1 final report section 1 general picture and background information july 2003 capacity plan for...

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FINAL REPORT Section 1

General Picture

and

Background Information

July 2003

Capacity Plan for 2003-2009: Market Consultation

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Cause

In the wake of the finalisation of the Capacity Plan for 2003-2009, TenneT increasingly found itself experiencing a need to sound out consult the various market players on the set-up and substance of the survey of the electricity market.

Fact-finding visits were paid to this end to a comprehensive range of businesses including generating companies, sector associations, supplier businesses, consultants and traders.

A total of 21 parties ended up being contacted all of which responded positively, with the subsequent interviews taking place in a highly constructive atmosphere.

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General picture

Notwithstanding the fact that each of the parties has discussed the various themes from its own perspective, the consultation round has nevertheless brought to light as a fairly general picture that the electricity market is currently still grappling with a large number of uncertainties that are seriously undermining the foundations of the market as such.

These uncertainties are to do with market structuring and with the Dutch and EU government policy inclusive of regulation.

According to the interviewees, governments in particular will have to make choices without delay to arrive at a stable level playing field to underpin a healthy investment climate.

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Main uncertainties:

Impact of future carbon dioxide, sulphur and nitrogen oxide emission trading systems.

Renewable development. Expansion of interconnector capacity domestically and at

European level. Phase-out of nuclear facilities. Outcome of process of liberalisation and privatisation of gas and

electricity markets. Tariff harmonisation. Emergence yes or no of market power on development of

oligopoly at European level.

More in-depth attention is devoted to each of the above uncertainties in the next pages.

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Impact of future carbon dioxide, sulphur and nitrogen oxide emission trading systems on the electricity market

• Political uncertainties are prompting businesses when preparing future scenarios to include emission trade as a major risk, which in turn is causing generators to be put off newly developing capacity. At present, in fact, almost no interest can be detected in new coal-fired capacity development.

• Capital expenditure schemes aimed at extending the life of existing plants are also being deferred as emission trade could necessitate substantial environmental investments having to be made and/or costs for old units having to be incurred.

• A further concern is that a multitude of national emission right trading systems could be formed rather than a single EU system. If this happened, no level playing field could be achieved.

• It is unclear at market level whether the government would be willing for the sake of the environment to introduce additional CHP incentives.

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CO2-emission trade in the Netherlands

The Dutch government in 2002 decided to go with the European Commission’s “cap and trade system”.

This system is to be rolled out from 2005 onwards. The cap and trade system provides the joint emission trade

participants with a fixed quantity of emission rights, thus creating an absolute cap (maximum).

The rights issued are identical in numbers to the emission which would take place in a policy-less scenario on deduction of the reduction target. Rights will be made available to the various parties without cost (“grandfathering”).

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Potential effects of implementation of CO2 emission trade (1)

McKinsey in a recent survey has demonstrated that the price for CO2 emission rights in a fully fledged market environment could turn out at EUR 25/tonne. This would push up electricity prices and cause coal to be supplanted by gas.

According to McKinsey, the “grandfathering mechanism” will enable many electricity generators to realise unexpected profits.

Source: These charts were originally published in "Climate change for Europe's utilities“, The McKinsey Quarterly, 2003 Number 1, and can be found on the publication's Web site, www.mckinseyquarterly.com. Copyright (c) 2003 McKinsey & Company. All rights reserved. Reprinted by permission.

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Potential effects of implementation of CO2 emission trade (2)

McKinsey has furthermore pointed out that European policy makers will have to strike the appropriate balance in realising the following goals:

Preservation of competitive electricity generation

Source: "Climate change for Europe's utilities“,The McKinsey Quarterly

Retail price maximisation CO2 emission reduction

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Future facilitation of “renewable” approach (1)

• Expectations for the coming years continue to point to major differences being maintained between the various EU Member States in terms of “renewable” subsidies. Although EU tax relief and subsidy status will in due course be secured for “renewable”, the time frame within which these changes are to be implemented is shrouded in uncertainty.

