ICIS Long-Term Power Analytics: The long road to decarbonisation in the Italian power sector, and the competition between CCGT and renewables

This story has originally been published for ICIS Long-Term Power Analytics subscribers on 13 April. The author of the analysis is Senior Analyst Stefan Konstantinov and can be contacted at stefan.konstantinov@icis.com.

Our ICIS Long-Term Power Analytics customers have access to extensive modelling of different options and proposals that are now extended out to 2050. If you would like to find out more about our Long-Term Power Analytics products, please get in contact with Justin Banrey (Justin.Banrey@icis.com) or Audrius Sveikys (Audrius.Sveikys@icis.com).

ICIS has published its latest quarterly update of European power price projections. With this iteration, we have extended the modelling horizon for Southern European countries, including Italy, to 2050.

The extension of the forecast allows us to present a long-term view of the evolution of market fundamentals such as power prices, installed capacity and generation mix.

This is of relevance with a view of the EU’s ambitious 2050 decarbonisation goals, which can now be fully reflected within the ICIS forecast. This also allows ICIS to track and analyse the lifetime of assets that have recently come online or will be commissioned soon, as the period to 2050 covers all, or most of the assumed technical life of the assets (renewable or thermal).

Analysis

Our updated assumptions and finalised data is now available on our platform.

Main findings

• Gas is currently the main thermal fuel in Italy’s power sector; however, its importance and relative share is projected to gradually decline due to the rise of renewables, with solar and wind overtaking CCGTs in the generation mix in the mid-2030s.
• Gas-fired generators’ load factor is projected to decrease throughout the forecast, as CCGTs are crowded out by renewables and their economics are suppressed by high carbon prices.
• Solar is expected to be the technology of choice for new economic capacity additions, reflecting the favourable conditions in Italy and significant learning rates leading to decreases in investment costs.
• The most important and dynamic elements of Italy’s merit order are renewables with negative marginal costs due to subsidies, zero-marginal cost market-based renewables and gas-fired plants.
• With high carbon prices, gas plants are increasingly pushed towards the end of the merit order. While average system demand is still met by thermal technologies by 2030, from the mid-2030s onward it is renewables that meet average demand. On the other hand, annual peak demand is met by gas-fired plants throughout the forecast period.
• Emissions decline in line with the commitments for decarbonisation and achieving a significant reduction of carbon emissions by 2050. In the forecast, this is driven by the combined effect of increasing penetration of renewables and the high carbon prices, which act to suppress gas-fired plants’ running and thus emissions.

Current installed capacity mix in Italy

• Currently, about two-thirds of Italy’s electricity demand is met by gas-fired generation, and it is the main fossil fuel used in the power sector, thus responsible for the bulk of power sector emissions. The share of coal in the generation mix has been decreasing rapidly over the last years and is currently at low levels. The decrease has been helped to a large degree by the recent strong increase in carbon prices, which has severely constrained the economics of coal generation.
• As part of the EU’s push for decarbonisation and achieving Net Zero by 2050, Italy will have to decarbonise its power sector, with the implications for gas-fired generation being that it will have to be replaced with low- and zero-carbon generation technologies. To that effect, Italy has implemented various RES support schemes over the years, with the current 2019-2021 auctions coming to an end without reaching their intended potential.
• As of 2021, Italy has installed over 22GW of solar and 11 GW of wind capacity, which account for 10% and 7% of total generation.

Projected capacity additions to 2050

• Italy’s 2020 NECP, which corresponded to a target of 30% share of renewables in final energy consumption by 2030, called for 52GW of solar, and over 18.4GW of wind to be added by 2030. To reach the current NECP target, Italy would need to add over 1GW of onshore wind and over 4GW of solar capacity between 2021 and 2030, according to ICIS analysis.
• The figure below shows the projected evolution of the Italian capacity mix out to 2050 as forecast by ICIS. The combined capacity of wind and solar is expected to increase quickly, with renewable installed capacity overtaking CCGT installed capacity by the mid-2020s. Solar capacity is the technology of choice for new capacity additions, based on the assumption for high learning rates, leading to progressive reduction in the capital cost required for new solar build. This is also supported by the fact that Italy has very favourable climatic conditions for solar generation. As a result, in the 2030s, an average of almost 7GW of solar capacity is installed annually, as projected by the ICIS Capacity Investment Model.

