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20/08/2013

The Belgian Electricity market: overview, analysis of todays issues and suggestions to fix it

The Belgian energy market is facing more and more challenging structural changes. The massive integration of renewables, the integration of Europe in the energy strategy, the decline of nuclear production and the investissements of international companies will entail a complete redesign of the energy system. The energy landscape and the current fleet of power plants will become more difficult to manage as the gas fired power plants face profitability issues, the renewables are intermittent and the nuclear baseload is disappearing. Sia Partners provides an overview of the main forthcoming challenges, quantitatively underbuilts, explores Belgium's plan to face these challenges and gives some recommendations for the politics to clear the way to a strategic roadmap.

? Current major dynamics influencing the electricity market

The European Policy is steadily more integrated to the Belgian Policy

The Belgian Energy Policy is more and more shaped by a European context and in specific by the EU 2020 targets for greenhouse mitigation, renewable energy and energy efficiency. This piece of EU legislation has, among others, introduced an Emission Trading System (EU-ETS) as a key tool for cutting industrial greenhouse gas emissions cost effectively, National targets for emissions and a specific share of renewable energy sources in final energy consumption. It was also the EU that made the Belgian energy market move towards a liberalized market (1999 - 2005).

National Law and Regulations create competitive differences between countries

The introduction of new measures like taxes on gas use and injection tariffs (although they were recently rejected by the Brussels Court of Appeal) create uncertainty for energy producers and investors as they are important competitive disadvantages for the Belgian power plants thus influencing financial decision making.

The massive integration of intermittent renewable capacity will stress the current energy production

In Belgium, the European 20-20-20 objectives have been translated into an objective of approximately 21% of the generated electricity coming from renewable sources, 12% renewable heating and cooling and 10% renewable consumption in transport. Wind and solar PV production will respectively be multiplied by two and nine between 2010 and 2020. This generation is intermittent, dispersed and weather dependent. Consequently, it impacts grid stability and might cause grid issues such as congestions or imbalances in case of high or low generation respectively. More flexible capacity needs to be callable in order to cope with congestions.

The closing of nuclear power plants will imply a decline in base load generation

Belgium's energy system is about to face an important future challenge as the Belgian government decided in 2003 to definitely step out of nuclear generation in 2025. Currently, nuclear energy represents almost 6000 MW of installed capacity, generating more than a third of the total generated electricity. The nuclear capacity constitutes a predictable, cheap and stable production that might be partly replaced by renewable generation.

? The reality of the liberalized market

Generation adequacy: the current organized market is not motivating energy industries to invest into new capacity

A liberalized market should lead to representative prices and security of supply by timely and adequate investments as a reaction to price signals. The reality however seems to be different with a decrease in investments. The current situation is characterized by a decreasing tendency to invest into power plants as the economic outlook doesn't look good. The business case of an investment plan doesn't create enough value in comparison with investments abroad. Guarantees of revenues also disappear as the prices are more volatile and regulations are changing more than they used to do before liberalization.

Flexibility: the current European policy is favourable for the renewables but not for a stable energy mix

While the EU massively supported the development of renewable energy sources, it unfortunately also faced a slight lower demand creating two paradoxical issues: one of overcapacity and one of under capacity. The issue of overcapacity arises due to the massive investments in renewable energy combined with a slight lower demand and an electricity system characterized by its limited flexibility and interconnection capacity. The issue of under capacity on the other hand arises due to the intermittent character of these renewables, (planned) closures of power capacity and limited cross border capacity. Thereupon, our most flexible power plants, especially gas fired power, are under pressure due to profitability issues and a decreasing number of operating hours.

Durability: the EU-ETS is not reducing emissions and coal is cheap

The EU Emission Trading Scheme is designed to reduce emissions by putting a price on carbon, favouring more clean technology. However, the price of carbon plummeted. The system has been designed in the mid-2000s when growth was strong and future demand for carbon allowances where expected to be high, ensuring a sufficient high price. Unfortunately, too many allowances have been allocated and the demand for allowances has decreased due to the economic crisis resulting in an oversupply and corresponding crash of the price.

