Why should you build solar parks close to a coal plant? Why are the electricity prices so high? Why is it so hard to shut down coal plants? How much power generation will we build in the coming years? These are just some of the things we discussed with Bjarne Schieldrup, one of Europe’s leading energy and commodity analysts.
We’ve been reading - and feeling - a lot about the prices of electricity in Europe this winter and spring. What is the current state of the European power market?
“The historic price in Europe is on average €40/kWh. What’s baked into this price? Very little of this is actually capex (capital expenditure), because in many European countries, the power plants are old and have been paid off by now. What’s left in the price is threefold: opex (operating expenditure), the price of coal and gas, and the price of CO2. And historically the price of CO2 has been low.”
So why are we seeing so high electricity prices these days?
“Coal and gas is expensive and the CO2 price has increased by 300%. What most people don’t realize is that a lot of the price increase is driven by the increase in the CO2 price. Coal and gas might fall, but CO2 will by €75-80/ton in the coming years, and then increase to over €100/ton. By 2025, we might even see €150/ton. The reason we haven’t yet seen an even higher increase, like €200/ton, is because we still have a buffer of approx 1.5 gigaton of CO2 allowances from the 2008-09 recession when emissions fell. But this will be gone in the next 3-5 years. Once this buffer is gone, there’s a real risk the prices will go high.”
Given the falling costs of renewables and pressure to decarbonize our grid, why don’t we close the expensive coal-fired power plants?
“First, if we look around Europe, where are the coal and gas plants? We find them in the intersection of supply and demand, i.e. traditionally in those areas with available coal or gas reserves and a power demand.
Second, these plants were built to satisfy demand, so simply put, you’d have one coal plant in one town and one gas plant in another town. You wouldn’t necessarily have both in the same place, which means that even if the coal plant is expensive to run, you need the power from that plant and therefore cannot allow it to close.
Third, to paint a simple picture: you could imagine a scenario where the mayor in the town with the coal plant asked the mayor in the gas plant town to buy their electricity since gas+CO2 is cheaper than coal+CO2. However, the engineers would then say: ‘Hold on, our gas plant is running at full capacity. And adding another gas plant in Gas Town might be feasible, but the interconnection line between the towns may not be large enough.’ The mayor in Coal Town therefore concludes that he’s stuck with his coal power plant paying €90-100 MWh or 20-30% more because they have coal.
So, the decision as to whether you can close a coal power plant isn’t just about the price, but is it at all possible to close it without building a new power plant to make up for the lost electricity? The infamous “switching from coal to gas” is therefore more in theory than in reality. The EU Commission says, ‘You should close the coal power plant’, to which the Coal Town replies, ‘So you expect us to just sit here in the dark?’ In sum, there are very few places where you are able to just close the coal power plants and rely on existing gas plants from neighboring towns or regions given the limitations in the grid and increasing production in existing assets. This then leads to higher prices in areas with coal, given the combination with CO2 prices.
Examples include Poland where you have a high number of coal power plants, but not gas. Poland will have €90-100 MWh prices, so solar energy will be very competitive. If we use an analogy from the animal kingdom, solar energy is the predator eating all the coal plants because that’s where the profits are.
Another example of what happens when we introduce a better, more cost-effective option into the market is from the US. Electricity generation from coal plants has fallen by 50% in just the last 10 years. Very little of this is driven by policy, it’s driven almost exclusively by price. New gas has been built, but we see here a strong example of how quickly the market reacts when cheap renewable energy and solar in particular enters the market. Especially in Texas, the energy capital, this has been the case where massive amounts of solar and wind are being built, squeezing out coal.
Solar and wind cannot immediately replace coal’s baseload abilities, but the cheaper it gets and the more advanced storage options we have, the more we can smooth out the generating curve from renewables from a 4-hour peak to a more uniform 12-hour profile.
What replaces base load generation then in the US? There has barely been any new nuclear built since the Three Miles Island incident in 1979 and they’re cutting coal.
“In the US, they keep building profitable generation assets. That means that over time, coal will disappear because it gets outcompeted. Using the same analogy, more and more solar predators will circle the coal plants because that’s where the prices are high. First, coal will lose the peak hours to solar, then the “shoulder” hours, and finally be left to only run during the night. But the coal plant still has many fixed costs, so if the capacity factor is 80% you can spread those costs over a high number of hours per year, but once you’re down to 50% you have lost 30% of the time you can spread those costs over, so the prices per hour get even higher and solar and storage then have a better value proposition and they continue to fall in cost. On top of this, starting and stopping a coal plant is difficult and leads to increasingly more wear and tear with consequently higher OPEX. And you can see how this vicious cycle continues.
The American reduction in CO2 emissions has been formidable. Many people think this is because of the increase of gas, but the truth is that it’s largely because of renewables as these are zero-emission assets. Gas in comparison is about one-third the emissions of coal. If you look at the American CO2 budget, yes, a lot of it is gas given how much has been built, but one cannot forget the role of renewables. If you look at the CO2 reduction in the power sector as a whole, it’s about 50% due to gas and 50% due to the increase in renewables.”