Source: ICIS

• Wind – onshore, and later in the forecast – offshore – is the other major renewable technology which is expected to be developed in Italy. We assume that an average of over 1GW of wind per annum is installed, to meet the 2030 renewable target, and at least part of that capacity is non-market based, i.e., it is supported by either a form of subsidy, or has entered a PPA which provides price certainty for the wind investor.
• After 2030, the assumed relative cost inferiority of wind means that it is less competitive than solar, given Italy’s climatic specifics. This together with the assumption that there are no more subsidies, results in significantly reduced wind capacity buildout past-2030, which only accelerates again towards the very end of the forecast period.
• The current share of CCGT capacity of just below 40% is projected to be quickly eroded due to both CCGT retirements in the 2040s and the addition of renewables. By 2030, it is reduced to below 30%, and to below 15% by 2050.
• Importantly, based on the assumed economics of CCGTs for the base case, some new CCGTs are still built in the 2030s, compensating for retiring units and keeping the system installed capacity constant. In the 2040s, however, the attractiveness of new-build CCGTs deteriorates further, given the projected high carbon prices. The reduced buildout, combined with retirement of CCGTs that have come to the end of their technical lifetime, explains the projected decrease in CCGT installed capacity in the 2040s.
• The high projected carbon prices in the period to 2050 enable the introduction of CCGT with CCS from 2041 onward, with an average capacity addition of over 0.5GW per annum for the decade to 2050.

Capacity load factors

• The figure below shows the evolution of load factors to 2050 for the main generation technologies in Italy. While renewables have almost constant load factors (accounting for some curtailment in the later years), the load factor for CCGTs is in constant decline. CCGTs are projected to go from their current mid-merit load factor of above 40%, to a single-digit load factor in the 2040s, leaving CCGTs as peaking plants.
• The decline in CCGTs’ load factor is accelerated from the beginning of the 2040s due to the competition of CCGT with CCS. The latter starts with a high load factor of 80% as its variable running costs are lower than unabated CCGTs given the high projected carbon price in that period. The load factor of CCGTs with CCS in turn declines steeply, as it is crowded out by increasing renewable generation.

Source: ICIS

Evolution of the generation mix to 2050

• The figure below presents the projected generation mix in Italy to 2050. Despite CCGTS’ relatively low share in total installed capacity, their starting share in the generation mix is over two thirds, reflecting the fact that CCGTs have a higher load factor than other technologies.
• Within the forecast horizon, the increasing wind and solar capacities at a constant load factor result in higher overall generation. As renewable generation grows faster than the projected demand in Italy, it starts to crowd out CCGT generation, resulting in reduced CCGT load factor, reduced share in the generation mix and an overall reduced generation of electricity.
• This process is projected to continue throughout the forecast

Source: ICIS

Projected merit order for the Italian power system

• The charts below represent the evolution of the merit order over the forecast horizon. Generation capacity is ranked by their short run marginal costs, which include fuel, carbon, and variable O&M costs. The negative marginal cost represents subsidies to renewables. As we assume that subsidies for new renewable capacities are withdrawn, there is a gradual reduction in capacities that have negative marginal costs, with all such renewables having reached the end of their technical life and retired by 2050. Newbuild renewables are ranked in the merit order with their economic marginal cost of zero, and the zero-cost section of the merit order increases significantly from 2030 to 2050, reflecting the increasing share of renewable installed capacity.
• As other thermal technologies like hard coal and oil get retired, gas remains the solе thermal fuel by the end of the forecast, represented by OCGTs, and CCGTs with and without CCS. Given rising carbon costs, CCGTs are firmly at the end of the merit order as peaking plants from the mid-2030s onward.

Italy Merit Order – 2021

Italy Merit Order – 2030

Italy Merit Order – 2040

Italy Merit Order – 2050

Source: ICIS

• The intersection of the average demand line with the merit order shows the marginal technology which meets average system demand, and the resulting marginal system prices
• While average system demand is still met by thermal technologies by 2030, from the mid-2030s onward it is renewables that meet average demand. This has the obvious implications of decreasing power prices during periods of average levels of system demand.
• On the other hand, annual peak demand is met by gas-fired plants throughout the forecast period. Given the projected rising carbon prices, this has the respective implications for marginal prices during peak demand periods, which increase significantly.

Emissions

• The figure below shows the evolution of Italian power emissions to 2050. Emissions decline in line with the commitments for decarbonisation and achieving a significant reduction of carbon emissions by 2050.
  • This is driven by the combined effect of increasing penetration of renewables and the high carbon prices, which act to suppress gas-fired plants’ running and thus emissions.

 Source: ICIS

Market impact

• The projected progressive introduction of renewables in the Italian power system will have a bearish impact on the economics of gas-fired plants – both in terms of despatch of existing ones, and of commissioning of new builds.
• Given the expected favourable conditions for renewables and particularly solar, the fundamentals point to a long-term bullish impact for renewables investors.