Coal condemned

During the last decade, the majority of the OECD countries decoupled their economic growth from energy consumption. Normally these rise in tandem – a trend that persists in developing countries and world’s soon-to-be fastest growing and most populous nation, India.

This decoupling happened as developed nations shifted to providing services and building knowledge economies, which is less energy-intensive than industrial production and manufacturing. China too has started down this path. Policy-makers now talk of “decarbonising” the economy. That is, only producing and consuming energy which does not release greenhouse gases into the atmosphere and contributing to climate change.

Decarbonisation is currently focussed in the electricity sector where it is being helped along by policy incentives. Subsidies, guaranteed prices for electricity and tax-breaks dramatically boosted the growth in renewable electricity generation across Europe in the last few years. The liberalisation of Europe’s electricity markets and new regulation improving competition also played a role. Although, falling prices and technology gains spurred the sector’s expansion more than any government policy, particularly for solar power.

For renewables’ expansion to make any difference to greenhouse gas emissions coal-fired power production has to be tackled. Although it is cheap, burning coal releases significantly more greenhouses gases than other fossil fuels including gas in the electricity sector and oil in transportation. Europe’s aging fleet of coal-fired plants are also extremely inefficient at generating electricity compared to newer gas-fired units. A quarter of electricity in the European Union and almost forty-percent in the United States is still generated by burning coal. It is around two-thirds of the electricity mix in China where the resulting air pollution in its major cities is fuelling a sense of urgency.

Political leaders are aware of this danger and are acting to reduce coal production and consumption in many countries around the world. By 2025 all coal-fired power in the United Kingdom will be shut down according to current plans. New Zealand will close its two remaining large-scale coal-fired power plants in 2018. The provincial government of Alberta in Canada, where the tar sands industry alone produces more emissions than Portugal, has announced plans to phase-out coal power over the next fifteen years. China’s goal is to cap coal consumption in 2025 and accelerate its decline thereafter.

President Obama’s Clean Power Plan intends to restrict emissions from current coal-fired power plans, substitute coal with gas-fired or zero-carbon generation and impose strict emissions standards on new plants. The goal is to cut emissions in the electricity sector by a third relative to 2005 levels. Coal mining states have fiercely contested this “war on coal”, which is bound to be difficult for certain towns and regions whose local economy and workforce are dependent on coal mining, not just in the US. Nevertheless, coal needs to eventually exit the electricity sector if the commitments made by the US and 195 other countries at COP21 in Paris late last year are to materialise.

Yet, none of the above is enough to slow climate change. India is set to contribute the greatest share of growth in global coal demand in the future, mostly from increased domestic production. How it intends to reach its goal to produce forty-percent of its electricity from non-fossil fuel sources by 2020 is unclear. In Germany, coal’s resurgence in the power sector has cast a shadow over its achievements in increased generation from renewable resources. Angela Merkel’s government is working on a plan to phase out coal by mid-century. From the European Unions’s biggest economy this is too long to wait. Decarbonising electricity production by phasing out coal remains a long way off. Coal has been condemned by the world’s leaders but not yet replaced.

Renewables menace traditional power model

Lots of things are shaking up the traditional power model. A decade ago gas and coal power plants were very profitable. Retail companies, which distribute to industrial and household consumers, bought wholesale electricity at a price that always covered operating costs and got a healthy boost during peak demand hours. Even fairly inefficient power plants could expect to have enough profitable operating hours to keep in the money.

Electricity generated from renewable energy sources has altered this dynamic, most noticeably in Germany where Energiewende policies encourage renewable energy development. The upfront costs of new renewable energy projects are subsidised. Once operational wind or solar parks are given priority access to the distribution grid – they can always market the electricity they produce. Furthermore, the government pays out a “feed-in” tariff. That is, guarantees a certain price for every megawatt hour of electricity generated by a wind or solar farm.

These policies have discouraged private investment that might have brought more competitive renewable energy technologies, ones that do not require government subsidies, to market sooner. Nevertheless, Germany’s goal to get 60% of its electricity from renewable sources by 2050 is on track. The eventual success or failure of these policies is the experiment the entire world is watching.

However, the rapid expansion of renewables has upset the incumbents – traditional thermal power generators that use coal and gas as fuel. Renewables harm their profitability for a number of reasons.

First of all, the average wholesale electricity price is lower. Once a wind turbine or solar panel is installed operating costs are near zero because the wind and sun are both free fuel sources. The price of electricity depends on where inflexible consumer demand matches producers’ supply. The producers with the lowest operating costs are always called on first. Then the price of electricity creeps up the supply curve until consumer demand is satisfied. Every day, every hour, producers receive a price for the electricity they produce based on the last generator called up in the so-called “merit-order.” The graph below illustrates this.

meritorder

The last generator is always less efficient. This means that its operating costs are higher and it will only generate electricity when the price covers these operational costs. Now that renewables are part of the merit order, we don’t climb as high up the curve as before. On average, prices have decreased, implying the recurrent “last generator” is more efficient than a few years ago.

Second, thermal power plants’ operating hours are down. A lot of electricity is being generated from renewable sources replacing supply previously provided by gas and coal power plants. This point is obvious – money can only be earned when your power plant is online and generating electricity. This adds to traditional power plants’ woes. Prices are weakened, but their sale volumes are also harmed as renewable energy production grows.