• The CO2 targets of the various Member States, will partly dictate the national subsidy options for “renewable”. This development could hamper the emergence of a level playing field.

• In the Netherlands the development of off-shore wind farms is being delayed due to the government not yet having endorsed the North Sea concession scheme. The issue of permits is suspended until the concession scheme has been finalised.

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Future facilitation of “renewable” approach (2)

• The energetic lobbying activities by environmental/pressure groups are being seen as an uncertain factor in terms of the expansion plans for off and on shore wind farms and biomass projects. Securing the appropriate permits usually is the main obstacle where projects are concerned.

• The government’s plans to start differentiating the subsidy for small-scale biomass installations on expiry of a three-year term of the implementation of the MEP Scheme could put off the development of this option.

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Main elements of government encouragement/subsidising of “green” power, CHP (combined heat and power) and CNFE (climate-neutral fossil energy):

Promotion of demand for “green” power:Consumers that opt for “green” power are charged less Regulatory Energy Tax (“eco tax”) (Netherlands Environmental Taxes Act, Section 36 sub i), with the eco tax on “green” power amounting to EUR 3,49/kWh compared with EUR 6,39kWh for “grey” power.

Promotion of supply of “green” power, CHP and CNFE:The generators of the above power grades receive compensation for the power they produce in the context of the MEP Scheme.

Awarding of the above grants by the government is effected on the basis of (“green”) certificates.

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MEP Scheme

The objective of the MEP Scheme consists in providing for powerful and cost-effective encouragement of the environmental quality of electricity generation in the Netherlands. The MEP Scheme enables plants generating renewable electricity or CHP or CNFE-generated electricity to be subsidised.

The MEP grant is a fixed amount per kWh and ranges from EUR 0.00 to EUR 0.07 per kWh generated and released to the grid or to a plant. The Dutch Minister of Economic Affairs resets the amount annually, through a Ministerial Regulation. The level may vary depending on the various categories of generating companies and of generating plants.

A MEP grant is awarded on a non-recurring basis in respect of plants that generate renewable energy, subject to a maximum term of ten years. This does not apply to CHP plant, for which a grant application is required to be filed annually.

Source EnerQ web site

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MEP Scheme

Source: Netherlands Government Gazette, 27 June 2003, no. 121.

Type of plant Amount (as EUR/kWh)

On-shore wind power 0.049Off-shore wind power 0.068Solar power 0.068Hydro/wave-induced/tidal power 0.068Biomass-fuelled plant (excluding waste incineration,

Having a nominal electrical capacity of no

Conversion of pure biomass0.068

waste dump gas or sludge fermentation-biogas fuelled plant)

more than 50MW Conversion of non-pure biomass 0.029

Having a nominal electrical capacity of

Conversion of pure biomass0.048

more than 50MW Conversion of non-pure biomass 0.029

Waste incineration plant 0.029

CHP 0.0057

CHP 0.0057

Having a efficiency of at least 26%

Provided generator feeds into grid

Provided generator feeds into plant: as soon as the electricity sourced by the generator plus that fed into the grid exceed 5,000,000kWh over the period from 1 July to 31 December 2003

Conditions

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Expansion of interconnector capacity domestically and at European level

• Uncertainties surrounding the taking into operation of the phase shifters are clearly affecting price levels. TenneT has not duly appreciated the major change which the 1,000MW in additional import capacity will make on the interaction between the Dutch market and the surrounding constituent markets.

• The failure to unbundle the grid and the generating companies in certain countries is calling the development of a single pan-European electricity market into question (see “Outcome of process of liberalisation and privatisation of electricity markets” below).

