Until this week, we thought that Sizewell B was likely to be the most expensive nuclear power station built in the UK. Image source: World Nuclear Association.

The Guardian newspaper of Monday 19 October broke the story that the UK government is preparing to guarantee a minimum price for carbon dioxide emissions to encourage the development of nuclear power stations. Putting a high cost on greenhouse gas emissions from power stations will force up the wholesale price of electricity, ensuring a better financial return for nuclear power stations (and for renewables such as wind). The decision to create a floor price for carbon demonstrates that the full costs of nuclear technology are probably well above today’s wholesale electricity prices. We may well need nuclear power but we are going to pay heavily for it. The government’s optimistic noises from 2006 to the middle of this year about the commercial viability of nuclear power have turned out to be wrong.

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More generally, this note argues that the failure to incentivise nuclear construction in the current liberalised electricity regime may oblige the UK to introduce high guaranteed ‘feed-in’ payments for all low-carbon generators, including the very largest power stations. Guaranteed tariffs may be a more effective instrument for incentivising low carbon generation than the carbon dioxide price.

2006 government views on the costs of nuclear
In September 2006, David Kennedy, then a senior civil servant in the UK Department of Trade and Industry (now BIS) and currently the chief executive of the Climate Change Committee, submitted a paper to an academic journal on the economics of nuclear power.[1] The paper was published the following year. In the paper Dr Kennedy looked at the likely costs of building new nuclear plants in the UK. He then used these estimates to say what the wholesale price of power would need to be to encourage the building of new nuclear power stations.

Table 3 of his robust and cautious paper contained 10 estimates from independent external sources of what is called the ‘levelised’ cost of electricity from new nuclear. ‘Levelised’ figures spread the costs of a power station over its expected lifetime generation of electricity and account for matters such as the deconstruction of the power station at the end of its life. An interest rate is applied so that money spent now is given a higher weight than the money expended in sixty years’ time.

The ten estimates quoted by Kennedy were as follows:

The average was £30 per megawatt hour (mWh). This is equivalent to 3p per kilowatt hour. For comparison, current UK retail prices for electricity are about 13p a kilowatt hour.

Dr Kennedy’s paper went on to provide a more conservative figure that UK policymakers might use. He assumed a cost of £37.50 per kilowatt hour. The analysis also suggested a figure of £43.70 as an ‘extreme’ high case.[2] The wholesale price of electricity, at least as shown in medium-term contracts to buy and sell power, varies between about £50 per mWh and about £60.[3] Ofgem’s recent energy market scenario report also suggests a figure of about £60 for late in the coming decade when the first new nuclear plants might be starting to generate. So readers of Dr Kennedy’s paper would have assumed that nuclear power is profitable at current market prices and at projected future levels. Indeed, government policy-making from 2006 to 2009 has explicitly assumed that nuclear is ‘cost-competitive’ with other forms of generation such as gas and coal.

The views of the Committee on Climate Change, December 2008
By late 2008, the Committee on Climate Change (CCC) had a very slightly different view:

Current estimates of the likely cost of generating electricity from new nuclear are in the range 4-5p/kWh (£40-50 per mWh). These cost estimates are higher than typically produced two to three years ago, as a result of the significant increases in steel and other component prices, and of significant supply bottlenecks which have emerged as demand for new nuclear power station construction has come up against a limited capacity supply industry.

But fossil fuel price increases over that period have produced an even greater increase in the cost of fossil fuel based electricity, and the relative cost position of nuclear has therefore improved.

Less than a year ago, the CCC was saying that nuclear was the lowest cost generating plant for power generation even though its estimates were higher than Kennedy’s figure of two years earlier. ‘4-5p’ per kilowatt hour for nuclear compared favourably to more than 6p for gas generation and more than 7p for coal. Its view was unambiguous:

Nuclear power is competitive with both coal and gas-fired generation in the central fossil fuel price scenario even without a carbon price.