Today's reality? Because of an abundance of cheap gas in the US, cheap coal floods the European markets. As a consequence, Europe is burning more coal while demand for gas, emitting far less CO2, is declining. A situation thus arises in which a lot of money is invested into renewables to reduce CO2 while more polluting coal fired power is again increasing, counteracting the benefits you are getting from renewable energy. Moreover, the EU Parliament recently voted down an EU ETS intervention. Mainly because of the economic crisis and the concern about the competitiveness of the European industry, not many short term movements on the European level are expected.

? How Renewables push gas fired power out of the merit order

The merit order is a historical way of ranking available sources of energy for electrical generation in ascending order of their marginal cost so the one with the lowest marginal cost is first brought online and thus first meets demand. The introduction of renewables has an important impact on this merit order and thus the operating hours of the Belgian power plants as illustrated by following figures.

Source : Sia Partners
Click to enlarge

Some actual consequences of the current context:

  • Following the European policy to make renewables a virtual priority in the merit order and the disappearance of nuclear capacity, the functioning is structurally changing;
  • The increasing share of renewable intermittent capacity has a big impact on the operating hours of gas fired power plants as above figures illustrate;
  • The increasing taxes and gas prices additionally reduce the number of operating hours of gas fired power plants as they are pushed out of the merit order;
  • Although base load foreseen, gas fired power units are evolving to half load stations or even peak power plants: a function for which they are not designed;
  • Some power plants are not in the money anymore and decisions are taken to close the less rentable power plants (also see analysis below).

While a bigger share of intermittent renewables will certainly ask for more flexibility in terms of production and/or demand, the most flexible power plants, namely gas fired power, are pushed out of the merit order by these same renewables.

? Why Renewables and current regulation measures create less profitable gas power plants

The profitability of gas fired power plants can be evaluated through the clean spark spread formula. The prices of the power generated by the power plants should be higher that the prices of the gas and the costs to transform it including the carbon tax.

Source : Sia Partners
Click to enlarge

From those graphs (Sia Partners analysis) it is clear that:

  • there is a clear shift from profitable and large power output (2009) to non-profitable and minimal power output (2011), which is also a confirmation of the merit order analysis;
    • the number of days with a positive CSS rapidly declined from 327 in 2009 to merely 77 days in 2012.

Regarding these numbers, one can more easily understand the decisions made by some operators to stop or close some units and confirm that gas fired power plants face structural profitability issues.

? More intermittent energy asks for a more flexible electricity system

Electricity demand and supply has to be balanced for the system to work properly. Increased penetration of intermittent renewables will as a consequence ask for more flexibility in terms of electricity generation power and/or demand, currently delivered by the interconnection capacity, flexible power plants such as gas and to a limited extent, by pumped hydro.

When an imbalance between generation and consumption occurs on the electricity grid, the Transmission System Operator (TSO) in question uses a range of mechanisms to restore the balance like exchanging the imbalances with foreign TSO's or accessing contractual reserves (primary, secondary and tertiary) of upward or downward regulation volumes. The graph (Sia Partners analysis) beside gives an overview of the used regulation volumes since 2006.

Together with the increasing share of renewables in our energy mix, the use this regulating capacity in Belgium has doubled since 2008 (see graph). A bigger share of renewables, causing an increasing need for flexibility, the lack of base load capacity and the closing of less profitable power units can cause a structural problem of absorbing intermittent capacity and providing sufficient capacity at all times.

? On the short term, new technologies are not offering the way out

The way to which a power system can cope with variations in supply is governed to an important extent by its flexibility - how quick can the system increase or decrease its supply or/and demand - in order to maintain balance? Sia Partners analyzes mainly from a cost perspective a range of technologies that can for most of all contribute in bringing in a short term flexibility to balance the Belgian grid.

Source : Sia Partners
Click to enlarge

Note that Belgian hydro power has almost been fully exploited and that the majority of storage technologies still have to be brought to a stage of commercial maturity, entailing a significant scale, a better performance and an economical viable business plan. Compressed air energy storage might be an exemption with significant potential; unfortunately, it is not yet investigated in Belgium. Increasing the share of gas fired power in the energy mix, expanding the interconnection capacity and demand side management are the other options left.

