The existing Kingsnorth power station. Image source: E.ON.

E.ON’s £1bn plan for a new coal-fired power station at Kingsnorth is waiting for approval from the UK government. Other generators have shifted away from coal. Drax, which owns by far the largest coal power station in the UK, is investing in biomass. Other companies have focused on new gas plants. Why is the world’s largest investor-owned utility pushing ahead with a project to burn coal without carbon capture?

The answer, unsurprisingly, is that burning coal to generate electricity is extremely profitable. Very low prices for emissions permits and tumbling coal costs mean that a profit-seeking management team is highly incentivised to try to push for permission to use coal in power stations. This article provides the background calculations for an estimate that the new Kingsnorth will generate an operating profit of about £300m a year if current fuel and carbon prices persist. Additionally, it also tries to show that the cost of fitting CCS equipment and running the plant to capture the large majority of all carbon emissions is likely to add no more than about 1.5p per kilowatt hour to the cost of generating electricity at current coal and carbon prices. This means that a new coal fired power station with CCS may have operating costs only marginally above gas power plants

Nevertheless, E.ON has just asked for government subsidy to install CCS at Kingsnorth from day one. The purpose of this article is to offer an estimate of the maximum the government ought to offer E.ON in order to get it to invest in CCS prior to opening the new power station.

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As the UK Climate Change Committee’s report of December 2008 showed, generators will generally wish to develop coal, rather than gas, power stations if carbon costs are low. E.ON’s persistence in the face of the widespread opposition to Kingsnorth is testament to the truth of this assertion. Coal is today’s fuel of choice. Speaking to investors on 3 March 2009, Dorothy Thompson, the CEO of the enormous coal power station at Drax, said that in current conditions ‘coal plants tend to be more economic than gas plants’. The company also said without equivocation that ‘coal remains the most attractive fossil fuel’.

The Kingsnorth project
The new Kingsnorth will be a ‘supercritical’ coal plant composed of two 800 mW units. Total output will therefore be about 1.6 gW when the station is running at full capacity. E.ON has entered the competition for a grant to fit CCS on a portion of the new power station. It has said that it will fit CCS on the rest of the plant when it makes sense financially, and not before.

E.ON has a point. It is in business to make money. CCS will always add – probably significantly – to the cost of generating power. So it wants the UK taxpayer to fund the incremental cost. Other generators around the world have made similar requests, though rarely in so bold a way. E.ON’s great rival RWE has proposed a 450 mW plant with carbon capture at Huerth in Germany, and has made pointed remarks to Chancellor Merkel about subsidy for construction costs. US coal-fired generators have proposed an imaginative scheme for encouraging early CCS projects.

The wily folks at E.ON must have noticed the fixed and discomfited smile on ministers’ faces when talking about Kingsnorth. Which politician wants to go down in history as the person who approved a new unabated coal power station just before the Copenhagen climate change negotiations begin? E.ON seems to have offered a tempting political bargain – give us the cash and we will fit CCS from the opening of the plant. It all comes down to money.

The economics of Kingsnorth
Coal stations need maintenance, both planned and unplanned. Drax managed to be available for operation for about 85% of the time last year. Its position as the lowest cost fossil fuel station in the UK meant that its output was actually asked for about 75% of the hours in the year. Other coal stations were similarly busy. Kingsnorth will probably run about 80% of the year, slightly more than Drax. It is newer and will have a lower marginal cost to operate. (Its position in the ‘merit order’ will be behind only nuclear and wind.)

Drax has already sold much of its output for 2011. The price is about £63 a megawatt hour. If Kingsnorth achieved this price its yearly output of approximately 11.2 terawatt hours would be worth about £702m. (11.2 terawatt hours is about 3% of UK electricity use.)

The primary costs of operating Kingsnorth will be coal purchases, carbon permits, coal transport, and operations and maintenance (O+M).

Coal
Kingsnorth will be very efficient for a coal-fired power station and turn about 42% of the heat value of coal into electricity, but to be conservative I have used a figure of 40%. To generate 11.2 terawatt hours, Kingsnorth will need to buy about 3.4 million tonnes of coal. At current spot prices – which may not be representative of levels in five or ten years, or of prices for long-term contracts – this will cost about £163m. (Although coal prices are currently low, they are still above the costs of extracting the fuel.)

Carbon
Kingsnorth will generate about 8.6m tonnes of carbon dioxide. At today’s European permit prices, this will cost about £103m. (I assume that by the time the station is opened power stations will have to pay for their entire allocations of permits.)

Coal transport
The current cost of shipping coal to Drax from non-UK sources is about $17 a tonne. It should be lower at Kingsnorth because the station is on the Kent coast and can receive its own coal shipments by ship. Nevertheless, I have taken the Drax figures. This adds about £42m to the costs of running Kingsnorth.

O+M
Drax cost about £230m to operate last year. This includes the cost of maintaining the station and keeping it running flat out for most of the year. A substantial problem at one of the six turbines probably slightly inflated this figure. I have calculated an O+M cost for Kingsnorth, pro-rated by the respective electricity outputs of the two stations. This is about £101m.

I estimate net operating profit at just under £300m. (Drax operates at an approximately zero net working capital position, so this figure would be approximately the same as the cash generated by the plant before any tax.)

Summary estimate of the operating profit of the proposed Kingsnorth plant

If these numbers are correct, E.ON can expect an annual return of about 30% on its proposed £1bn investment.

