Analysis: UK fuel switch gains traction but road not smooth

Gas-fired power generation in the UK is more profitable than coal-fired production on the dark- and spark-spread forward curve for all of next year’s delivery periods, latest ICIS calculations show.

But the full extent of the actual fuel switch will remain dependent on a number of further factors. Increased gas burn would boost demand for wholesale natural gas across the country.

Clean spark spreads are indicators of gas-fired plant profitability, while clean dark spreads fulfil the same function for coal plants. The UK also includes a carbon price support (CPS) tax on fossil-fuelled power generation.

The Q1 ‘16 clean spark with CPS became more profitable than the equivalent dark on 1 November, while the Winter ‘16 clean spark flipped in favour of gas burn on 9 November. The Summer ‘16 clean spark was more profitable going into the month, and has remained there since (see graph).

This bucks the trend as historically dark spreads hold a premium for winter delivery periods (see graph).

UK wholesale gas prices have been heavily bearish so far this winter, with mild temperatures and numerous LNG vessel arrivals. This has made it more attractive to run gas-fired plants.

“Unless coal prices continue to match gas prices on the way down, we should see more gas burn,” French-headquartered bank Societe Generale said in a note on Friday.

The CPS comes on top of standard EU emissions trading system (ETS) costs for electricity generation. The CPS doubled to £18.08/tCO2e earlier this year, which has been a key factor in really pushing gas-fired generation, which releases less emisisons than coal-fired generation, into the money.

Renewables drive

Analysts do expect gas-fired generation to play a more prominent role in the UK mix in 2016, although there are other factors which could dampen this effect at times.

For example, the July ‘15 clean spark with CPS was on average £0.28/MWh below the equivalent dark spread with CPS in June 2015. While the July ’14 spark with CPS was £2.00/MWh less than the dark spread with CPS over the same period a year earlier.

However, UK gas-fired generation actually dropped year on year in July 2015 while coal-fired output rose, according to latest UK government figures released at the end of October.

“It could be the impact of renewables hitting record levels,” Stewart Spink, lead market analyst from UK-based energy supplier LG Energy said.

Wind power generation rose 72% year on year in July to 2.14TWh, Department of Energy and Climate Change (DECC) figures showed. Countries such as the UK are keen to utilise cleaner renewables output when available.

Complex

Furthermore, in reality the picture is more complex beyond that suggested by mere spark spreads.

“This is just an indicator. It doesn’t actually show if there is fuel switch happening in the market,” Jan Ahrens, business director at ICIS analysts division Tschach Solutions, said.

“There are so many restrictions on must run, on heat supply, on dispatching,” Ahrens added. “If you have just two hours when you can switch your coal plant against your gas fired plant, you don’t do it – it’s not economical.”

Nevertheless, other analysts thought the quick start-up nature could favour the technology and push it further into the mix.

“Gas-fired generation has more flexibility to respond,” Spink said. “It can respond to hourly changes in price or in the balancing mechanism.” The balancing mechanism is used to ensure electricity supply meets demand. ben.lee@icis.com