UK excess power margin could hit 0% in the winter of 2016-17, making winter blackouts and other power problems more likely. This has created an opportunity to invest in ‘Reserve Power’ – high-specification, small-scale generating plant that receives multiple revenue streams by providing electricity when most needed.
The UK’s power supply has typically operated with a total generating capacity that exceeds peak demand by a comfortable margin. This ensures a robust electricity supply during periods of peak demand, even if some power generating assets experience temporary technical problems or outages.
But spare capacity is coming under pressure due to 4 key factors:
1) The closure of coal- and oil-fired generation under the European Union Directive
2) The decommissioning of 14GW of nuclear power stations over the next decade whilst political and financial issues have delayed replacements
3) The intermittent nature of renewable energy sources creating unpredictable power supply
4) The prohibitive expense of gas-fired generation
As a result, Ofgem now forecasts that spare capacity could fall below 2% in winter 2015-16, and to 0% the following year. If this occurs, it becomes more likely that businesses and homes will experience blackouts and brownouts.
To mitigate this issue, both the UK Government and National Grid, which has responsibility for balancing power demand and supply, have put in place a number of measures designed to reward companies that can provide additional power during periods of peak demand.
These measures include:
- TRIAD payments – received from large users of electricity such as utilities, in return for provision of power during the three highest periods of demand each winter.
Frequency Response payments – received from National Grid for being available to provide power at short notice.
Capacity Market payments –introduced by the 2013 Energy Act, awarded per MWh to companies that can make capacity available.
In addition to these 3 incentive payments, generators sell the power produced into the Grid under a Power Purchase Agreement (often at elevated prices given generation us focused on periods of market stress).
- The cumulative effect of multiple revenue streams creates compelling investment opportunities, and Oxford Capital is investing in Reserve Power projects. These projects, typically installations of 15-20MW built around containerised diesel generators, aim to secure all 4 revenue streams above during times of peak demand.
- We expect the generating equipment to run 200 hours each year, and provide a 20 year life. For conservatism, we assume 18 years of cash flow, which results in ungeared project IRRs over 10%. This is a base-case forecast, and we expect a number of years where tight supply/demand balances will drive returns significantly higher than this. There are also trading opportunities which we do not include in our forecasts.
Putting it all together, our investments in Reserve Power capture diverse revenue streams, augment existing investments in Solar PV and Anaerobic Digestion, and further broaden our exposure to the structural shift underway in UK Distributed Energy.