GIF Inside Story: Expensive gas, unstable renewables boost Europe’s coal-fired power output in 2021

Laura Mendes

31-Aug-2021

Additional reporting by Daisy De Selliers, Eugene Poon and Chetan Patel

LONDON (ICIS)–European coal generation has made a comeback in 2021, especially in the past few months, and bullish power fundamentals due to historically high gas prices and underperforming renewables indicate this trend is set to remain through the rest of 2021.

Coal-fired power plants across continental Europe and the UK are set to ramp up at the expense of natural gas over the remainder of the year, with a notional 35% efficiency coal plant in the money over a 49.13% efficient gas equivalent for the first time since 2018, and coal at its most profitable relative to gas since 2015.

Coal and lignite have already ramped up to take share from gas in Germany’s power generation mix this summer, according to data from research institute Fraunhofer ISE, as gas shippers attempt to prioritise injections into storage.

In the UK, oal power provided supply to the grid for more than 60 days in a row with the streak ending on 20 August.

Coal plants were only active for four of these days in 2020’s equivalent period.

Across the months of June and July, this year’s streak is the longest since 2017.

Overall coal plants have been actively generating for more than 170 days to-date this year, more than the same period in both 2019 and 2020.

Likewise in the Netherlands, coal-fired generation in August surpassed gas-fired generation, according to ENTSO-E data. Coal plants generated 2.4GW, while gas plants generated 2GW between 1 August and 19 August. ENTSO-E data also show that coal generation in 2021-to-date exceeded coal generation in 2020. Coal-fired generation in 2021-to-date was 1.9GW, while it averaged at 1.1GW between January and August 2020.

The ramp-up in coal-fired generation is expected to continue if strong Dutch gas prices keep a lid on the profitability of gas-fired power plants relative to coal-fired plants.

In a more long-term horizon, by 2030, European markets are expecting to phase out over 50GW of coal, 19GW of lignite and 21GW of nuclear capacity.

As previous ICIS analysis suggests, much of the retiring capacity is expected to be replaced by rapidly expanding renewable generation, on a de-rated basis – see UK and German examples – this will likely lead to a generation deficit. Gas-fired generation will therefore be critical in plugging this gap especially considering the need for baseload in electricity systems with a high penetration of renewables.

Spark and dark spreads

In June 2021, German wind production dropped almost 31% compared to the same time in 2020, then in July it also dropped 15% year on year. Dutch onshore wind and solar output also declined in 2021-to-date compared with 2020 levels in the same period, ENTSO-E data showed.

However, offshore wind output was higher in 2021 with the commissioning of the Borssele III and IV farm in the North Sea.

Normally, fuel plants such as gas would ramp up to compensate.

But with the Dutch TTF front month surging 35% over the course of June and rising further thereafter, German gas-fired power output also fell 36% year on year in July.

Although rising nuclear output also took share from gas, coal and lignite generation have also climbed.

Hard coal output roughly doubled year on year across both months.

Due to supply tightness on European natural gas markets and low wind power production, gas prices surged more than other energy commodities in 2021.

As a result, 49% efficiency clean spark spreads have dropped below 40% efficiency clean dark spreads for curve contracts, according to ICIS calculations, which suggests that gas plants became less profitable than coal plants.

Clean dark spreads are indicators of profitability for coal-fired generators that take into account the cost of carbon, while clean spark spreads indicate profitability for gas-fired generators.

August expiring with coal in the money ends a run of 31 straight months stretching back to December 2018 in which gas was more profitable than coal in Europe, according to this measure.

Coal’s profitability will peak in December, according to spreads calculated on 2 August.

The clean dark spread premium of €9.49/MWh over the clean spark for that month is wider than any expired spreads since December 2015.

Since 8 July, the Dutch Year ’22 clean spark spread dropped below the clean dark spread and remained in negative territory most days, according to ICIS calculations.

However, the Year ’22 clean spark spread rose from a low of -€4.91/MWh on 16 August to €2.51/MWh on 19 August, driven by sharp losses on gas markets.

The temporary decline in gas prices followed the announcement of Russian producer Gazprom on gas flow expectations along the Nord Stream 2 pipeline for 2021.

Nord Stream 2 is 99% complete and could be launched this autumn but uncertainty remains about technical and regulatory certification processes for the pipeline.

Supply fundamentals on gas markets remain tight, as stocks in Dutch storage facilities remain emptier than average and LNG supply is expected to remain weak. This will likely maintain support to TTF near-curve prices, resulting in low gas plant profitability.

