Liebreich: Power Struggles – The Growing Geopolitical Role of Electricity Markets

By Michael Liebreich
Chief Executive
Bloomberg New Energy Finance

Between 1929 and 1933, in response to a vicious recession sparked by a credit bubble, European powers embarked on a rivalry which would see world trade collapse to nearly nothing within four years – creating the conditions which ultimately led to the outbreak of the Second World War.

Had the countries been bound together more closely by trade in energy, they would have found it much harder to reverse their economic linkages and fight each other. While no one is suggesting that the current increase in global trade tensions will end with a world war, the implications for geopolitics and trade liberalisation of upping the integration of the world’s energy systems is more than just academic.

In particular, the expansion of electricity grids across borders is emerging not just as a huge area of investment opportunity, and as something that will directly affect the extent to which the world can reduce emissions – but also as geopolitical glue. It is a positive trend, early in its development, and a ray of hope amidst the worrying allegations about unfair trade in wind and solar hardware that I covered in this space last month.

Could cross-border transmission really have such a big impact? Well, the challenge of upgrading grids to cope with renewable energy has certainly moved closer to the forefront of the minds of both investors and policy-makers in the last year.

Bloomberg New Energy Finance’s figures for financial investment in clean energy in the third quarter of 2010 showed a 12% rise from Q2, to $37.9bn. Instrumental in that increase was $1.9bn aimed at linking offshore wind farms in the North Sea to the grid – in the form of two high-voltage cabling projects in German waters.

Q3 is the first quarter that investment specifically targeted at integrating renewable assets has made a material impact on our regular figures for investment. Our policy is to include grid projects in the overall data if they are required only or very substantially for renewable power transmission. So, for instance, we do not include grid updates in areas where onshore wind or solar PV plants operate as well as fossil fuel power stations.

And the third quarter of 2010 will be only the start. Transmission projects catering specifically for renewable energy, particularly offshore wind, are set to become more and more important in the years ahead.

Bloomberg New Energy Finance’s estimates are that in Europe alone, some 30GW of offshore wind will be installed between 2010 and 2020, requiring 800-1200km per year of high-voltage cabling through 2016 and up to 1600km per year thereafter. The total bill for the cabling and substations in this period will be up to EUR 30bn, and there is likely to be other investment in offshore grids of EUR 10bn to EUR 15bn.

Other specialist renewable energy transmission projects are also in the news. Earlier this month, Google announced plans to invest in a $5bn underwater transmission network, the Atlantic Wind Connection Project, to harvest electricity from wind farms of the Mid-Atlantic coast and deliver power to Virginia, New York and New Jersey. The cost of the first 150-mile phase will be at least $1.7bn, although it is unlikely to progress until the introduction of federal or state incentives specifically backing offshore wind.

In solar, the Desertec Foundation (read consortium) is lobbying for its grand vision of linking 400GW of projects in North Africa with southern Europe. Even if this remains largely a mirage, there is no question that there will be significant development of solar power in North Africa, and transmission capacity across the Mediterranean will most likely make economic sense as much for shipping excess European wind power to North Africa to drive desalination as to divert cheap North African solar power for use in Europe.

Until comparatively recently, sceptics believed that there was a natural limit to the amount of intermittent, renewable energy capacity that any one country could usefully generate. Denmark, with 20% of its power coming from wind by 2008, was thought to be about to hit some kind of natural limit, with the country lurching from excess generation and negative power prices to insufficient generation and skyhigh prices. In Spain, wind energy fluctuates between 1% and 54% of the nation’s electricity demand. Yet in both cases, the grid is stable, demand is met, investors manage to achieve returns on their capital and the system cost has barely been driven up. When Spain hit 12% penetration of wind into total capacity, the cost of balancing renewable-energy intermittency was estimated by the grid operator at just $1.80/MWh.

Scotland’s First Minister Alex Salmond really wants to push the clean energy envelope, pledging in late September to increase renewable power by 2020 to the equivalent of 80% of his country’s electricity consumption. Given that the current figure is only 20% or so, and that wind will make up most of the increment, his commitment raises the issue of how to cope with the resulting intermittency.