? The current Belgian Strategy: The Plan Wathelet

Belgian Secretary of State for Energy Melchior Wathelet reckons the Belgian electricity system is in a transition period, facing adequacy and flexibility issues. As a response to these issues, to ensure security of supply at reasonable cost and with respect to the transition to a new energy model, three mechanisms are proposed (Plan Wathelet - July 2012):

(1) A better framework for definitive and temporary closures of production units. A new legislation is proposed, making possible that a specific production unit stays available in a strategic reserve, only to be used when the security of supply is threatened.

(2) A better planning for the nuclear phase-out, including the provision of the extended part of the nuclear capacity on the market.

(3) Triggering the procurement procedures foreseen in Belgian and European legislations to install new production capacity. The government will make it possible to get an assured profitability of the new installed capacity.

? Which recommendations are highlighted by Sia Partners to face with this current context?

Our electricity markets are going to major changes. Among others as a consequence of the need to generate a larger share of electricity from renewables, the operating hours and profitability of necessary flexible gas fired power units are being reduced. This is a problem which is among others already clearly visible in Belgium, raising concern about the generation adequacy, the flexibility and the durability of our electricity system. Awaiting a future with a real integrated European grid in which energy storage, hydrogen, demand side management and other promising technologies might play a key role, following options are provided to above issues.

Create a stable long term vision with interest for a new market model that goes beyond the current market model

An energy market is a market characterized by its capital intensity, its long investment cycles and its European scale. Loose from the nuclear phase out decision, a clear long term investment framework without any form of uncertainty is therefore an absolute prerequisite. Ideally, such a long term framework has to be framed in a European context and will most probably have to go beyond the current market model and with more interest for flexibility and capacity remuneration. Today's decisions shape the energy mix for the next decades.

Review national competitive disadvantages

Energy and greenhouse gasses are both products not bonded to a country, greenhouse gasses do not stop at the border of a country and neither does electricity. The energy market is a market of European scale and as a consequence, it also has to be treated that way. In this context it is proposed to review every measure that may form a competitive disadvantage to our power units such as injection tariffs, extra taxes on gas use, etc. These measures both make our power units less attractive and thus competitive as they lead to a lower number of operating hours with profitability problems as a first consequence.

Investigate a Capacity Remuneration Mechanism for at least all gas fired power units

Although they have a key role in every energy transition scenario, they are indispensable for grid stability and they are by far the most durable fossil fuel fired power source, gas fired power units are currently not remunerated for the flexibility and the capacity they make available to the market, a.o. by being bid out of the market by coal and nuclear power. A (temporary) mechanism supporting all gas fired power is therefore definitely worth considering.

A Capacity Remuneration Mechanisms (CRM) refers to a (group of) mechanism (s) designed to provide an extra capacity-based revenue stream as a complement to the energy-only market. The height or the amount of support can be designed in such a way so it corresponds to a sufficient amount of capacity for the market. A CRM provides investors with a minimal guaranteed stream of revenues for their investments, solving the profitability issue, creating incentives to invest and ensuring the security of supply. As a consequence, also price volatility is reduced. Such a measure can be framed in the energy transition in which flexible gas power units will certainly play a role. It may be clear that this does not has to be a permanent solution but that it also can serve as a transitional measure awaiting a European solution.

Regarding the costs of existing and new gas fired power units, this proposal might be an overall cheaper solution compared to the measures proposed in the plan Wathelet, only focusing on new power units or strategic reserves not interacting with the market. Increasing the share of gas fired power into our energy mix leads to higher flexibility, higher durability and clears the way for a deeper penetration of renewables in the energy mix. Given the fact that the EU is not planning to intervene in the EU-ETS system, national action might be the only, though absolutely not perfect, way to keep gas fired power plants competitive.

Invest in and investigate the technological potential in Belgium

It is clear that there are certainly some technological options with the potential to contribute to our electricity issues. Energy storage technologies can be a part of a general answer to our future energy challenges. Electricity generated by renewables such as wind and solar are intermittent sources. Electricity storage can optimize the energy flows between supply and demand and clear the way to a deeper penetration of renewables in our energy mix. Different technologies are currently under development in multiple countries but Belgium is lagging behind both in terms of research as in terms of application. Innovation could be key in order to challenge this status quo. CAES is a technology which might definitely have potential in Belgium. The actual necessary investments in technology are a pending question mark, one which urgently has to be answered.

Adriaan De Geyter - Sia Partners

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