20 Jun 2019
Keeping the lights on
Investec’s Power & Infrastructure team, together with White and Case and Baringa, hosted a round table discussion with industry experts to discuss the future of the European power market - specifically the crucial role that existing thermal assets play in providing the base load needed to “keep the lights on” in Europe and the UK.
The successful adoption of renewable power in Europe and the UK in recent years has surprised even the most optimistic of supporters of wind and solar energy. However, it has also helped to generate a heady sense that the transition to a low carbon economy is nearly complete.
The current limitation of renewable energy and storage technology might require the markets to recognise that thermal power, and specifically Combined Cycle Gas Turbines (CCGTs), will be needed across Europe for at least the next 15 years to fill the growing gap in Europe’s and the UK’s power supply mix.
Investec stands ready to assist with its expertise and willingness to provide capital to support the market for both existing and new build gas thermal capacity. Our team has a deep understanding of the thermal generation sector, having funded more than 15 CCGTs globally since 2013.
In Europe Investec has recently been Sole Bookrunner and Mandated Lead Arranger on the financing of Saltend, a 1.2GW CCGT plant in Hull, UK and 1.3 GW Dutch CCGT power generation platform for Castleton Commodities International.
European and UK power markets at a crossroads
Many countries across Europe have seen significant political shift towards an all-renewable source of energy supply. This is largely due to growing public concerns about global warming and the increasing affordability of renewable power. The shift to renewables has been accompanied by an accelerated push to close down coal plants, while deep uncertainty remains over nuclear.
Over the next 10-15 years in Europe, according to Baringa, around 70 gigawatts of a total 90 gigawatts of coal energy capacity will be decommissioned. Over the same period, a further 30 gigawatts of nuclear power capacity will be coming off the grid.
Demand reduction and grid management technologies are only partly able to compensate for the ongoing closure of old plants across Europe which has started to put serious pressure on system margins and places power markets at a crossroads.
CCGT offers the cleanest, most efficient and flexible thermal energy solution to fill the gaps in Europe’s and the UK’s power supply mix
The case and challenges for supporting CCGTs
At the roundtable agreement emerged on the valid business case for existing thermal assets and, selectively, an investment need in new build CCGTs.
While renewable capacity is only going to grow and load factors will continue to improve, overcoming intermittency of power generation from solar and wind (sometimes for a long period of time) will remain a challenge as battery storage is still in its infancy, both in terms of technology and its high levelised cost.
For the foreseeable future CCGT technology offers the cleanest, most efficient and flexible thermal energy solution to fill the gaps that are likely to appear in Europe’s and the UK’s power supply mix.
However, CCGTs are still perceived by many as the last vestige of a sunset fossil fuel industry; until recently, historical owners of thermal fleets had taken a beating as a result of excess capacity arising from over-building in the run-up to the global financial crisis, the inroad of renewables and historically low carbon prices. System margins have however reduced with progressive coal closures and carbon prices have surged due to lasting policy changes.
The government has branded the low price at the 2018 capacity auction as a great outcome from a tax payer perspective, but a number of industry participants have pointed to the shortfalls of this mechanism – favouring incumbent generators or technologies such as interconnectors that may not provide the degree of security of supply needed in extreme weather events.
In 2018, the UK witnessed the legal challenge to the capacity market mechanisms, increasing the perceived regulatory risk and resulting in greenfield investments being held back. In the meantime, system margins are becoming dangerously low – narrowly avoiding blackouts – whilst market signals remain insufficient to foster new build of thermal assets. The situation is not unique to the UK – many European countries face similar energy transition challenges.
For the next 10-15 years, the outlook for CCGTs remains promising. The technology is improving and there is a lot of liquidity available in the bank and institutional debt markets for financing.
Increased market activity for gas power assets
In this context a number of utilities have embarked on exit strategies for their thermal power activities, focusing their strategy solely on renewables.
Many equity investors have previously held off investing in thermal assets due to concerns around revenue visibility and the difficulties in achieving a stable dividend payout. Given this, and the risk of funding “white elephants”, there is wide consensus that traditional equity investors will need a better regulatory framework and strong market convictions to feel able to invest their money in large scale new build projects.
Nonetheless, this situation has created an opportunity for investors that understand the current market dynamics and are able to take a view on CCGTs as an “interim” solution to be eventually replaced by renewable energy and storage technologies. Over the last few years coal closures, nuclear costs and regulatory vagaries have made operational, flexible and efficient CCGTs in particular far more valuable.
As a result, for the next 10-15 years, the outlook for CCGTs remains promising. The technology is improving and there is a lot of liquidity available in the bank and institutional debt markets for financing – both secondary acquisitions and new builds. Much like a back-up generator in hospitals, thermal plants need to be considered an essential utility and treated accordingly by government and regulators. It is the government’s responsibility to ensure security of supply.
Deep sector knowledge
Investec has structured deals successfully with and without capacity market support and is well-known for its deep sector knowledge. We believe that our approach
can deliver significant value to investors ready to embrace this challenge while helping the decarbonisation of the economy and aid the fight to keep the lights on!