The End of Conventional Power Generation?
The energy transition is about bringing a long term structural change in our energy systems. It involves changing the way in which we satisfy our energy needs, both in terms of consumption as well as production. With electricity being one of the largest energy sources, the composition of our power generation portfolio plays an important role in the energy transition. Traditionally the investment in new generation units is characterized by long payback periods. Market conditions as well as regulatory changes have had a significant impact on the business case and related asset profitability. This has urged power producers to review their investments and decide on the future of their production assets, for which it is crucial to maintain a life-cycle cost approach. Given the options available to energy companies, how will the Dutch conventional generation portfolio develop?
Operating in unfavorable market and regulatory conditions
It leaves no doubt that the current market conditions have become challenging for traditional power producers. Over the last couple of years, the energy market has been impacted by several major developments, amongst which:
- Large overcapacity, as a result of large investments in new generation units. Since the start of the economic crisis in 2008 over 14 GW of capacity was added to the Dutch grid, while demand decreased.
- Decreasing usage rate of Dutch conventional generation units, due to large import volumes of (subsidized) German power.
- An increased competition and lower wholesale prices (-33% since early 2009).
- Historically low coal prices, leading to coal-fired power plants being able to obtain a better position on the merit order compared to gas-fired units
- Ongoing regulatory developments, aimed at lowering carbon emissions, resulting in the closure of inefficient coal-fired generation units and the subsidization of the use of renewable energy sources
The future of fossil-fueled power plants
In the light of this more and more renewable energy-driven world, power producers need to review their asset portfolio. In making the right decision a life-cycle cost approach may be used, which entails making a careful consideration of all costs and revenues associated with the ownership of an asset over its lifetime. One needs to explore the environment in which their generation units may operate five, ten, or even twenty years from now. Different scenarios for the future could be constructed, in which the following options may be considered for generation units:
1. Remaining operational
3. Conservation (‘mothballing’)
The first available option, to keep the fossil-fueled units in base-load operation mode, is mostly interesting for coal-fired power plants. Based on current coal, gas and CO2 prices, the clean dark spread averages around €11/MWh, whereas the clean spark spread is negative at -2,20/MWh. If operation cannot be continued while remaining profitable, the generation unit could be renovated to increase efficiency or flexibility, or to reduce costs. For example, Engie (formerly GDF Suez) recently installed a low-capacity cooling system in one of the units of the gas-fired Maximacentrale to keep temperatures down while the unit is not generating power. Such adjustments may improve its position in the merit order and increase the employability of impacted generation units, making the business case for competing units even more difficult.
If renovation is too costly, ineffective, or technically impossible, power producers can also opt for short to long-term mothballing, which entails a temporary closure of the power plant, until market conditions improve. However, this option needs to be carefully assessed. On the one hand, conventional generation units will most likely continue to lose ground to renewables on the merit order. On the other hand, (flexible) conventional assets will still be required to supplement renewable generation and act as a backup for less sunny and windy days – improving the business case for gas-fired units due to its higher level of flexibility. While mothballing is intended to directly cut back fixed operating costs, a restart in the future may be expensive as a major overhaul of the technical installations will be required, new personnel has to be recruited and supply lines reopened.
Finally, the worst-case scenario is the (forced) closure of the power plants. Although this option will come at a cost, it can also offer the possibility to decommission and relocate the turbines to another location, which could be a potentially attractive solution for power producers. If a power producer is legally forced to close one of its plants, it could however receive compensation for the loss of revenue incurred. Nevertheless, a forced closure will definitely have a negative effect on the expected rate of return.
Other options have been considered as well, such as linking the currently mothballed Clauscentrale to the Belgian grid, but without result so far. The limited amount of interconnection capacity available and the high lead time to generate additional capacity means that generation units will mostly have to stay deployed for the Dutch market. The figure hereunder shows the current situation on the Dutch power generation market, with several power producers having already opted for one of the above options. It becomes clear what choices power generators have made so far: coal-fired units remained operational, while many gas-fired units have temporarily ceased operations.
Figure 1: overview of power generation units in the Netherlands.
What will the Dutch generation portfolio look like in 2020?
Needless to say, current market conditions do not call for additional investments in large-scale conventional production capacity, and as such no investment plans are known. Conversely, regulatory changes are affecting the continuation of existing generation units, as the imposed energy efficiency standards for coal-fired units (a minimum of 38% in 2016 and 40% in 2017) are forcing the closure of five generation units in the Netherlands, removing over 2700MW of capacity from the grid. Scenarios for removing even more coal-fired generation capacity have been announced, though the actual decommissioning may take many years due to the inevitable legal issues. Meanwhile, the negative outlook for the profitability of gas-fired units does not create an incentive for mothballed units to resume their operations. Hence, it is expected that the conventional power generation capacity will decrease, while being further pushed out of the merit order due to the commissioning of large offshore wind farms agreed upon in the ‘Energieakkoord’ (4450MW of generation capacity by 2023).
The consequences of the low utilization rate of gas-fired units and the associated process of mothballing new and efficient power plants are already visible. Over the past months, many energy companies depreciated the value of their mothballed asset portfolio, leaving deep tracks in their financial reports. For these companies, it may be vital to find cost-saving measures elsewhere within the organization, and push for a capacity mechanism to increase revenue in the future. With the increasing share of renewable energy sources, gas-fired units might once again regain their profitable position in the merit order by providing flexibility to the power market, though . While this seems like only a matter of time for gas-fired units as a result of improved market conditions, the future doesn’t look so bright for coal-fired units, which might have to cease operations due to regulatory pressures. The challenge for both will be to find the optimal balance between daily operation and final closure, to survive now and in the future.
Copyright © 2015 Sia Partners
 Source: TenneT: Monitoring security of supply 2013-2029 report
 Source: Endex, year-ahead future prices
 Source: Energeia (http://energeia.nl/nieuws/654970-1512/stemming-afnemende-staalproductie-...)