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‘Carbon leakage’ could hit UK electricity generation sector

26 Jan 2012 17:45:41 | edem

UK lawmakers have been warned for the second time in three days that plans to act unilaterally on reform of the electricity market could do more harm to the power sector than good.

The move will add to the air of uncertainty in the market, with some participants gambling on a rethink, one trader said.

The warning came in the same week that a cross-party committee of parliamentarians was told that capacity payments, one of the four pillars of market reform, "cannot work in a single European market" (see EDEM 26 January 2012).

On Thursday, a second of the four pillars - this time the carbon price floor - came under heavy criticism in a report published by the cross-party Energy and Climate Change Committee.

The policy will push up wholesale electricity prices to levels that will cause substantial harm to industry, the report said, and will result in carbon leakage - the act of business relocating overseas to avoid a carbon tax - across the power generation sector.

"The threat of leakage within the EU is particularly acute for the electricity sector," the committee said, pointing to an anticipated build in interconnection capacity.

"Electricity is readily transportable between the UK and mainland Europe and can be traded instantaneously on spot market prices," it said. "This makes electricity generation more susceptible to leakage than other sectors, such as goods manufacture, which may be restricted by the difficulties of relocating production."

The Department of Energy and Climate Change (DECC) said in its market reform white paper that "if most current proposals were realised, [Britain] could have 8-10GW of interconnection capacity by the 2020s".

In 2010, the most recent year for which figures are available, total UK power consumption was 328TWh. Theoretically, 10GW of interconnection could import a maximum of 88TWh annually, which means the country could meet 37% of its demand via electricity imports.

Impact

UK Chancellor George Osborne unveiled details of the world's first carbon price floor for the power generation sector in the Conservative-Liberal government's budget last year. It will be set at £16.00/tonne (€19.00/tonne) of carbon dioxide equivalent (tCO2e), rising to £30.00/tCO2e in 2020, in 2009 prices (see EDEM 23 March 2011).

Its impact on power futures prices was immediate. Between close of trade on 22 March 2011 - the day prior to the budget - and 25 March 2011, Summer '13 Baseload moved from £55.80/MWh to £59.35/MWh, a £3.55/MWh increase, or 6.4%. Winter '13 Baseload rose from £60.00/MWh to £63.10/MWh, a £3.10/MWh increase, or 5.2%.

The Summer '12-Summer '13 spread broadened from £0.35/MWh to £3.60/MWh over the same period, while the equivalent winter spread moved from £0.15/MWh to £2.90/MWh, underlining the impact of the carbon floor.

At the close of trade on Wednesday, the spread between the two forward Summers had widened to £7.35/MWh - although, the gap was more a symptom of a weak front season than the carbon floor impact - with the Winters at £4.20/MWh.

The impending carbon floor has unsettled the market, one participant said. In November, traders cited a surprise flurry of deals on longer-dated spark spreads which squeezed the contango on the far curve - a reversal of the pattern seen after the carbon floor announcement (see EDEM 25 November 2011).

"The carbon floor is the reason why there is a lack on consensus on longer dated sparks," one utility-based trader said on Thursday. "There is so much political risk, yet the government won't turn around. But still - fears regarding the policy abound." JS

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