Issue Number: 98   July 2013

Return of the King

With the UK's economy slow to recover, and the public increasingly worried by rising gas and electricity bills, the return of old King Coal is being met with less resistance than might be expected.

The increased use of coal for power generation has come at a time when public support for the more expensive renewable energy appears to be slightly waning. A continuation of this trend could result in the UK missing its climate change targets as it seeks a return to economic prosperity. Technology does have the ability to change this. Increased competiveness of technology in the renewables sector will see less need for the feed-in-tariffs that have allowed renewable energy to account for around 12% of total power generation in the UK [1]. Alternatively, or even in conjunction, the development of Carbon Capture and Storage (CCS) technology, allowing the UK to take advantage of potentially cheap coal and gas without the carbon emissions, would also help in meeting climate change targets. In reality neither of these is looking particularly promising, certainly in the short term.

Cheap Coal

In an ever-increasing trend, it appears that the shale gas revolution in the US is behind the increased use of coal. The drop in price of gas has allowed US industry to flourish, and seen gas consumption increase. Some of this consumption has replaced coal (particularly in power generation), and US coal demand has decreased by almost 80 million tonnes oil equivalent (mtoe) in the last two years, and by 12% in 2012 compared to 2011. With coal production not declining to the same extent, cheap exports have found their way to the rest of the world, and significantly Europe and the UK.

The price of coal, or at least burning it, might not be so attractive but for the ineffectiveness of Europe's emissions trading scheme (ETS), which should encourage industry to reduce greenhouse gases. In an effort to reform the floundering scheme, the European Parliament has recently agreed to delay the release of EU allowances (normally referred to as EUAs) for 900m tonnes of carbon. This should help cut the oversupply of EUAs that has been prevalent since the economic crisis and the resulting drop in electricity and industrial production which led to fall in price of permits. Whilst that vote is good news, far more drastic measures will need to be taken for the price to get above €20 a ton of carbon dioxide emissions (typically expressed in €/tCO2) or even €30/tCO2, a price which analysts think will give incentives to switch away from coal to lower carbon energy generation. Following the vote, the price of EUAs increased 10%, but still to only €4.75/tCO2[2].

According to BP's recent statistical world review the UK consumed 39.1 mtoe of coal, a 24% increase on the previous year's figures. In fact, consumption of coal hasn't been this high since 2006, and before that 1997. Exactly what this means for the future is unclear. Lord Smith, chairman of the Environment Agency has warned that the heavy use of cheap coal is threatening the UK Government's attempts to tackle climate change [3]. In 2012, coal accounted for 40% of the fuel used for electricity generation [4]. This rise in coal use is likely to have contributed to the 3.5% rise in UK greenhouse gas emissions [5], although it ought to be noted that weather conditions also contributed - a long and cold winter demanded greater power production.

EU Directives

There is also a second reason for the increased use of coal. The EU Large Combustion Plant Directive (LCPD) was brought in to regulate the emissions of sulphur dioxide, nitrogen oxides and dust, due to the damage they cause to human health and their contribution to acid rain. All combustion plants built after 1987 have to comply with the emission limits, whereas those built before 1987 either have the option to comply with LCPD by installing emission abatement (Flue Gas Desulphurisation) equipment or to 'opt out' of the directive. In the case of the latter, the plant is required to close by the end of 2015 or after 20,000 hours of burning [6]. All together 8GW of coal-fired plants in Britain chose to close rather than clean up. A number of closing UK plants have taken the option of using their 20,000 hours, burning cheap coal as quickly as possible, hence the rise in coal consumption. In fact, some plants used their hours before the carbon price floor was implemented on the 1st April this year. This might lend credence to the idea that the coal usage rise in the UK, and arguably the rest of Europe, is merely a pre-2015 quirk and not a signal that the UK is at the end of the pursuit of a decarbonised future. This surely not what the policy makers had in mind, but clearly the low price of coal, not affected by the ETS, and combined with closures has conspired against them.


Figure 1 - Didcot Power Station in Oxfordshire, UK. Didcot A, a coal and oil power plant was shut down in May 2013 and Didcot B, a CCGT (combined cycle gas turbine) remains in operation.

Despite these closures in the UK, about 20GW of coal-fired capacity will still remain and if prices of coal remain low, then coal is expected to continue to play a key role in power generation. Further EU directives are likely to limit power station lifespan with analysts expecting unabated coal to tail off in the mid to late 2020s. But currently, the profit available from burning coal far exceeds that of gas. Icis Heren found the gross profit margin of burning coal to be far larger than that of burning gas, with the clean dark spread [7] of £15.28/MWh in 2012 compared to the clean spark spread [8] of £1.37/MWh. If these numbers continue in favour of coal, then it seems unlikely that the use of coal for power generation will diminish significantly.

Providing the cheaper running costs are passed on to the consumer, everyone will be happy with lower bills. In reality, the use of cheaper coal has meant that electricity prices have stayed fairly steady whereas had more gas been used, the electricity price probably would have mirrored the price of gas, which has increased over the last 5 years. But this can only come at an environmental cost - an environmental cost that some are suggesting may result in the UK not meeting its climate change targets in the future.

