Keeping the Lights On: Navigating Choices in European Power Generation

Keeping the Lights On

Navigating Choices in European Power Generation

By Christophe BrognauxYvan Jansen, and Jo Whitehead

The European market for electricity is in flux. Deregulation, growing demand, and changes in the mix of power generation technologies will create a more dynamic market and an abundance of opportunities. But Europe must also decide how or whether to achieve conflicting goals, including more competition, greater customer choice, cheap and stable prices, reductions in emissions of greenhouse gases, capped or reduced nuclear-generated power, energy independence, and reliable supplies of power. Although these goals are interrelated, many are being addressed separately, which risks being counterproductive.

Everyone—power generators, governments, and regulators, as well as gas players, energy retailers, intensive users of energy, and power plant manufacturers— needs a holistic framework to navigate these issues, assess opportunities, and make choices. With this in mind, The Boston Consulting Group conducted a study of the European market. The study is part of the firm’s continuing efforts to help companies, regulators, and governments understand tradeoffs, build scenarios, make choices, and prepare strategies. This research project integrated the factors that are shaping the evolution of the market and considered what possible scenarios would mean for prices, capacity, power generation technologies, gas supplies, and the impact of the Kyoto Protocol on global warming.

The major findings include the following:

Europe is in danger of experiencing a boom-andbust cycle that will make it difficult to smoothly meet the region’s need for at least 65 gigawatts (GW) of new capacity by 2012. Periods of underinvestment and rising prices and profitability (the boom) would be followed by periods of overinvestment and falling prices (the bust). Even though this cycle could create opportunities for some companies, it would damage customers, investors, and society at large.

Such boom-and-bust cycles are common in commodity markets. But as the brownouts and price spikes that hit California and the midwestern and the northeastern regions of the United States have demonstrated, the damage from the boom part of the cycle in electricity can be much more severe than that from booms in other markets.

A boom-and-bust cycle could be avoided, but designing and implementing solutions would be complex and time-consuming. At this point, the best bet is that Europe tries to muddle through: the region does not act in a unified fashion, and individual countries pursue initiatives on their own or, in some cases, with their neighbors. This outlook is not necessarily a bleak one for all power generators, gas players, and large energy consumers. It would present them with an array of opportunities that would surface in individual local markets at different times.

Europe will need to import significant amounts of gas to fuel new generating capacity, but this will require major investments in risky field development and transportation infrastructure. Attracting the investment will be problematic.

Combined-cycle gas turbines (CCGTs) almost certainly will account for the vast majority of the generating capacity Europe builds in the next decade. When the economics and the greenhouse-gas emissions of technologies are compared, CCGT scores best overall.

But the new CCGTs will require annual gas imports to grow from 230 billion cubic meters (BCM) today to between 465 BCM (without Kyoto) and as much as 565 BCM (with Kyoto). There is plenty of gas potentially available, but most of it costs more than existing sources and is located in technically challenging and politically risky places such as Russia, the Middle East, and North Africa.

Overall, an investment of €95 billion to €110 billion in upstream field development, pipelines, and infrastructure for regasifying liquefied natural gas (LNG) would be required by 2012. There are no current commitments to provide a substantial portion of this amount, and raising it will be challenging because of all the unknowns hanging over the energy market. They include the impact of deregulation in gas, the extent to which Kyoto will be implemented, the fate of nuclear power, and the impact that a boom-and-bust cycle would have on both the volatility of energy prices and the health of power generators.

Especially if Kyoto is implemented, the amount of generation powered by renewable energy should grow considerably, thanks to a continuous flow of subsidies. Wind power is the leading contender but has significant drawbacks.

BCG expects the amount of generating capacity powered by renewable energy to increase by 70 gigawatts (GW) if Kyoto is implemented.

The role of wind-powered electricity has grown and appears likely to become even larger for several reasons: most viable sites for hydropower have already been developed, wind power’s cost position is improving, and governments are subsidizing this energy source. But the costs are still high and a power market cannot count on its being fully available: significant conventional capacity would be needed to back up wind-generated power, adding to its cost.

If Europe remains committed to implementing Kyoto, it may have to rethink its aversion to nuclear power. There are long-term considerations that argue for keeping the nuclear option open.

With strict adherence to Kyoto, Europe may eventually reach a point—around 2020—at which nuclear power becomes necessary to avoid increasing CO2 emissions. Moreover, nuclear power may become competitive with CCGTs by then. Finally, growing dependence on imported gas may lead Europeans to reconsider nuclear power.

The minimum direct cost to Europe of implementing the Kyoto targets in the power industry alone would be about €20 billion per year, which would amount to 0.2 percent of the European Union’s gross domestic product, or about €50 per person. More important, there would be significant winners and losers among stakeholders. The big question is how governments and regulators decide to allocate— or reallocate—the burden.

To comply with Kyoto, it is highly likely that governments would require power generators to be responsible for 25 to 50 percent of the reductions in CO2 emissions that Europe would have to make. That burden would result in a direct cost of at least €20 billion per year—mainly to build power plants and supply gas that would not otherwise be needed.

Even more important, Kyoto would cause tens of billions of euros to change hands every year. If governments did not intervene, the losers would be energy consumers and owners of coal-fired and old oil- and gas-fired plants. The winners would be gas players; existing nuclear, wind, hydro, and CCGT plants; states (from carbon-tax receipts); and manufacturers of power plants. But governments might redistribute the gains to reduce the burden on some of the potential losers.

Although uncertainty hangs over the European energy market, stakeholders should take concrete steps to shape its development and be prepared to seize opportunities and minimize risks.

Uncertainty is not a reason for inaction: all stakeholders can acquire a thorough understanding of how the market may develop—at both the European and local levels. The evolution of power generation technologies and their economics, the current and potential mix of generating capacity, Kyoto policy, and competitors’ behavior will drive the balance of supply and demand, as well as the choice of new investments, retirements, and prices. All stakeholders need to understand these fundamentals. This will help them avoid the overinvestment and wealth destruction that occurred in the United States and the United Kingdom. It will help them identify the optimal times and places to acquire, build, or contract for power generation. Volatility creates opportunities for those that are prepared.

In addition, there are a multitude of specific implications and choices that apply to individual categories of stakeholders. These are discussed in the section “Implications and Challenges for Stakeholders,” page

Keeping the Lights On