The Guardian’s news story
In October 2009, if the Guardian reports are accurate, the government is admitting that nuclear is not able to compete with fossil fuels except with protection from a high carbon price. The newspaper mentions a figure of €30 a tonne, compared to today’s price of CO2 emissions permits in Europe of about €13 a tonne. This levy will be added to the cost of using coal as a fuel for the power station and the effect will be to increase wholesale prices.[4] A €30 price for a tonne of CO2 will add about £20 to the cost of producing a mWh of coal-generated electricity.

During the course of 2009 the implied cost of nuclear power has risen from being no worse than competitive with gas and coal (at a zero carbon price) to being €30 (£27) per mWh more expensive.

Put at its simplest, the progression in nuclear cost estimates is therefore as follows:

* £20 for the carbon permits to produce a mWh of coal-fired electricity added to the current wholesale price of £50 or future prices of £60 per mWh. Assumes that that the €30 a tonne figure suggested by the Guardian is the level required to cover the ‘levelised’ costs of nuclear power per mWh.

For reference purposes, it may be helpful to know that the last nuclear power station built in Britain, Sizewell B, has levelised costs in today’s money of about £60 a mWh, or somewhat less than the apparent current projections of nuclear costs but higher than any of the government figures from the 2006-8 period.

Why is this important?
Nuclear power has gone up in price, probably by a factor of between two and three above what was expected even a few years ago. This is no surprise and even this blog predicted such figures early this year (see here and here). The continued problems at the new Finnish nuclear power station raise the strong suspicion that cost estimates will rise further in the future.

More generally, the Guardian report buttresses the case of those who say that the UK needs a guaranteed floor on the carbon price urgently. Today’s gas prices are very low by recent standards and depressed world economic growth may cause this to continue. The rational investor is therefore looking to build new combined cycle gas turbine power stations to profit from these low fuel prices. This runs the risk of either locking the UK into carbon-emitting power generation and/or shortages of power if the current glut of gas reverses unpredictably or if emissions targets oblige the generators to curtail production. But, as it stands today, the generators are queuing up to build unabated gas power stations. At today’s gas and carbon prices not only nuclear power but coal with carbon capture is looking very expensive.

The EU’s decision last week to back Powerfuel’s Hatfield coal gasification (IGCC) plant is welcome, but the project may only make financial sense with carbon prices at least as high as needed for nuclear power. Powerfuel’s proposed technology is still largely unproven at the scale envisaged and it may well turn out to be far more expensive than expected. There are many sceptics out there around the world saying that IGCC with capture will be even more expensive than nuclear. And offshore wind, today buttressed by a temporary increase in renewable subsidies in the UK, will need similar long-term incentives.

Are there any solutions?
My strong sense is that the woefully slow progress in developing new UK sources of low-carbon electricity might possibly be remedied by agreement between the main UK political parties on a high and semi-permanent carbon tax, probably of at least £40 a tonne. This may imply an increase in electricity costs of about 3 pence per kilowatt hour, a painful jump on already historically high levels.

Or – and this runs completely against the spirit of electricity market liberalization over the last twenty years – it may be simpler to copy the micro-generation feed-in tariffs scheme and offer a stable and guaranteed price for low-carbon electricity sources constructed in the next fifteen years, perhaps with higher prices for the first 10, 20, and 30 gigawatts of capacity constructed. The early rate might be £80 per mWh for nuclear, £90 for coal with capture, £70 for onshore wind, and £100 for offshore. The effect of this measure will be to unwind the working of the free(ish) markets in electricity generation and retailing. Few people may yet be willing to contemplate such a massive change, but even enthusiasts for liberalised energy markets must surely admit that the inability to incentivise the construction of nuclear, coal with CCS or even wind under the current system is indicative of a market failure of dangerous and unprecedented proportions.


