FEATURE: Future of UK gas-fired power clouded by policy, economic uncertainty

Since the UK's famed "dash for gas" strategy in the 1990s and another government push in the early 2010s, gas-fired power has enjoyed a good run.

Last year, however, output fell 13% year on year and, while gas continued to be the dominant fuel in the UK generation mix, its 36.5% share was down four percentage points on 2019.

Clearly COVID-19 had a impact, but the future for conventional combined-cycle gas plant in UK has never been more uncertain, faced with an ongoing boom in renewables, ambitious net-zero targets and the stealthy success of low-cost gas peakers in the capacity mechanism.

Potential investors in central gas plant may also be spooked by a lack of visibility on the UK's future CO2 emissions trading arrangements, while price signals for gas-fired power also raise serious doubts about its economic viability.

Three CCGTs operated by Calon Energy, which went into administration in 2020, remain unsold. And two other recent deals in the UK show that certain operators -- especially those with shareholders that may want to prioritize ESG and environmental care -- are keen to leave gas behind.

In February, Drax closed the sale of four UK CCGTs with a total 2 GW capacity to Vitol-owned VPI Holding for GBP193 million ($257 million).

At the time, Drax said the CCGTs had performed well since they were acquired in December 2018, but did not form part of the group's "core flexible and renewable generation strategy."

Similarly, France's EDF in April agreed to offload its 1.33 GW West Burton B CCGT to US-based institutional investor EIG for an undisclosed sum.

While EDF did not specifically attribute the sale to a greater focus on cleaner energy, there could well be a reputational element to the French company's decision to sell West Burton B.

If the deal is completed, it would leave EDF with just one fossil-fired plant in the UK -- the coal-fired West Burton A, which is operating under the Capacity Market until September 2022 and will then close.

The value of the Drax-Vitol deal works out at GBP97/kW, which is some 30% lower than the GBP138/kW sale by Centrica in 2017 of 2.3 GW of CCGT capacity to EPH.

And the backlash against the use of fossil fuels in Europe, which has gained traction in recent years, is likely a factor in companies looking to exit the UK and a reluctance to build any new CCGTs, according to analysts.

"The sale of CCGTs and a lack of appetite for building new ones reflects a few factors, including reputational risk from exposure to fossil fuels," Glenn Rickson, head of European power analysis at S&P Global Platts Analytics, said.

Vitol and EIG -- the two most recent buyers of UK plant -- may see less of a risk of being exposed to fossil gas in the near term. "They don't have the negative risk around fossil fuel asset holding that the large public companies would be exposed to," Rickson said.

The UK market may also present a challenge to new investors given the upcoming launch of the UK Emissions Trading Scheme. This, Rickson said, introduces a "new variable for EU players, and increased hedging requirements."

Rickson said there was added uncertainty from the UK's political future following Brexit, including the shape of the UK ETS and the launch of a hydrogen strategy.

"This has major implications for the long-term value of CCGTs. Uncertainty around that and other policy issues is likely a factor in why the Calon plants haven't found a buyer yet," he said.

Economic considerations

Another key risk to the viability of UK CCGTs is their profitability. Gas-fired power economics in the UK are impacted by the UK Carbon Price Support -- set at GBP18/mt until at least 2023 with no indication of a change in policy direction from London -- which adds pressure on UK spark spreads.

Platts Analytics forecasts that the average quarterly UK clean spark spread will turn negative from 2025 onwards, which could disincentivize investment in gas-fired power generation assets for any potential buyer looking at the longer term.

Gas is set to make up just 23% of the UK's generation capacity by 2026, according to Platts Analytics forecasts, compared with almost 30% in 2020.

Despite the poor economic outlook, there is money to be made in the short term through the UK capacity market.

In the most recent one-year-ahead capacity market auction, the price out-turned at GBP45-50/kW/year, a record high.

"There is still the potential to earn good money with a large generation asset without actually having to run it," Rickson said. "With more nuclear closures to come and power demand expected to lift there is still value to be had in the capacity market."

Still, the longer-term future for gas-fired power in the UK and across Europe as a whole remains uncertain unless operators invest in carbon capture or hydrogen conversion technologies.

Last month, Norway's Equinor and UK utility SSE said they would develop two low-carbon power stations in the UK -- one of the UK's first power stations with CCS and the world's first major 100% hydrogen-fueled power plant in northeast England.

The two also plan to combine to have a gas-fired station with CCS at Peterhead in Scotland.

The companies stressed, though, that the projects are in the development stage and dependent on the progress of government policy.