The Dutch parliament and senate passed a law in December 2019 banning the use of coal in the production of electricity from 2030.

The four remaining Dutch coal-fired plants, – Amercentrale, Rotterdam Centrale, Maasvlakte Centrale and Eemshaven Centrale – are expected to close between 2024 and 2029.

According to EEX transparency platform, all coal-fired plants are expected to be fully available until the rest of 2021, as they went through maintenance during the second quarter.

Gas remains price-setter

Coal prices were historically the main driver of the German power far curve, as the greater prevalence of the fuel in the country’s generation mix meant that the last unit of demand was typically met by a coal-fired plant.

Coal will not return to its position as the marginal price setter, as it does not have as much flexibility for power plants, according to a market participants.

In order for coal to become the marginal price-setting fuel, gas prices need to continue rising while carbon and coal fall, a trader said. But greater demand and profitable margins are supporting coal prices. The Rotterdam benchmark Year ’22 coal contract has followed a bull run since April.

Nuclear gap

Traders contacted by ICIS generally agreed that coal-fired power output will continue to rising at the expense of gas.

One said that this trend is set to continue in Germany at least until next spring.

This is because of the 4GW nuclear phase out by the end of 2021, which leaves a gap in the German capacity mix.

“It is possible that we need two winters for natural gas markets to come back to levels we have seen two years ago, because 2020 was the other extreme,” 
he said.

The results of the last coal exit auction in Germany show that more people realise that the profitability of coal is increasing, another trader added, as it was not oversubscribed unlike prior auctions.

Germany is retiring almost 3GW of lignite and hard coal combined by the end of 2022.

With coal plants retiring, including some relatively new and efficient, clean dark spreads need to rise further relative to clean sparks to achieve the same fuel switch achieved in prior years.

Therefore, depending on how gas storage levels recover and whether more LNG supply comes into Europe, the use of coal in the German power mix may drop back to previous levels.

UK’s coal phase out was brought forward to 2024, which signals a longer-term difficulty facing the UK power grid during periods of severe tightness where wind supply is limited.

The UK government has made a pledge to produce net zero carbon emissions by 2050.

In order to reach these targets, the UK government’s main strategy is to rely heavily on renewables as its main carbon neutral source of generation, alongside a greater interconnector import capacity.

While not carbon neutral, gas generation will also play a part as a transition fuel for the coming decade.

New nuclear has appeared to take a back seat in the UK’s net zero pathway. According to ICIS Analytics forecasts, nuclear capacity will find a floor of 3.6GW from 2024-2027 before gradually increasing from that point onwards.

However, as plants are being closed down faster than new plants being currently planned to be built, nuclear capacity is not poised to overtake 2021’s total until 2034.

While other sources of energy like battery storage are also expected to play a role, it will mainly be gas generation that will meet demand when turbines are not generating, making the UK’s adherence to its emissions targets more difficult.

Tom Greatrex, chief executive of the Nuclear Industry Association, said that “Britain is caught in a fossil fuel trap, and the only way to escape is to build new nuclear power stations alongside renewable capacity. Our existing fleet have produced more zero-carbon power than any other assets in Britain, but if they retire without replacement, we will burn more gas and emissions will go up. Our path to net zero starts with replacing the existing nuclear fleet and investing in a strong and balanced zero carbon mix.”

Supply outlook

With baseload generation from coal and nuclear dropping substantially in the coming years the role of gas as a stable source of power generation will increase.

However, with output from both continental shelf and onshore fields dropping a large proportion of much needed gas supply is expected to come from LNG and Russia.

LNG has taken centre stage across Europe replacing indigenous production to become the region’s marginal source for gas along with Russian supply.

Across the past three years 22% of European gas consumption was met by LNG supply with North American volumes seeing a major expansion into Europe.

Current regasification capacity could see LNG account for almost 45% of gas demand in the region. This could potentially top 50% by 2025 with more than 300bcm of expected operational regasification capacity.

This would primarily be used for power generation, as gas-for-power is forecast to rise by five percentage points between 2021 and 2023 to make up 24% of the stack across Europe. This comes as nuclear, coal and lignite generation drops by 2 points over the same period.

It is expected that up to 40bcm of gas from fields will be removed from the European energy balance by 2025, making the increase in LNG supply ever more important. However more reliance on LNG will lead to growing price volatility across energy markets with piped gas being a more stable and immediate source of supply.

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