Gas Generation: Times Have Changed

Looking back at the history of natural gas in Europe, things seemed pretty easy in the past, according to Klaus Schaefer, CEO E.ON Global Commodities, who opened a debate at Gas Week 2013 entitled Investing to Make a Clean Future Real.

He began, "Natural gas has been championed, and rightly so, as a cost effective bridge to a low carbon economy for Europe. Gas supports sustainability and represents the quickest way to reduce greenhouse gas emissions. It's the most efficient form of power generation, flexible for intermittent renewable power generation, as a fuel for more efficient heating applications and as a clean alternative to the European transport sector's dependency on oil."

Mr. Schaefer added that gas ensured security and for decades provided a highly reliable source of energy for hundreds of millions of end users across Europe, and would continue to be reliable and secure in the coming decades. As LNG developed further, he said, natural gas was becoming increasingly diverse as a global market.

"Gas was and is competitive," he stated. "Competition has even increased quite a bit across European markets between players, but also because the hubs have developed and the majority of gas in Europe is bought and sold on those increasingly liquid hubs, which has provided big advantages to end users."

But if there were no caveat, there would be no reason for a debate, he admitted.

"Gas and the gas-to-power market certainly are now facing more dark and uncertain times ahead," he commented. "The rise of renewables in Europe and the general view of flexible gas-fired generation as an ideal partner was, not long ago, seen as a positive development for natural gas in Europe and encouraged significant investment in combined cycle gas turbines (CCGT) across the continent in the last decade."

Unfortunately, reported Mr. Schaefer, the prospects for gas had turned dramatically in recent years due to demand destruction from the economic crisis, the rise of renewable production, cheaper coal and energy efficiency measures. Subsidies for renewables had pushed conventional fuels aside in power generation, especially in Germany, where photovoltaics had grown dramatically due to feed-in tariffs.

"Consequently gas has been pushed out of the merit order during summertime," he explained, which depressed the demand for conventional generation.

He recalled, for example, that last year during the first year of July the range of solar and wind power went from zero to 20 gigawatts, challenging fossil-fuel generation. "In one day last summer within 12 hours Germany lost 7 gigawatts of wind and 7 gigawatts of solar."

According to him, despite political consensus on the importance of natural gas in the energy transition, the near zero emissions certificates and cheap coal from the US meant that coal-fired generation was currently favored to compensate for the variable output from renewables in Europe, which had clearly had an impact on the continent's CO2 emissions, raising them.

"This means gas-fired generation, which most of us accept must play a role in the transition, is on its knees. In a study last year from IHS Cera they predicted that more than 110 gigawatts of gas-fired generation is at risk of closure, with up to 25 gigawatts of plants likely to retire in the next couple of years," said Mr. Schaefer, who said that gas's prospects as a low carbon bridge consequently did not look very promising. He said this meant the industry was standing at a crossroads.

He explained, "The European power industry is ready to follow the path of a far-reaching decarbonization of the sector by 2050, but at present is unwilling to mobilize the necessary capital, because at present it is completely uncertain whether the future framework will allow an adequate return."

Policy makers needed to construct consistent energy and climate policies to create a competitive environment in which all low-carbon technologies - including gas - could succeed, said Mr. Schaefer.

Another speaker in the session, Kurt Oswald, Partner, A.T. Kearney, began by stating that the biggest gas consumption in Europe took place in 2008 and since then there had been a decline of around 12-30% up to 2011.

He noted "In Germany in just one year there was a decline in gas consumption for generation of around 28% in 2011-12. These are striking numbers. It's mainly due to a combination of cheap steam coal coming from the US, driven by the shale gas revolution, the low carbon price, and, compared to other commodities, a higher gas price."

Clean renewables had been paired up with dirty coal.

Mr. Oswald continued: "The question is, what is future gas demand? Will it change? I think the picture is somewhat gloomy. I can't draw a rosy picture of gas demand for power generation because of the global supply and demand dynamics and pricing dynamics of gas and coal will not change immediately; the price constellation of these commodities will not change. The low or negative spreads of gas-fired power generation will probably continue."

Meanwhile, renewables looked to continue to grow, and energy efficiencies would increase.

"I think if you don't change the regulatory framework conditions, the market will not heal it, so gas will not catch up in power generation."

Topics to be address, according to him, were the ETS scheme, and capacity markets to give incentives for investments in gas generation, but it was a question as to how such schemes should be designed.

He suggested making renewables accountable for seeing to the challenges of their intermittency. "Let them take over market risks, or be responsible for balancing their portfolio," said Kurt Oswald.

Thierry Bros, Senior Analyst, European Gas and LNG Markets, Societe Generale, tackled the question of what market signals were necessary to make sure that investments in natural gas generation took place in Europe.

He said there were three main barriers to this: the price, the price, and the price.

Mr. Bros explained, "If we want gas to come back into generation in Europe, we need coal prices to go up by 70%, CO2 prices to be multiplied by 13, and gas prices to go down by 40%."

He said the prices for coal and CO2 were out of European hands. "This leave us with the price of gas. Here the market and consumers are aligned: consumers think and want the cheapest as does the market when it comes to a commodity."

In the longer term, Mr. Bros said it was a question what producers should do: sit around and watch the cheap coal from the US, or LNG arriving on their shores?

He suggested a possible linking of natural gas prices, either to coal or the price of electricity. "If you don't give a discount of 40% to the users, then it's not going to be used," he explained, that consumers would instead use coal or renewables.

Were capacity mechanisms to remunerate flexible power generation a remedy to this situation? That question was asked of Klaus-Dieter Borchardt, Director, Internal Energy Market, DG Energy, European Commission.

Admitting that he was a newcomer, he said that capacity markets had been mentioned several times in the first few weeks in his new role. "There are two things that I would rule out completely: that the European Union or the Commission would come up with an EU-wide capacity market model applid cross border to all member states—forget it.

"The other thing I would clearly rule out is that we just sit on our hands and watch member states create their own capacity mechanisms, because this would clearly go against what we all intend to do with the completion of the internal energy market. Twenty-seven different capacity mechanisms, some of them poorly designed, would lead to more fragmentation of the market than to more integration. It would have a negative influence on investment decisions that are to be taken," said Mr. Borchardt, who said the situation was being closely monitored, including frameworks in France and the UK.

He offered that cross-border trade and storage facilities might address some of the problems created by the intermittency of renewable energy source.