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UCTE capacity balance: forecast for the third Wednesday in the month of January 2003

SPAIN + PORTUGAL (1)

NGC 64.0 GW GC 48.1 GW RL 40.4 GW RCRL 7.7 GW RCRL/NGC 11.9 % RCRL/RL 18.9 %

ITALY (3) NGC 79.5 GW GC 51.5 GW RL 51.2 GW RCRL 0.3 GW RCRL/NGC 0.4 % RCRL/RL 0.8 %

CENTREL (4)


UCTE except (1) & (2) & (3) & (4)


JIEL + GREECE (2)


ENGLAND & WALES

NORDEL

Legend

NGC National Generating Power C apacity (GW) GC Guaranteed capacity (GW) RL Reference Load (GW) RCRL Remai ning capacity at reference load (GW) RCRL / NGPC (%) RCRL/RL (%) On the basis of ETSO Winter 2001- 2002 NTC between regions (MW)

(DC lines in blue)

ROMANIA & BULGARIA

NGC XXX GW

GC XXX GW

RL XXX GW

RCRL XXX GW

RCRL/NGC XXX %

RCRL/RL XXX %

NORTH AFRICA

IPS/UPS

Burshtyn Island

lines temporall y out of ser vice


TURKEY

2,000

2,000

2,210

1,720

350 300

1,400 1,200 6,000

NRV

330 500

0

0

0 0

1,600

2,050

0 0 15

0

100

? ?

?

? ?

?

2,400

4,600

300 600

0 400

Island operation

Island operation

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Phase-out of nuclear facilities

• There is wide-spread doubt regarding the planned phase-out of nuclear facilities in Germany and even more so in Belgium. “Acid test” scheduled for German units will be the closure of the Biblis nuclear plant in 2006.

• This uncertainty could hamper the development of newly built generating capacity in Germany in particular.

• The factors giving rise to these doubts include: Kyoto agreements – The closing down of nuclear plants will

place the emission targets out of reach; The decision to keep the Borssele plant in operation until

2013; The debate in Sweden and Finland on extending operation of

and newly developing nuclear plant, respectively.

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Phase-out of nuclear plant: The German situation (1)

Total operational capacity in Germany amounts to some 22GW.

About one-third of German electricity consumption is accounted for by power generated in nuclear plants (approx. 160TWh).

A covenant was concluded in 2001 between the German government and generating companies providing for the closure of all nuclear facilities. It was determined in this context what residual power generation would be permitted per individual nuclear plant beyond January 2000. This implies that the only remaining nuclear plant will be closed down around 2025 (provided the current operating times are perpetuated).

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Phase-out of nuclear plant: The German situation (2)

The nuclear plant phase-out schedule is far from predictable due to the trade in generating quota being permitted under specific circumstances.

*1) Year decommissioned on assumption of a capacity factor of approx. 85%

Centrale (jaar in bedrijf) Productiequotum Capaciteit Jaar uitvanaf 2000 bedrijf *1)

(TWh) MW)

Obrigheim (1968) 8.7 357 2003Stade (1972) 23.2 663 2005Biblis A (1974) 62.0 1204 2007Brunsbuttel (1976) 47.7 806 2008Biblis B (1976) 81.5 1300 2008Neckarwestheim I (1976) 57.4 840 2009Isar 1 (1977) 78.4 907 2012Philippsburg 1(1979) 87.1 900 2013Unterweser (1978) 118.0 1247 2013Grafenrheinfeld (1981) 150.0 1345 2015Krummel (1983) 158.2 1316 2016Gundremmingen B (1984) 160.9 1344 2016Gundremmingen C (1984) 168.4 1344 2017Grohnde (1984) 200.9 1430 2019Philippsburg 2 (1984) 198.6 1362 2020Isar 2 (1988) 231.2 1475 2021Brokdorf (1986) 217.9 1361 2021Neckarwestheim 2 (1988) 236.0 1365 2023Emsland (1988) 230.1 1314 2024

Totaal 21880

*1) Bij aanname m.b.t capaciteitsfactor van ca 85%

Opgesteld vermogen Duitse kerncentrales

0

5

10

15

20

25

2002

2004

2006

2008

2010

2012

2014

2016

2018

2020

2022

2024

Jaar

Ve

rmo

gen

(G

W)

Source: Covenant dated 14 June 2000 between the Federal Government of Germany and the power generating companies.