The impact of adding CCS
Dr Golby, the CEO of E.ON UK, says that first generation CCS will reduce the efficiency of the plant by 20%. This is a surprisingly low estimate; others have produced much higher figures for the efficiency loss. In effect, E.ON is saying that to produce the same amount of electricity it will need about 25% more coal.[2]

Adding 25% to the cost of coal purchases will cost £41m. This is about 0.36 pence per kilowatt hour. The capital cost of a plant will be much higher if CCS is installed and its operating costs will rise. E.ON has estimated elsewhere that these extra costs total about 2p per kilowatt hour. (See ‘Carbon, costs and consequences’ from the E.ON website – I have estimated this figure from the bar chart on page 9 of the PDF.) So the additional cost of adding CCS is about 2.4 pence per kilowatt hour.

But the plant will save most of its cost of CO2 permits. Most power engineers assume that CCS will cut emissions by 90%. Only having to buy 10% of the existing volume of emissions will save E.ON about 0.83 pence per kilowatt hour.

The net consequences of adding CCS to the Kingsnorth project are therefore approximately as follows:

At current gas and coal prices, the prospective future margins for electricity generation are about 1 pence per kilowatt higher for gas than for coal.[3] (It is fair to note that gas turbine power stations are cheaper to construct than coal-fired plants, which will somewhat reduce the significance of this figure.)

The implication of this is that at today’s fossil fuel and carbon prices, and using E.ON’s own estimates, adding CCS to Kingsnorth leaves this coal power station only marginally more expensive to operate than a new gas-fired power station. Coal with CCS may be only about half a pence a kilowatt hour more expensive than gas.

Why does this matter?
E.ON’s recent announcements have opened a negotiating door. The company is clearly signalling that it wants a deal over CCS. It seems to be asking for a guaranteed price premium. Rather than see Kingsnorth open without CCS, the government might be prepared to agree a deal. The purpose of this note is to suggest that the premium should not be large; analysis seems to suggest it can be well under 1p per kilowatt hour.

To the outside observer E.ON’s tactics do not look pleasant. The government knows that the electricity supply situation looks grim beyond 2016. It may have to accept more coal. So E.ON is offering to make that new coal capacity more environmentally acceptable – provided we all pay the additional cost. In my view, the government should do the deal, provided it can keep the cost below 1p.



Footnotes
[1] Operating profit takes no account of interest payments or depreciation.
[2] If efficiency goes down by 20%, it will fall from 40% to 32%. To get the same daily output, coal use would have to rise by 25%.
[3] The ‘Dark Green Spread’ less the ‘Green Spark Spread’.

A powerful US coalition of large industrial companies, power producers, and environmental defence organisations has produced the first sensible plan for incentivising the early introduction of carbon capture at solid fuel electricity plants. The scheme proposed by the US Climate Action Partnership (USCAP) addresses the most important environmental issue in the world – the burning of coal to generate electricity – in a plausible and coherent way. Coal, which is almost exclusively burnt in power stations or in steel-making, is responsible for about 36% of US emissions. If we can find a way of cheaply capturing the CO2 from power stations and storing it underground, we can then also provide the technology to Chinese and Indian generators.

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The key points are as follows:

1. The cap and trade scheme that the new US administration is likely to implement may not produce a carbon price that is high enough to force coal-fired power stations into CCS. Therefore CCS may need a special financial regime.
2. USCAP says the US should pay power stations to sequester carbon. Payment should be highest for the first power stations to fit CCS equipment. The proposal suggests that $90 a tonne is sufficient to incentivise the first 3 gigawatts of power capacity to switch to using CCS. 3 gigawatts is approximately the power output of two large power stations such as Didcot A in the UK.
3. The paper states that $90 a tonne is enough to cover the costs for the first projects. This statement is hugely encouraging because it is lower than many people expect. USCAP has members that operate coal-fired power stations so the number will not have been lightly chosen. Expressed in terms of cost per megawatt hour, the proposed payment is perhaps $80-$100, depending on the age of the plant. For comparison, UK baseload power prices are currently about $80 an hour. Prices are much lower in the US. Once 3 gigawatts of CCS plant have been installed, the report proposes that the price per tonne drops. The scheme therefore provides the highest incentive to the first-movers.
4. A floor price of $30 is suggested for years 11 to 20 of the scheme. Let’s be absolutely clear: if we can actually get coal CO2 sequestration for $30 a tonne, then CCS is a viable technology. If we could decarbonise the entire UK economy for this price (i.e. not just coal-fired electricity generation), then the cost would be about 1% of GDP.
5. USCAP proposes that all new payments should stop once 72 gigawatts of power generation with carbon capture has been installed. This is about a quarter of current US coal generation capacity. This further incentivises operators to move quickly down the CCS road.

Other steps

6. Financial measures need to be accompanied by a national programme of R+D on geologic storage and CO2 pipeline networks. (A skeleton CO2 pipeline infrastructure already exists in the US.)
7. Quantitative restrictions. In addition to the CCS proposals, USCAP says that:
   • a) All new power stations should have to pay for their carbon allowances.
   • b) Tightening restrictions should be placed on all new power stations from 2015 onwards. I suspect that the levels proposed would only be achievable using what is loosely called ‘clean coal’ technology, probably the largely unproven IGCC approach (Integrated Gasification Combined Cycle – the coal is gasified and then burnt in a turbine). IGCC ought to be able to achieve emissions levels not far above today’s natural gas power plants and within the 800lbs (less than 350kg) CO2 per megawatt hour proposed as the cap in 2020.

Taken together, this package of proposals is a sensible way of paying power station owners to invest quickly in CCS. The levels of payment that are suggested are much lower than most people believed were possible.

The UK and other countries must take note of this package. It is a very much better set of proposals than any European scheme because it creates pressure for power station operators to start to push CCS now. In the UK, by contrast, the generators are sitting on their hands waiting to see how much they can extract in direct subsidy from government. A further advantage of the US scheme is that it provides limited reason for the inventor of any technology to restrict other generators from using the successful approach.

The rest of the extremely sensible package of proposals from USCAP can be found at http://www.us-cap.org/.