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The EU's vanishing electricity market


By Ross McCracken in London


March 22, 2012 - The EU's contestable electricity markets are shrinking. The deployment of subsidized Renewable Energy Sources (RES) is eating up the lion's share of new demand growth, or, where demand is contracting, they are biting deep into the share of the contestable market.


As a result, wholesale electricity prices are becoming increasingly disconnected from the cost of new generation plant. (See related chart: Generation plant dispatch)


There are two forms of power generation that have dominated new build capacity in recent years in Europe, and increasingly in the United States: natural gas-fired plant and wind.


This suggests that the backbone of the low carbon energy system of the near future will be flexible gas-fired plant responding to the vagaries of wind and other variable RES.


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This will be combined with baseload power from biomass and a declining amount of legacy coal and nuclear.


Gas will act as the hydrocarbon bridge to a more sophisticated low carbon smart energy system that will include a greater range of RES, backed by demand response, storage and other clever means of balancing electricity supply with demand.


Whether this is a viable proposition is an open question. It is certainly one that raises many technical questions, but it appears to be the literal outcome of the curious subsidized market hybrid that EU electricity markets have become -- at least so far. Gas and wind are, or perhaps were, the only games in town.


Marginalized market


The tension between subsidies and open markets is becoming more acute as the renewables sector grows in size towards the EU's 20:20:20 targets.


On the one hand, EU governments are willing to subsidize RES to achieve both security of supply and climate-related objectives.


On the other hand, the EU's institutions have historically been deeply committed to liberalizing EU electricity markets, fighting some member states inch-by-inch for more than a decade in pursuit of a single European market.


Throw in a double-dip recession and the outcome of the prioritization of climate goals is that the size of the electricity market genuinely open to competitive pressures is shrinking.


This has created two choices for energy companies: either enter a declining competitive market or pursue subsidy-backed renewables.


The first proposition is clearly much higher risk than the second.


The first option's lack of attraction is also very much the product of the second. As a result, the incentive to build gas-fired plant is disappearing and with it that bridge to the low carbon energy system of the future.


Market share


Gas-fired power plant has to compete against other energy sources, such as coal and nuclear, in wholesale electricity markets.


It has to compete for space on economic grounds in a shrinking contestable market against existing plant, much of which will have amortized some or all of its initial capital costs.


And, of course, it has to compete against subsidized renewables.


RES' off-take, by contrast, is usually guaranteed and prioritized. Feed-in-tariffs, renewable certificate schemes or the latest incarnation -- Germany's market premium -- combined with must-take guarantees, backed by utility mandates and priority dispatch mean that investment in well-established renewable technologies faces two main risks: planning and consents at various levels of government, and the possibility of retrospective regulatory action that takes away or reduces the benefits promised at the time of investment. (See related table: Germany -- total electricity consumed and share of RES)


Both risks are real, but neither has anything to do with whether new generation capacity is needed, nor at what price it might be commercial.


Next page: Electricity demand





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