As the next section will suggest, the public want clean energy but would rather not pay extra for it. This seems pretty obvious and is not unreasonable. Where coal is cheap, CCS technology has the potential to cover both of these points, from an emission point of view, albeit not in the ideal manner. Currently, that potential is not being realised as the technology is not financially feasible and for the public to reap price benefits it needs to be significantly improved. There is of course the argument that money would be better invested on renewable energy which is not subject to price fluctuations.

With CCS seemingly a way off, coal a threat to the legally binding climate change targets, and investors unsure whether to invest in gas generation at the moment, the UK appears in danger of having a capacity shortfall, or not meeting its climate change targets. In fact, last week Ofgem warned that Britain's spare production capacity for electricity could fall to just 2 per cent by 2015, triggering power cuts.

The following graph gives a snapshot of the variation in price of emissions in euros per tonne of carbon over the past year.


Figure 2 - ICE ECX EUA Futures, €/tonne (Past year)[9]

Renewables

Central to the debate about price of energy versus emissions, is renewable energy. There is no doubting that the public are in favour of renewable energy as an idea. Its advantages are both obvious and well documented. Its disadvantages are, arguably, equally so. Leaving aside arguments about aesthetics, both wind and solar are not subject to costs of a fuel nor do they release harmful emissions. On the other hand, they are not terribly efficient, they require back up generation capacity, probably in the form of gas, to protect against days with no wind and sun, and they are expensive.

For some, the benefits of renewable energy far outweigh the disadvantages. In effect, they are happy to pay extra now to reduce harmful emissions. Additionally, renewable energy, as part of the energy mix, reduces dependence on the import of gas and therefore can protect from potential high prices, although one might argue that with the potential development of shale resources around Europe and the rest of the world there is less chance of high prices. On the other hand, whilst many welcome the increased use of renewables, they would rather not subsidise it.

Despite Germany leading the way in the development of renewable energy, it currently has some of the highest electricity prices in Europe. Like the UK, it has seen an increased use of coal, simply because the cost of coal is less than that of gas. For both countries, this price issue will only change as a result of an artificial rise in carbon prices, or perhaps, in the event of higher shale gas supplies.


Figure 3 - World's largest offshore wind farm London Array
Credit - London Array Ltd.

If the carbon price continues to rise then eventually renewables will become the preferable form of electricity generation. However, this will still mean high bills. The ideal situation remains for an improvement in renewable technology, or even infrastructure, which brings down the price of renewable energy, making it competitive without subsidies. All this means that, like coal, improvements in technology can be decisive in not only meeting climate change targets but also in reducing prices. Unfortunately, at present this might be nothing more than wishful thinking.

Conclusion

The end goal for any Government is to generate cheap, reliable and clean electricity for its residents and for its industry. Unfortunately, this is rarely achievable. As can be seen in the UK, a number of factors have conspired to allow the UK to maintain fairly level electricity prices, but at an environmental cost as more coal is burnt. At the moment there is nothing really to stop utilities using coal. The carbon floor price in the UK has only just been implemented, and although the European Parliament took its first steps to reforming the ETS, it is nowhere near the level needed to actually discourage the use of coal in power generation, or industry. At the moment the next threat to coal use is an EU directive that is unlikely to halt its consumption until the mid-2020's. In this vein, as far as the consumer is concerned, either CCS or renewable technology must be improved and competitive within the market. Concerning the former this seems unlikely, even in the medium term, whereas for the latter there is a little more hope, but still not in the short term. The only other hope to reduce carbon emissions is the artificial, but effective manipulation of prices through carbon tax, which will price coal out of the market and help the road to decarbonisation, but increase the cost of energy to the consumer. As the UK and Europe continue to traverse this transition phase on the journey to decarbonisation it is clear that there are number of challenges to keep energy clean and to keep it cheap.

See also:
Financial Times: The comeback of Old King Coal, Nick Butler. Financial Times: Renewables - a fading dream, Nick Butler. (Both accessed 26 June 2013)


[1] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/208569/electricity.pdf

[2] http://www.guardian.co.uk/environment/2013/jul/03/emissions-trading-reforms-pollution-permits

[3] http://www.bbc.co.uk/news/science-environment-22711416

[4] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/208569/electricity.pdf

[5] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/193414/280313_ghg _national_statistics_release_2012_provisional.pdf - Note, this figure is emissions of the basket of six greenhouse gases covered by the Kyoto Protocol.

[6] http://www.nationalgrid.com/NR/rdonlyres/DD31ED99-F769-4995-84E3-809E29CE2E19/19877/pp07_32_LCPD_revised.pdf

[7] The clean dark spread is the electricity price minus the assumed fuel cost of generating electricity from coal, including the cost of emissions.

[8] The clean spark spread is the electricity price minus the assumed fuel cost of generating electricity from gas, including the cost of emissions.

[9] http://www.marketwatch.com/investing/future/ECX%20EMISSIONS?CountryCode=UK - accessed 8th July 2013


July 2013 MZINE