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Capacity Auction Lifeline for Gas-Fired Plant

deep sea oil£1tn. That’s the forecasted investment required to enable the recovery of the remaining North Sea Oil and Gas reserves.

Oil & Gas UK the UK Offshore Oil and Gas trade body claims in a new report that in order to extract the potential out of the remaining reserves contained in the UK Continental Shelf (UKCS) a £1tn investment is required or the forecast energy payload of 20bn barrels of oil equivalent (boe) will remain below ground for ever.

Malcolm Webb, chief executive of Oil & Gas UK said:

“Maximising recovery from the UKCS is the collective responsibility of all those who fund, regulate, tax and operate the offshore oil and gas industry and achieving our full potential will require a tremendous effort on the part of everyone involved.

“Our industry makes far too important a contribution to the economic and energy security of the nation to be allowed to falter at this critical point.”

Michael Tholen, Oil & Gas UK’s Economics Director agreed saying:

“We need a lighter tax burden, a simpler and more predictable system of field allowances and fiscal support for exploration. The outcome of the Fiscal Review, expected to be announced in December this year, must be relevant, radical and robust.”

North Sea Oil Production

Whilst North Sea production grew by 1% in the first half of 2014 following a £28bn investment in 2013, the long-term investment required is many multiples higher.

It is not only the difficulties of extraction, as less accessible reserves have naturally been left to last, it is also the tax regimes and opportunities available elsewhere around the globe that competes for the attention, expertise and investment of the oil majors. As difficulty increases so do returns diminish, overlay on that punitive tax levels and very quickly the 20bn boe can be rendered uneconomic.

But whilst the viability of extraction of North Sea gas is in question, the government are pushing ahead with a scheme that they hope will add much-needed new power stations to the current generation roster.

The construct of the UK generation market has been in trouble for some time, with fossil fuels out of favour, nuclear energy subject to a long-term moratorium and subsidy rich renewables popping up all across the UK, the market has changed beyond recognition.

Renewable Energy

This has led to a growth in intermittent renewable sources and the mothballing and closure of otherwise viable non-renewable plant amid a move to drive fossil fuel stations from the landscape.

Unfortunately however ‘new build’ generation plant simply hasn’t been developed quickly enough to fill the gaps created in capacity leading to a precarious supply and demand balance and the threat of black outs.

The government and industry, after decades of neglect, have realised something has needed to be done and have launched a ‘capacity market’ to encourage the production and development of new and existing plant.

These problems have arisen through a lack of investment in traditional generation sources amid an environment of long term uncertainty, something that is further exacerbated by the fact that until recently most fossil fuel power stations could expect to be commercially viable simply by selling electricity into the market. However this is no longer the case.

Government subsidies and environmental policy has driven the development of intermittent renewable power sources who are leaving traditional stations with the limited role of filling holes in the generation gap caused by renewable generation and in so doing undermining their business models.

The impact has been to render such plant as increasingly unprofitable leading to them exiting the market either temporarily (mothballing) or permanently.

The response of the government and industry has been to announce yet another series of subsidies to balance out the impact of the myriad renewable subsidies.

Energy Capacity Market

Step forward the capacity market, a reverse auction whereby power stations, both planned and existing, bid for the rights to generate a stated volume of energy, and are chosen based upon a lowest price wins basis. Their compliance is necessary, as more dependable generation sources are needed to take up the slack created by renewable intermittence and to thereby prevent wholesale blackouts.

In normal circumstances it would be expected that pre-existing plant would have the upper hand but these aren’t normal times and therefore in the latest 50GW auction, scheduled for December 18th, it is expected that many existing gas-fired power plants will want to use the auction to secure relatively high prices from 2018 and thereby allowing new entrant generators to bid lower and win the auction.

To add to the distortion new plant will be offered subsidies for 15 years, whereas old plants are only able to secure either one-year contracts, or three-year contracts and then only if they invest heavily in upgrades.

As a result, though National Grid say that although sufficient pre-existing plant has applied to enter the auction to cover the full 50GW it is unlikely that they will fully outbid the 9GW of new operators in the auction.

This could therefore mean that eight or more new gas-fired power plants could be built with a view to be generating electricity by 2018, which is ostensibly a good thing for a market facing regular blackouts.

However the capacity market isn’t without controversy and is forecast to add £14 to a typical annual household energy bill, just to keep the lights on.

In addition critics of the scheme say it hands a windfall to some existing plants – particularly nuclear reactors – which remain profitable even without subsidy given their ‘always on’ status.

However welcoming the upcoming auction as part of a wider government energy strategy, Ed Davey, Secretary of State for Energy and Climate Change said:

“At the same time as we’re building a new generation of clean, home grown electricity supplies, we have to deal with an energy crunch caused by a legacy of underinvestment.

“The high level of interest in the first ever capacity market auction – from large and small generators, and from both established and emerging players in the market – shows that we’ll be able to deliver the capacity we need, and get a good deal for bill payers in the process.”

A long overdue rebalancing of the fuel mix is welcome; let’s just hope we have access to enough North Sea gas to keep new and existing plant operating.