Plant (year commissioned) Operating capacity of German nuclear plants

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Outcome of process of liberalisation and privatisation of gas and electricity markets (1)

• Uncertainties surrounding the security of supply are making a variety of authorities turn away from the comprehensive liberalisation of the electricity market. Some national authorities are becoming concerned with the dependence from other countries where it concerns the supply of energy (carriers). In the Netherlands, for example, both the Social Democrats and the Christian Democrats in the run-up to the 2003 general elections argued that the Netherlands should be significantly self-supporting in this respect. The focus on national self-sufficiency within the EU is developing into a theme.

• Confusion surrounding the breaking up of old generation monopolies is frustrating the opening up of the market in some countries including France and Belgium.

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Outcome of process of liberalisation and privatisation of gas and electricity markets (2)

• Protectionist measures in some EU Member States are delaying the opening up of the market. In Germany, the government has decided to continue power production from lignite-fired plants. The EU has launched an investigation in the context of which all these national schemes are being probed.

• Trends in the gas market, the tariff structure applied by Gasunie, etc. are having a negative impact on CHP and the investment climate. Uncertainty surrounding the position adopted by authorities, fuel prices and the fuel mix in the years beyond 2010 represents a further theme.

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Liberalisation of electricity market

Ratification, in early June 2003, of the EU Energy Directive:

1. monitoring will continue at national level, albeit that the Member states will be under the obligation to report potentially anti-competitive conduct to the European Commission;

2. monitoring of misappropriation of nuclear plant decommissioning funds;

3. stipulations regarding power labelling, opening up of distribution grids, legal unbundling and preservation of reserve capacity;

4. agreements on deadlines for opening up of markets: 1 July 2004 for the wholesale sector and 1 July 2007 for the retail sector.

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Liberalisation of gas market (1)

EU agreement on draft CHP Directive:1. At least 18% of aggregate electricity generating plants in the

individual EU Member States by 2010;2. settlement of definitions for CHP and certification;3. supply-back guarantee;4. settlement of transparent and consistent permit and grant

scheme.

EU: Second European Gas Directive – no long-term contracts except for planned Anglo-Dutch link, provision for “open season” and “use it or lose it” principles, no tariff regulation.

Kyoto debate increasingly in tandem with sentiment regarding nuclear energy vs. gas consumption.

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Liberalisation of gas market (2)

EU seeks to achieve integrated electricity and gas market governed by a single set of rules regarding the environment, safety, liberalisation and technological harmonisation (grids, infrastructure).

EU Member States: Collaboration with EU neighbours increasingly crucial due to increasing dependence on energy (carriers), but tough negotiations with Norway and Algeria with a view to supply contracts involving third parties in the EU in infringement of EU competition regulations.

The increase in the demand for gas for power generation is set to exceed that for other fuels in relative terms.

The Dutch small-scale field policy is affecting the gas price.

The access policy that has been developed for Gasunie’s gas network has met with EU approval.

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Political strategy accompanying security of supply and self-sufficiency (1)

The Dutch Ministry of Economic Affairs, from the perspective of security of supply, is working on the implementation of measures aimed at optimising grid reliability such as quality regulation, performance standardisation, yardstick competition and certification. Furthermore the Ministry is looking into how to safeguard the generating capacity in the long term. The Minister has identified the following key conditions in this context:1. intensified monitoring of demand and supply;2. enhanced investment climate for peak capacity;3. appreciation by the market players of their own responsibilities.

Increasing resistance in the political sphere in the Netherlands against European liberalisation due to: 1. excessive dependence on “foreign countries”;2. arduous liberalisation abroad due to nationalistic mindset;3. the concern of the imports foreseen not being guaranteed.

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Political strategy accompanying security of supply and self-sufficiency (2)

Political parties are advocating government guarantees regarding adequate national generating capacity e.g. by putting in place a market for reserve capacity or making it mandatory to maintain reserve capacity. The Dutch Ministry of Economic Affairs has for the time being confined itself to commissioning additional investigations aimed at providing an insight into the reliability of supply and provision in terms of “use and necessity” and “cost-benefit”.