Footnotes
[1] David Kennedy, ‘New nuclear power generation in the UK: Cost benefit analysis’, Energy Policy, 35.7 (2007), 3701-16.
[2] Kennedy 2007: 3709.
[3] Drax power station, by far the biggest in the UK, records in its latest financial statement of August 2009 that the average price it has sold electricity in the forward market for 2011 is £60.30 per mWh.
[4] This requires the assumption that coal power stations are pressed into service last: after gas and renewable (i.e. in economist’s language, coal stations are the ‘marginal’ producers).

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’.

Power Station 571 aka the solar panels on my roof.

People like me who buy solar panels tend to become unreasonably fond of them. Many homeowners come to regard these silent blocks of silicon on our roofs as part of the family. I’m also particularly proud that our panels are registered at Ofgem, the utilities regulator, as Power Station 571. The reason for going through the cumbersome process to convince Ofgem that my silicon should be listed alongside Drax and Sizewell B was to benefit from the government incentive scheme for renewable electricity generation.

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I am meant to get a cheque every year as a payment for the electricity that panels generate. But I have never had a penny. The large generators get paid reliably every month but my many attempts over the last couple of years to collect the money I’m owed – not a lot, it has to be said – have failed. It hasn’t been for want of trying. My file is full of faxes (remember them?) submitted and then resubmitted at Ofgem’s request, notes of endless telephone calls, and a futile attempt to appoint Southern Electric as my agent. The regulator’s excuses have been many and various: the faxes were lost, the computer system had been changed, the manager left, the numbers had to be checked, or Southern Electric hadn’t sent through some details properly.

Because I have a professional interest in how the government support scheme for renewables works, I have persisted long after a more rational individual would have given up. The latest excuse – provided today – is that one of the other ‘microgenerators’, as we are respectfully called, has emigrated to Australia meaning that a batch of approvals can’t be completed. I have a sneaking suspicion why this family left its beautiful silicon panels behind. Dealing with Ofgem would make any sane person eager to get as far away as possible. Perhaps as they got on the plane these hapless microgenerators gave a shout of relief as they left the regulator and its absurdly malfunctioning systems behind. ‘Don’t worry about the money – we never wanted it anyway – just use it to reduce the national debt,’ is what they probably said.

I went to the regulator’s annual report on the renewable payments scheme to see if there were any clues as to why us pioneers are suffering. What I read there was truly humbling. I may resent the ten or twenty hours I have spent in the last year chasing my £66.43. But Ofgem is upset as well. The report crossly says that the 1,000 or so microgenerators in the UK cost the regulator £600,000 last year in staff and office costs. That’s £600 per generating site, ten times the money they owe me. I may have been frustrated by the time I spent chasing my payment, but they appear to have spent days and days justifying why the money hadn’t been properly sent to Power Station 571. In fact, Ofcom unashamedly comments that cost of generators like me was substantially more than the value of the electricity we produced. Between the thousand of us we generated about 8,000 megawatt hours, or just about enough to cover the electricity needs of 200 homes or a large secondary school. But Ofcom has a section of five or ten people responding to our complaints and trying to find new reasons not to send us the cash. Reading between the lines, the regulator is trying to tell government that it is fed up with dealing with us and our miserable dribbles of electricity. Heaped on the superstructure of baffling incompetence is a new threat. Apparently, Ofgem is worried that some naughty microgenerators have been exaggerating their production figures. A new team of crack auditors is to be formed to visit places like Power Station 571 to ensure we are correctly completing our forms. Next year perhaps it won’t cost £600 to make life difficult for the average microgenerator, it will be £800, £900, or even more.

I therefore have a simple proposal to help all of us. Instead of locking us in continuous disputes about a few tens of pounds, Ofgem should close down its microgeneration section, and hand £300 a year to anybody who can show them a photograph of solar panels or a wind turbine on their roof. We gain, Ofgem gains, and the taxpayer gains. We might even get the family in Australia to come back.