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Market News

 April 15, 2005
The rise in electricity prices - the future of the energy market

 Brighton, United Kingdom - In the 12 months prior to March 2004, electricity prices have risen by 25% and are expected to rise a further 30% in the next twelve months; then further rise beyond this period. Lets look at reasons behind this trend and explains how CHP can protect commercial, industrial and public sector energy users against rising prices.

The price of electricity has been at an unsustainable low level, mainly due to workings of the New Electricity Trading Arrangements (NETA), which came into effect on 27th March 2001. The problem with NETA is that the system supply capacity is market-driven not policy-driven. Therefore, the market that has been created is not designed to recognise that a certain level of overcapacity is desirable and necessary. Indeed, it does not pay generators to consider the bigger picture - thus short-term thinking is the order of the day. This has to change and it has to change in the very near future.

The pressures of NETA have generated a market where marginal plant is forced off-line to the point where the plant margin has fallen from 15% (before NETA) to its current level of 10%. This represents too small a reserve in a market where the growth in demand for electricity is rising at a rapid rate.

In the last three years, over 3.5GW of capacity has been mothballed, with only 1.5 GW currently being built. Many of these mothballed plants cannot be re-commissioned easily or cheaply for environmental and maintenance reasons. Significant further investment in power generation is necessary or this could lead to an increased possibility of black-outs in specific regions. In a recent Security and Supply Issues debate in the House of Lords on 7th January 2004, Lord Tombs argued that these low plant margins would be inadequate and would bring serious risk of prolonged disconnections. The investment in new power plant is absolutely essential -- and is needed now.

Coal-fired power will become expensive to operate, due to the high cost of investment in environmental emission controls to meet European emissions standards and DEFRA's National Emissions Plan (NEP). Coal-fired power stations will be allowed to burn more coal but will have to purchase emissions credits - which at today's prices will add in the region of £7/MWh -- a cost which we can expect to rise. Significant investment in new, natural gas-fired, combined cycle plant is necessary which will drive electricity costs higher.

Taking the most recent figures available (February 2004), the generation mix currently consists of generation from three sources in broadly equal proportions: coal-fired power stations, gas-fired combined cycle power stations and nuclear power stations. Nuclear power is expected to be one third of its current level by 2015, carrying with it a high decommissioning cost.

The Renewables Obligation places a legal requirement on electricity suppliers to obtain an increasing proportion of their electricity from renewable sources. If they fail to meet these targets they could face heavy penalties - for major power suppliers, these penalties could amount to £100million per annum. Under the rules of the obligation, these funds would then be redistributed to competitors who do meet their targets. The target percentage of electricity from renewable sources started as 3% in the year 2002, rose to 4.3% of electricity for 2004/2005 and will rise to a significant 15% by the year 2015 with the expectation to rise to 20% by 2020. Electricity suppliers have to prove their compliance to this legal requirement by providing Renewable Obligation Certificates (ROCs) equivalent to their target obligation. If a supplier fails to show proof of ROCs for the required percentage, they have to pay a penalty of 3.139p/kWh (index-linked) to the government. In February 2004 alone, shortfalls in electricity generated from renewable sources cost the electricity industry in the region of £50million. With a rising obligation, the pressure will drive the price of ROCs upward, driving the price of electricity generally upwards.

On 1st April 2001, the government introduced the Climate Change Levy, subjecting all non-domestic energy consumption (ie. gas, electricity and coal) to tax with the potential to increase the average electricity bill by 13% and the average gas bill by 30%. By increasing non-domestic energy costs, the government wishes to encourage the application of energy saving measures in commercial and industrial environments. Secondly, tax exemption on Renewable and Combined Power encourages the use of these technologies as a means of reducing CO2 emissions. The deductibility of CHP savings is dependent on efficient use of heat (>80%).

In the last 12 months prior to March 2004, electricity prices have risen by 25% in that period and are expected to rise a further 30% in the next twelve months.

Currently gas prices are typically 3 times lower per unit than that of electricity. The spark spread, which is defined as the ratio of electricity price to gas price, is expected to rise in the medium to long term. Whilst over the last 6 to 12 months, the price of natural gas has risen by around 16% - 20% to May 2004, this is significantly less than the recent rise in the cost of electricity. Whilst short-term indications point to a rise in gas prices, the medium to long-term view on the price of natural gas suggests that a abundance of natural gas by 2007 may contribute to the lowering of natural gas over the long term. Should this long term lowering of natural gas prices not occur, then the result would be a further increase in electricity prices due to the increasing proportion of generation from natural gas.

The answer to this problem is CHP, commonly accepted as a useful way of hedging against future increases in energy costs, and also the possible introduction of further energy/carbon taxation. In addition to this, we are now in a position where because of the pressure on CHP providers to compete with artificially-low electricity pricing, the overall cost of CHP related products and services has been driven to an all-time low, making this the optimum time to invest in the technology.

Undoubtedly, the combined effect of the increased cost of electricity, together with any additional legislative drivers, will create a climate of supply and demand which can only result in a subsequent increase in the component cost of embedded generation. There is evidence that CHP suppliers will come under rising cost pressure influenced by the price of mild and stainless steel used in the manufacture and installation of CHP systems. Consequently, the current economic environment provides optimum conditions for those wishing to enter the market for CHP.

CHP provides users with a net reduction in overall energy consumption and hence cost, significant reductions in CO2 emissions, and security against present and future energy/carbon tax. CHP can also offer other strategic benefits. These include grant funding through the Community Energy Programme, Transco Affordable Warmth, the EC and the dti New Opportunities Scheme. It also offers advantages in emissions trading. Whilst the full implications of the EU Emissions Trading Scheme are yet to be finalised (emissions reduction projects and activities located within the EU and the UK will have to wait until 2008 before they can generate CO2 credits), it is already established that there is potential for CHP schemes of less than 20MW (thermal rated input) to be considered as eligible projects. The inclusion of CHP and tri-generation will also provide increased security of supply both electrically and thermally. And finally, Building Regulation Section L compliance (both asset rating and operational rating) are enhanced through the use of CHP on site.

In summary, by investing in CHP plant, end users can save money, save energy and save the environment. In the current economic climate for electricity, few companies can afford NOT to invest in CHP.