james wang and Samuel ebohon | utility week | 6 November 2015
This article first appeared in Utility Week
There are clear benefits from increased interconnection but conventional generators in Great Britain will lose out because they cannot compete on a level playing field with generators on the continent.
In 2002, the European Union, as part of its aim to build “the most integrated, competitive and sustainable common energy market in the world”, set a 10 per cent target for interconnection between member states. This policy direction was reinforced in October 2014 when the European Council decided that this 10 per cent target needed to be achieved “as a matter of urgency” by 2020, and that interconnection levels should increase to 15 per cent by 2030.
Levels of interconnection in the GB market currently stand at 5 per cent of installed capacity. So the 10 per cent target, in conjunction with structural market differences between Britain and the continent, has incentivised the development of a number of new interconnector projects. These could provide 9.7GW of interconnection capacity by 2025 and link GB with neighbouring markets in France, Belgium and the Nordic countries. It is clear that this level of interconnection will have significant implications for the GB electricity sector.
Consumers will benefit because cheap electricity imports will help to maintain 2025 wholesale electricity prices at around today’s levels (despite assumed increases in inflation-adjusted commodity and carbon prices). These cheaper supplies would primarily be sourced from nuclear electricity from France and Belgium, as well as hydro electricity from the Nordic countries.
However, this downward pressure on prices will have a detrimental impact on domestic thermal generation capacity. GB’s thermal capacity is already operating at a disadvantage relative to capacity from the continent because of the significantly higher carbon price and other system charges. This means that, as the level of interconnection capacity increases, fewer new thermal plants will be built and the closure of existing thermal generation capacity will be accelerated.
A highly interconnected system would also substantially change the way that GB electricity demand is met. If all the potential projects come to fruition by 2025, a quarter of total GB electricity requirements would be met by imports.
This high dependency on imports will have a profound impact on security of supply. In particular, it will decrease our domestic de-rated margin (calculated as the sum of generators declared as being available during the time of the peak demand less the expected peak demand with reserve requirements) to negative levels. As a result, the UK will be heavily dependent on neighbouring countries to maintain adequate margins and keep the lights on.
Another effect of increased interconnection is that the associated CO₂ emissions emitted abroad from imported electricity will not be included in UK-specific carbon calculations. So while the replacement of local coal-fired capacity with renewable and gas-fired capacity is the primary driver of decarbonisation, increased interconnection provides a further boost to decarbonisation efforts. Sourcing more electricity through interconnectors provides a direct mechanism to reduce CO₂ emissions. In addition, the replacement of local coal-fired capacity with renewable and gas-fired capacity will act as another primary driver of decarbonisation. As a result, the UK’s CO₂ emissions from the electricity supply industry could be almost halved in 2025.
There is also a clear first-mover advantage for interconnector developers because incremental increases in interconnection will reduce the price spread between GB and the continent. Those projects that are delivered earlier will see the shortest payback periods and therefore a longer period of profitability. Despite this incentive, current projects are not sufficiently developed to meet the 2020 target.
With a 250 per cent increase in interconnection capacity relative to today’s levels, the ambition to create an integrated European electricity market would have a profound impact on the GB energy landscape and will have major implications for the business models of all those involved. Policy-makers face a double-edged sword and need to think carefully about how they balance the attraction of meeting their carbon reduction targets and the benefits of cheaper electricity with the increased risk to security of supply.
James Wang and Samuel Ebohon are energy experts from PA Consulting Group's energy markets modelling and analytics team