, Elia activates its ancillary services – a set of processes that keep the power system in operation, stable and balanced. The costs of these ancillary services are then passed on to the BRPs with an imbalance under the form of an imbalance penalty.

Overall, imbalance penalties can be quite significant for generators and suppliers: Sia Partners analysis shows that suppliers pay between 0.5-3.5 €/MWh in balancing cost for each MWh sold, depending on the portfolio and expertise in balancing its portfolio. Ultimately, these balancing costs trickle down to customers in the form of higher prices. The installation of the NEMO-link will allow to decrease the overall negative impact of imbalances due to two main effects:

  • Price effect: Due to the NEMO-link, Elia will be able to optimize its portfolio of ancillary services by also procuring ancillary services in the UK. This will increase competition for ancillary services and decrease overall procurement cost for Elia which will translate into reduced imbalance prices for suppliers/generators.
  • Volume effect: The NEMO-link will allow to decrease the total system imbalance due to a new scheme called imbalance netting. Imbalance netting allows to neutralize imbalances by pooling opposite imbalances on the grid of neighboring countries. For instance, if France has a positive imbalance of 200 MW (due to greater supply than demand) and Belgium has a negative imbalance of 150 MW (due to greater demand than supply), imbalance netting allows to pool these opposite imbalances and decrease overall system imbalance up to the residual 50 MW. This scheme thus decreases the overall volume of costly activations of ancillary services. There are plans to introduce imbalance netting in the UK as well, the NEMO-link will consequently decrease the volume of ancillary services needed and reduce costs for energy suppliers and generators.

Conclusion

In times of scarce capacity, Belgium will benefit greatly from the NEMO-link as it helps mitigate the risk of costly black-outs. In addition, increased cross-border trade power by the NEMO-link will increase overall European welfare in the long term in following ways:

  • Belgian and other European producers can scale up revenues thanks to increased export opportunities.
  • UK consumers benefit from lower wholesale prices powered by Belgian and European producers.

Overall, the aforementioned increase in welfare far outweighs the small increase in Belgian wholesale cost caused by converging prices, making the NEMO-link an excellent investment. Moreover, in the long run, the NEMO-link will increase security of supply and reduce the cost of balancing, avoiding costly investment in new back-up generation power plants. However, with Brexit looking around the corner, policymakers should be cautious on relying on the UK market to supply flexibility needed for its security of supply.

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