Third, renewables are very variable. Already gas power plants have shut down and new projects have been cancelled because they could not survive the renewables’ economic shake-up. However, some days the sun does not shine, or there is no wind, and traditional generators are still needed. This can vary hour-by-hour, minute-by-minute. Only very modern gas facilities are capable of ramping up and down to balance unpredictable renewable production. Although, this is simply not profitable in a weak price climate where operating hours are down. So, these rapid-response power plants are no longer being built. This is called the “missing money” problem.

Fourth: the rise of the prosumer. Households and businesses have been installing solar panels with the hope of decreasing their electricity bills. In some countries, excess electricity that is generated can be injected into the grid earning you cash back from the local electricity retailer. This is how the word prosumer came about. Households connected to the distribution grid were traditionally pure consumers. Having installed solar panels the consumer is now a producer as well. They may even be electricity self-sufficient on sunny days or exceed their own electricity needs, affording them the opportunity to sell back to the grid.

Alone, one solar powered household cannot produce enough electricity to perturb the traditional power model. Yet, the arrival of hundreds and thousands of prosumers on the grid has the potential to be very destabilising as seen with commercial solar generation.

These four issues are part of a bigger problem: electricity infrastructure and markets are inflexible. They were not designed to manage decentralised and unpredictable electricity production. Nevertheless, this is the model we will have to manage in the future. Distribution lines also have ramping limits constraining how quickly power flows can be increased or decreased. Volatile prosumers and commercial wind and solar farms compromise the grid’s technical stability. And we still need back-up for the days and hours when renewable electricity production is low. Managing variable electricity production demands a model where this responsibility is shared by the market players.


Graph was found at www.powermarket.eu

Welcome

The perfect energy source – that is cheap, safe, abundant, reliable, environmentally friendly and producible on any scale – doesn’t exist.[i] When it comes to energy, we can’t avoid making judgment calls. Energy is policy. It is a choice.

Do we want the most stable, reliable electricity production possible? A government-sponsored nuclear industry, like France’s, makes sense.

Or is cheapest best? This is most relevant to developing economies. Coal is abundant, transportable and very cheap. And very polluting. China is the world’s biggest consumer of coal, but it still plays a huge role in countries like Germany, Poland and the US.

Or do we want to reverse climate change? If so, our society needs revolutionary rethinking. Cars, freight and planes would have to all but disappear.

Sunshine and wind are abundant in many countries and not polluting in themselves (the production of parts, installation and noise pollution aside). But who will bear cost of realising an entirely new smart electricity grid? What power generation will be used as back-up on the days the wind doesn’t blow and the sun doesn’t shine?

This blog is intentionally bipartisan. I am interested in solutions, not ideology. Developing solutions that address climate change and pollution, while also supporting development and fairness, and allowing for profitability. This requires both creative thinking and diverse inputs. We can benefit from the efficiency and dynamism markets encourage without rejecting the crucial role governments can and do play – and should, since safety is at stake.

Misunderstanding of energy issues is pervasive – exacerbated by misleading articles in the media. And our politicians struggle to promote their own energy policies, as they themselves lack clarity about the issues.

A lot of activists with worthy motivations – preventing dangerous climate change from engulfing the planet or radiation from poisoning another generation of young Japanese – make hasty suggestions about how to deal with the problems that worry them.

This isn’t surprising as energy issues are complex. They don’t conform to classic economic models. Each sector seems to have its own strange dynamic. Gas is regional. It is transported by pipelines and blighted by geopolitical manoeuvring. And it has yet to make strong in-roads into the transport fuel market to compete with petrol. It is still mainly being used by industry and for heating.

Oil is traded a hundred times more in paper than in physical barrels. This liquidity stems both from its being easy to transport as well as from strong competition. Yet, fundamental constraints affect the oil market too. The stuff of value is the refined petroleum product obtained from processing crudes. And the refineries that do this are both very expensive and inflexible, and can only be used to refine a particular crude oil.

Oil’s price level directly affects inflation and the cost of living in most of the countries that consume it. And, in the big producing countries, it often forms the backbone of their governments’ budgets, and can dramatically increase or decrease income levels.

Electricity may not be the biggest contributor to climate change, but the debate around renewable energy, particularly solar and wind power, takes centre-stage here. Electricity markets reflect their infrastructural base as electricity can’t be stored it must be consumed immediately after it is created.

The make-up of electricity systems varies greatly according to country – and within nations. For example, New Zealand’s predominantly renewable electricity mix is based on geothermal and hydropower. This is only possible because of the country’s local geographic and climatic conditions.

The often forgotten market is dirty, but abundant coal.

Coal is usually local. It is also the fuel that would suffer most if a price for carbon was integrated in its valuation. A little appreciated fact is that shifting 1% of global coal usage to natural gas would be the equivalent of increasing current renewable energy production by 11%.[ii]

A good understanding of the dynamics of the energy industry and markets is necessary if we are to be serious about addressing the global problems we face; whether these are fair consumer prices, climate change, energy poverty and access, economic and industrial growth, energy supply security or global financial stability. I’m very serious about these – although I don’t believe the solutions are easy or obvious. But we mustn’t be dismayed or dissuaded by the complexity of problems that face us. We will discuss them here.


[i] Although a cheekier analyst might suggest that energy efficiency – not wasting energy – is the cheapest fuel we have.

[ii] Data from BP Energy 2035 Energy Forecast, C.Ruhl, January 2014