The General Energy Council of the Netherlands (AER) is making serious allowance for the risk that the original intentions underpinning the market mechanism will only be partially achieved, with self-sufficiency representing a theme in this context.

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Confusion regarding the breaking up of generation monopolies is frustrating the opening up of the market (1)

Belgian-based Electrabel and the Belgian municipalities apply price-fixing agreements to electricity sales.

Considerable opposition against the planned German regulator which intends inter alia to fix the conditions governing connection and use.

Many European grid companies continue to date to be associated with the original energy companies.

The Flemish government has determined that suppliers should source part of their electricity demand from Flemish generating companies of renewable power, on penalty of being fined.

The French have been frustrating the EU liberalisation target: the time frame having been set in the eventual agreement being generous.

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Confusion regarding the breaking up of generation monopolies is frustrating the opening up of the market (2)

The EU is suing France for its failure to proceed with the liberalisation of the gas market.

Both Germany and France are misappropriating nuclear plant decommissioning funds.

The Spanish authorities insist with their “golden share” in Endesa on developing a strong national player first.

The United Kingdom protests against the lack of discipline of its continental counterparts, with British companies falling prey to takeovers.

Source: Finergy Project Report, no.11

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Opening up of market being delayed due to protectionism

Germany is allowing considerable subsidies for lignite/coal-fired electricity generation, as is France, which moreover subsidises nuclear electricity generation.

Lawsuits concerning the German “lignite clause”, viz. market players whose operations thwart power generation using lignite may be denied grid access.

The privatisation of EDF is proving to be quite costly to the French government due to pension rights and commercial refinancing charges. The government is already facing steep costs, with state guarantees for nuclear plant being a must because of uninsurable risks.

The EU has requested from Germany and France that they should cut back government support (tax relief/credit bonds).

The German government is contemplating the amendment of the Electricity Act so as to be able to refuse power imports from insufficiently liberalised markets (countries), France in particular.

The EU is tackling Spain and Italy for their legislation aimed against EDF acquisitions.

Power imports are not permitted in Poland whereas this country’s inadequate distribution facilities make its power exports expensive.

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Tariff harmonisation

• Differences between tariff systems will disrupt the level playing field. The Dutch generators’ tariff (LUP) puts Dutch generators at an arrears of over one euro per MWh as compared to their foreign counterparts. This accounts for approximately 20% of the current forward price discrepancy.

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European tariff systems

Source: ETSO

31


Electricity transmission costs (inclusive of system services) in Europe

Source: ETSO

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Emergence yes or no of market power on development of oligopoly at European level

• Current prices are below the long-term marginal costs, and may have resulted from a surplus situation or from the efforts made by established market players to ward off new market entrants.

• As the generation of electricity represents a capital-intensive industry an oligopoly of vertically integrated companies at EU level would appear to be the most probable future market situation. A balance will have to be struck between competitor numbers and profit margins.

• New market entrants will probably have to confine themselves to niche markets.

• The ongoing process of consolidation among market players and the fact that some national monopolies are being maintained are combining to dampen enthusiasm where the development of new generating capacity is concerned.

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Ideal model Reality

Monopoly Economies of scale. Scope for achieving social and environmental ambitions as well. Unambiguous public responsibility

Due to the technical dominance at E industry management level, marketing/financial performance difficult to measure and control. No consistent government interference

Competitive market

The disintegration of the chain is causing wholesale and retail markets to form and will be forcing down prices. Overinvestment has become a thing of the past. Greater financial drive, which will spark competition among raw material and supplier companies as well.

Companies are securing their chain, thus causing vertical oligopoly to form. Over and underinvestment cycles will emerge. Higher costs for administration (software) and customer contacts (marketing communication) are being charged on to the customer. Social/environmental ambitions are scarcely being lived up to/achieved