Scottish and Southern Energy’s recent acquisition of AEP’s Fiddlers Ferry and Ferrybridge coal-fired plant has signalled the further consolidation of generation ownership in the UK, and has increased the vertically integrated structure of the market. It is little surprise that concerns are being expressed that the increasingly structured market is limiting free market forces, which in turn is raising concerns that the market is not working as envisaged when NETA was introduced in 2001. Although Ofgem has launched a consultation into the acquisition it is a safe bet that it will not be opposed.
The issue of vertical integration is not unique to the UK, but is a wider European issue. Indeed much of the recent integration has been propagated by European companies with three of the ‘big six’ UK utility groups being owned by European national champions. Since markets started along the path of deregulation regulators, both national and European, have not sought to deny takeovers, merely amending operation licences or, in some cases, insisting on virtual power plant auctions. The market is suffering at the moment with all European markets languishing to a degree through wide cross ownership of European generation and supply assets.
The irony of this situation is that all Member States are conceptually in favour of a competitive market but rather than develop a single open competitive European market as envisaged by the European Commission directives the Commission and national governments have instead created a single structured market. And in allowing this structured market to evolve regulators and governments have allowed psychological constraints to take hold, leading to a perceived reluctance among utilities to provide capacity and thereby reducing the incentive to trade this capacity.
With respect to capacity the main debating point is coal, which is further highlighted by the Scottish and Southern Energy acquisition. Conventional market practise is for generators to run coal more as base load plant, the rationale being that coal pant takes longer to warm up and therefore is less suited to being run as peaking plant. But with environmental constraints forcing investment in gas-fired plant and new renewable energy plant, and in particular wind power, there is a persuasive argument that coal plant could be used more as merchant plant, being brought online to meet peak demand. The rationale for such an approach is based on the high book value of new gas and renewable plant. As such these plant need to be run constantly if the investment is to be recovered over a short-time frame. Most coal plant, by comparison, is over 40 years old and has little or no capital costs remaining on the books.
This approach to coal is already being seen in Germany, where coal plant is being run as peak shaving plant because the heavy investment in new gas-fired plant requires this plant to be run constantly to pay off the investment. The economics of this strategy make sense as generators can make a return on the coal plant by limiting it to peak shaving operation.
When Scottish and Southern Energy acquired Fiddlers Ferry and Ferrybridge the obvious question was why would a company buy coal-fired plant that does not have flue gas desulphurisation units fitted, and therefore its usage will be constrained under the impending large combustion plant directive. But, as Scottish and Southern Energy explained when announcing the acquisition, Fiddlers Ferry and Ferrybridge provide it with a more diverse generation portfolio. And with the company seemingly not intending to add flue gas desulphurisation units it may well be that the company will look to run the plant as merchant plant similar to the coal plant strategy being used in Germany. From an economic perspective this would appear to make sense as the acquisition cost of £250 million (including fuel costs) could be recovered during the period of the large combustion plant directive by limiting the plant to peaking operation.
Indeed it may well be that the future of coal plant will be more for peaking operation purposes. Although the UK and European governments are committed to invest in renewable energy in order to meet their emission reduction targets there are concerns that this plant will not provide sufficient capacity to mitigate the loss of coal plant through environmental constraints. It is highly unlikely, for example, there will be a linear relationship between new renewable capacity being brought online and coal capacity taken offline. More likely, a large capacity of coal will be removed from the market before sufficient renewable capacity can replace it. In addition, renewable plant such as wind and wave power is intermittent plant. The concern therefore is that without any flexible coal plant there could be capacity shortfalls.
With the power market becoming increasingly more structured the operation of generation plant becomes increasingly pivotal to the utility business. And although coal plant is being progressively marginalised through environmental restrictions the efficient operation of this plant will be crucial not just to the generation business but also the wider market. As such the acquisition by Scottish and Southern Energy would appear to be an astute piece of business.
Oil dependency
In terms of column inches oil is big business. But it is big business that is starting to suffer from oil’s relentless price rise due to its dependence on oil. And with analysts believing $50/bl is now more probable than not the consequences of this oil dependency will prove expensive. This oil dependence permeates through the entire energy complex. High oil prices impact on gas and electricity, and, as a consequence, emission prices. Arguably this should not be the case in a competitive energy market. A competitive gas market should be priced primarily on gas-on-gas competition, which in turn would reduce the pricing reliance of electricity on oil. But even in markets where gas is theoretically de-linked from oil, such as the UK, oil prices have a strong influence on gas and electricity markets to the extent that oil has become a proxy market for gas and electricity. This in turn tends to undermine the real market fundamentals that should be influencing gas and electricity prices, and as a result undermines trading in these markets.
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