Interconnection: small perturbations in a flat line graph

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There has been a veritable flurry of activity on the interconnector front over the past couple of months. No interconnectors as such, or even the prospect of new interconnectors in the near future, but quite a deal of fluffing of feathers and (sort of) discreet nest building moves that suggest that maybe there might just be something in it all.

There was the departmental paper ‘More Interconnection: Improving Energy Security and Lowering Bills’ in December. Before that, The Guardian reported in October that the Icelandic President was getting very excited about a possible 1000km interconnector following the signing of a statement of intent between the UK and Iceland. Such an interconnector could supply perhaps 1.5% of the UK’s electricity needs by the early 2020s. There was a proviso on his excitement however: that the UK would guarantee the cost of £4.3bn for the line to be laid and connected.

Then this month, in a less than generally noticed footnote to his letter to Ofgem about gas prices, Ed Davey asked Ofgem to ‘indicate what benefits there might be for competition and for consumers from further steps towards completion of a Single European Energy Market of which interconnection could play an important part’.

I’ve long thought that interconnectors (for electricity that is) are a real no-brainer as far as our future energy security is concerned. Britain is almost an energy island as well as being an, er, actual island; we can only source about 5% of our supply via interconnection.  Even at this measly level (Germany, for example, is able to source 14% of its supply through interconnection) interconnection makes an enormous difference to our putative supply margins (as I set out some time ago at the height of the ‘lights are about to go out’ scare of last year).

Ofgem doesn’t count interconnection as part of our national supply margin because, well, interconnection could go two ways, although analysis of the Brit-Ned interconnector last year showed that 99% of the time flow was into the UK. If it did count it, the regulator cheerfully records, the doomy-sounding 5% margin in 2015 would look like a far healthier 10% gap. So imagine what a relatively easily achievable doubling of interconnection would look like. You might even not have to build quite so many new gas fired – or even nuclear – powered plants in the future.

So why the snail-like progress because of course you couldn’t even start to argue that an Iceland interconnector might go two ways – what would a country that can hardly move for hydro power and a population the size of Cardiff want with ever importing electricity? The clue, I think, is in the Icelandic President’s reported ‘ask’ of the UK government: that the project is somehow underwritten in order to go out to tender. Tricky, because in recent years the assumption has always been that interconnectors should essentially be ‘merchant undertakings’  at no risk to consumers. Furthermore it was assumed that the money to pay off the investment should come from what the December DECC strategy paper calls ‘price arbitrage opportunities’. Another way to put it is that interconnectors should make their living out of speculation as to price differentials between the UK and Europe. But with moves towards a more integrated and liberalised European energy market the likelihood of these differentials decreases. Perversely therefore, greater connectivity on a merchant basis and a level energy playing field means a lower likelihood of additional interconnection being achieved. The full bullet point in the DECC strategy paper incidentally, reads: ‘questions as to whether price arbitrage opportunities adequately capture the benefits of interconnection including security of supply’.

So the little flurry of late is therefore pretty interesting. Because, as can be seen in the language of Ed Davey to Ofgem and in the way the case for  interconnection is put in the strategy paper, it is apparent that feelers are being put out towards a different way of doing things. Stupid question I know but could it be that ‘arbitrage opportunities’ really do not reflect the value of interconnection to UK security of supply, and that, subject perhaps to EU competition regs (see ED’s coded reference in his letter to Ofgem above), a real case might be made to underwrite such projects from the public purse?  That probably wouldn’t be difficult, since the EU has recently designated no fewer than three UK-continent interconnection proposals as ‘European projects of common interest’. This designation is not a million miles from what the UK Government has tried to put to the EU Competition Commissioners about another project not likely to come on stream until well after a number of interconnectors could be up and running, namely Hinkley C power station. That project will have tax breaks and an underwritten power price behind it but a problematic route to travel with EU Competition Commissioners.  Interconnection, on the other hand, currently has no assistance of any sort riding on it but does have a loudly banging and waving open door from the EU.

As I’ve said, it’s a clear no-brainer and wildly in the national – and EU – strategic interest to pursue. It just needs a little prejudice-swallowing to get going quite rapidly. And sort of well done to DECC for beginning to raise the possibility of such a turn around, albeit in deep code. It would be good just to get underwriting in the public interest out in the open and get on with it, though, wouldn’t it?

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Scary Ed or scary George? Investors choose…..

So who’s scaring off investors more? This is one to puzzle over, especially with the emergence on Monday of a letter from a number of global ‘investors in the energy sector’ (covered in the Independent here) that George Osborne’s removal of a decarbonisation target from the Energy Bill  risked the ‘£110bn overhaul of Britain’s energy network’.

Last week, of course we had a similar claim from Centrica and others in some of the national press that Ed Miliband’s proposals for a freeze on energy bills from 2015-17 would lead to exactly the same risk to that ‘£110 billion overhaul’.

I suppose, just to put the cat among the pigeons, we might look at some of the evidence behind these claims. Incidentally the new paradigm for what it will cost for this ‘overhaul’ seems to be more modest in ambition than it was just two years ago, when we were supposedly in for £200 billion (here’s what I said about that at the time).  This figure is now expected to be about £100 billion by the early 2020s ; still a very large number I would agree. All these figures, though, do seem to be derived from various scenarios from Ofgems ‘Project Discovery Energy Investment Scenarios’ – last revised in 2010. These ‘scenarios’ veered between a pot of £200 billion for its ‘green transition’ picture (which envisages that ‘there is a rapid economic recovery and significant new investment globally’) and £95 billion for the ‘slow growth’ scenario (which posits that the ‘impact of recession and credit crisis continues…generation build dominated by CCGT energy efficiency measures have limited impact..’).