But the reduction for gas is also tied to the life cycle of methane leaks because you don’t need more than just a few percentage points of leaks before this changes the “positive” impact of gas and gets ugly considering that methane is 80 times more potent as a greenhouse gas than CO2.
“Absolutely, and this is a problem we’ve barely started to look at but something that is getting increasingly important. We’re starting to think more about emissions from a “cradle to grave” perspective. For instance, car manufacturers will need to both account for their emissions and all of their suppliers and their suppliers again. Another example of supply chain emissions accounting is in the steel industry. In Denmark, the authorities are looking to regulate the wind industry so wind developers will have to use low-carbon steel. In Europe, we’re looking to build perhaps as much as 60,000 offshore wind turbines in the coming years. Remember, each of these turbines is the size of the Eiffel Tower, so we’re talking about a lot of steel. If all of these are then built in China with high carbon intensity steel with electricity from coal plants, we’re shooting ourselves in the foot in terms of how green we are. Because of what might be new regulations from Denmark, we could very well see that all government tenders in the next 12 months will mandate low-carbon steel, which would be a game changer.”
How will the future power sector look given that so much of what today is fossil-based will someday be decarbonized, therefore increasing the need for electricity?
“If we look at Europe, the power consumption has been fairly stable, but we’ll need to triple our electricity generation by 2050 to meet the increasing demand. Triple today’s generation in just three decades. This is also the case in emerging markets, they will also move away from fossil fuels covering much of the overall energy supply to electrifying more and more sectors, pushing up the electricity demand. The historical growth in global power consumption has been 2-3% per year.
In 2019, the EU and the UK combined consumed 3,200 TWh, the Nordics being approximately 400 TWh and Norway around 150 TWh. So just in the EU, we need 230 TWh of new power generation every year to 2050. However, in terms of decarbonization, we must also remember that 80% of emissions are outside of the power sector, so if you take away all the coal and natural gas, you’ve only solved 20% of the problem. So the real challenge isn’t just to remove coal and natural gas from the current electricity mix, but to do this and electrify large parts of the other 80% in order to decarbonize our societies. The power sector will become insanely large, whereas today it’s actually quite small.
We have to build half of what all the Nordics combined consume, which is 230 TWh every year. If we calculate just in a back-of-the-envelope kind of way, to build 7000 TWh we need €2-300 billion every year, just in the EU + UK. If we look at the oil sector, the investments have been around €500 billion per year, so what we need in just Europe is half of the entire capex spending globally from oil and gas every year. This is a serious amount of money.”
So what needs to happen to unlock this massive amount of capital to build the power sector?
"Higher electricity prices! What we have, as mentioned, in this first round of higher prices is the combination of coal, natural gas, and CO2 prices. In the next round, we need the CO2 price to be at least €75-85/ton. This means that the new normal for electricity prices in Europe will be €80 MWh instead of the historical €40 MWh.
I talk to people who tell me, “There’s no profit in the power sector, so how can you build this without governments burning their cash in the form of subsidies?” Part of the problem is that so much of power trading is now in the spot market, but just like in natural gas where you need long-term contracts to secure the supply, I believe we also need long-term contracts in the power sector so investors have the predictability and now they can sell the electricity to a certain price for the next 20+ years. If I was going to invest €200 billion, I wouldn’t want to settle with just selling the electricity in the spot market. I’d want to lock in €80/MWh for the next few decades. I think the structure of the power sector will likely change. It might be similar to what we have in the carbon capture market where in the EU we have a “contract for difference” structure. This means that if the price for carbon capture is €120/ton CO2 and the CO2 price is €60/ton, then the government will cover the delta, so the risk is largely eliminated for the investors and ensures that the assets get built.
We’ll spend the equivalent of a defense budget to build the energy transition, 1.3% of the EU + UK’s GDP, but this is likely a conservative estimate because it doesn’t factor in grid expansions, batteries, and everything else.”
In the Poland example, if you build solar close to the coal plant, you also need to build storage for the winter, right?
“Yes, we definitely need storage for the intermittent sources. Many people believe that that’s where natural gas comes in. Most conventional natural gas plants are built to run for 40 years with a 90% capacity factor. These have very high quality, state of the art from suppliers like Siemens and General Electric. However, if natural gas’ role changes from baseload to only running a few hours a year, we can build much cheaper gas plants with some gas storage instead so if we have an extra cold winter, we can fire these up to supply extra heat and/or electricity. So these “peakers” will likely increase in numbers to offset renewable energy’s intermittency.“
Thank you to Bjarne Schieldrup for taking the time to discuss these projections in detail with us! At Glint Solar, we’re invested in growing the solar market across Europe and the U.S. If you’re in the early stages of solar development, contact us today to learn how we can help your project succeed from the start.