Salmond’s vision becomes feasible only if there is a big increase in cross-border electricity trade between Scotland and England, Scotland and Scandinavia, and Scotland and other northern European countries. Scottish wind could be used in tandem with balancing gas- and coal-fired capacity in Yorkshire, the Low Countries and Germany, and with hydro capacity and other resources in Scandinavia. The First Minister told a conference in Edinburgh that in his view the main obstacle in the way of rapid growth of renewable energy in Scotland was not the billions of pounds in debt and equity finance needed for the offshore wind projects themselves, but the grids.

A group of European companies, including Nexans, Areva, Hochtief Construction and Mainstream Renewable Power, are pressing Brussels to support a $46bn “supergrid” that would distribute 22GW of power capacity around the continent by linking offshore projects to “supernodes” at sea.

Even more ambitious is the 170GW inter-regional grid being championed by the European Climate Foundation in its “Roadmap 2050” report. This said: “On the supply side, we found a comparable level of benefit from wide geographic integration, with the well-documented local variability of renewable primary energy sources like wind and solar largely disappearing with the level of trans-European integration envisaged here.” They claim there would also be a financial saving for the cross-border network too, as it would allow “sharing of reserve capacity between regions, reducing total reserve requirements by around 40%, avoiding significant redundant investment”.

Securing the finance for international transmission – assuming diplomatic and regulatory hurdles are overcome – ought to be easy, since construction risks are relatively low and the technologies of high-voltage direct current and high-voltage alternating current cables are more mature. With institutional investors such as pension funds struggling for yield, with 10-year bonds offering 4% or less in most leading economies, low-risk infrastructure offering 7-9% looks attractive indeed. Even more so if the construction phase is financed by a utility and the project is only sold onto institutions once it is operating.

A big challenge, however, is how to get developers across different markets to deliver interconnected wind farms, when each country’s incentives are structured to encourage them to link projects back to their domestic shore as cheaply as possible. Generators report that returns are too low for them to consider using more expensive HVDC grid equipment, and demand that if integrating offshore wind farms into a single grid offers public benefits (such as promoting interconnectedness, energy security, etc) then governments should pay for it, not investors.

The German offshore grid investments we recorded in our Q3 figures – while serving to link new projects to load centres deep in the country – will still not interconnect these projects with other nations. At least, unlike past investments, the technology in these grid connections is somewhat futureproofed, in that it can be interconnected at a much later stage.

There will also be political and practical complications. Sweden and Norway have found it more difficult than they expected to integrate their green certificate markets, and France is sensitive to the idea that a competitive European power market might weaken EDF. And making crossborder links work as expected can be hard, as the UK found in summer 2003 when it was exporting power to France just as a heatwave forced up demand at home.

So there is still a stony path ahead towards the hoped-for surge in international trade in electricity. Europe is likely to be a test-case on how quickly these issues can be resolved. Once they are – and I am optimistic that we will see strong progress in coming years – the inevitable next step will be a higher level of integration in power markets and exchanges. There is talk of a major California-Mexico link, involving the latter investing $4bn in storage for wind and solar power.

Cross-border power exchanges would make sense in the most unlikely places. Medium-sized and small countries in Latin America, south east Asia and Africa should be exchanging power from different sources to better match supply and demand – solar and wind from Thailand with fossil-fuel power from Malaysia for example, or a Central American grid with wind from Costa Rica criss-crossing with geothermal from Guatemala and biomass from Belize, or wind from Kenya and small hydro from Rwanda and Uganda.

It will take many years for these relationships to develop and for the grid hardware to be paid for and installed. Even an optimist like myself would say that while it could be an important part of the world energy system in 2030, progress will be modest between now and 2015. But policy-makers will increasingly realise that transmission is essential if we are to see significant increases in the percentage of renewable power in the world’s energy mix.

If this leads some countries to build more intimate, mutually-dependent links with their neighbours, in the name of efficiency and cost-saving, that is surely only to the good. Europe may not need an interconnected electricity grid to remain at peace. But who knows, one day we may see wind farms in Israel’s occupied Golan Heights powering consumers in Syria. Or maybe it will be the other way round. One can always dream.

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Bloomberg New Energy Finance (BNEF) is an industry research firm focused on helping energy professionals generate opportunities. With a team of experts spread across six continents, BNEF provides independent analysis and insight, enabling decision-makers to navigate change in an evolving energy economy.
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