So I guess the new agreed investment figure is towards the ‘slow growth’ end of the scenarios. But even so, it is made up of a number of components such as interconnectors, offshore wind, smart meters, onshore/offshore transmission, grid-strengthening and so on, which have little to do with what many consider to be traditional ‘energy investment’. In fact only about a quarter of total investment will come from what we think of traditionally as old-style, centralised power plants. The other three quarters will come from those less-familiar components, with over half the total coming from renewable generation itself.

And the significant feature of these investment figures is that the Big Six utilities will not feature heavily in the investment profile for these categories. Indeed if we look at the balance sheets of the Big Six, four of the six have net debts of more than two thirds of their market capitalisation. This means that they are unlikely over the next period to lever themselves up still further in order to splash the cash for investment in any of the sectors at all. Most of the £110 billion will have to come from elsewhere and will indeed do so.

And, by the way, if there is to be investment coming from the profits ofthe Big Six, it will hardly be damaged by what may or may not happen to their retail arms, which, as we know, Labour want to separate from their wholesale businesses.  The aggregate profit margin made by the Big Six on generation in 2011, as Ofgem records, was 24.4%, whereas for supply it was 3.1%. Whilst of course there is a connection between generation proceeds and supply prices, these figures hardly suggest a drying up of profits on generation. Separate retail companies at that point, with lower returns, would probably value and work best on some form of regulated price and return regime (but that’s another point entirely).

So where does that get us to? Well it looks like most investment will have to come from non-Big Six companies not primarily affected by a retail energy price freeze, but far more affected by larger instability and long term uncertainty. Long term uncertainty in an investment market which is seeking to finance the equipment and transmission that will need to sit alongside the different form of energy economy that we are all supposedly signed up to. And they seem to be the ones signing letters to the Chancellor right now.

That onshore / offshore UK / not UK plan in full

On the subject of interconnectors, I had a presentation made to me last week of a scheme called ‘Greenwire’ that is … er… about interconnectors but it isn’t. It’s also about offshore wind, but it isn’t. It’s also about on-shore wind, but isn’t really either. What it does seem to do is deliver possibly 3gw of installed capacity of renewables to the UK’s arsenal of low-carbon power, so the hand of the developer should be bitten off  just for that, but I suspect there will be a lot of protocol to be worked through first before any hands can be proffered up for biting.

So let’s see if I can describe the plan in one breath. It essentially entails developing  up to 3gw installed wind power at about twenty sites in the centre of Ireland. These sites are connected between themselves and then onto two large interconnectors  of 2.5gw capacity running across the Irish Sea to land in north and south Wales, and from thence feed into the Grid.  Good news, apparently: the UK gets two new interconnectors.  But… this possibility is for the future: in the immediate term the wind farms only would be connected to the interconnectors and not to the Irish Grid. That is, they would exclusively provide power for the UK, which is why I have described it as I have.

It is,  in essence a large offshore wind farm, with landing interconnectors of shorter distance than those that will be landing round three wind farm power from the Dogger bank. But of course the offshore wind farm is on shore: just not our on-shore.  And because it will in the first instance be connected exclusively into the UK, it will perform exactly the function that a large round three wind farm does, except that the power can be delivered, it is estimated at about two-thirds of the cost:  a little higher in price than UK onshore turbines, but much cheaper than ‘proper’ offshore.

So now to the protocol: would it be ‘imported’ power, like any import from a Norwegian or Icelandic interconnector might be? Clearly not, since it is not , as it were, touching the ground anywhere else other than the UK, although other, future supplies through the interconnector would be. So if it isn’t would it qualify for UK ROCs, or later for CfDs?  I would have thought so, except that, as matters stand it can’t since the ROC regime specifically excludes reward to power sourced beyond UK boundaries.  But if it did qualify, what kind of ROC/CfD would fit the bill? It is offshore , so would it get 2 ROCs? Probably not, because it … er… isn’t eventually actually offshore. But then it lands on the coast, so it must be. And it is more expensive to deliver, because it is landed, so perhaps 0.9 ROC wouldn’t be appropriate. My head hurts. I would think that a smart government might provide for some intermediate system to accommodate it. And there is some very, very buried indication that government might be thinking about this. This is what appears on p88 of the CFD Operational Framework document:

“CfDs may also be used to support generation that is located outside of the UK should the Government make the decision to do so. Before taking that decision, consideration would be given to how the CfD could apply to low-carbon generating plant located outside of the UK“.

The Irish government certainly is:  here’s what the Irish Energy Minister Pat Rabbitte said on May 28th:

“Given the scale of our wind resources, in the medium term we could be exporting wind energy on a scale that matches the total electricity consumption of the country. “We use 6 to 7 Gigawatts ourselves each year and I believe we could be exporting the same quantum to the UK and beyond in the coming years.”

Quite whether this means a ‘captured’ export remains  to be fully clarified, and there is at first thought, something odd about planting large number of turbines on someone else’s land and then taking all the product – but then I’ve just advocated doing almost that with Iceland’s geothermal energy, so there isn’t really a difference in principle. It would be interesting to see whether this sort of proposal gets the support of the 101 Conservative anti-winders. Is onshore wind OK so long as it’s someone else’s onshore wind?

I think that the bottom line of all this would be that the UK would gain two substantial interconnectors and a very large secure and permanent addition to low carbon capacity, probably well before 2020 so we should go for it. We just need to lock several very smart DECC officials in a room with wet towels wrapped round their heads to work out the details.