3 Intelligent Well Technology: Status and Opportunities for Developing Marginal Reserves SPE
[INCOME RISK OF EU COAL-FIRED POWER PLANTS AFTER KYOTO]
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[Luis M. Abadie, Bilbao Bizkaia Kutxa, +34-607408748,
[Jose M. Chamorro, University of the Basque Country, +34-946013769, jm.
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Overview
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In a deregulated electricity market, presumably only generation assets that enjoy a positive difference between the price of electricity and the price of a particular fuel used to generate it under prevailing market conditions will be operated. It is this spread that determines the economic value of a generation asset that can be used to transform the input fuel into output electricity. Thus, power operators pay close attention to the dark and spark spreads.
The dark spread represents the theoretical profit that a coal-fired power plant makes from selling a unit of electricity having purchased the fuel required to produce that unit of electricity. Similarly, the spark spread refers to the equivalent for natural gas-fired power plants.
Within the EU Emissions Trading Scheme (ETS), the price of emission allowances can affect the cash flows of a power plant during its entire lifetime. Upon the introduction of carbon costs, the former spreads must be corrected by the allowance price. They become, respectively, the clean dark spread and the clean spark spread.
The purpose of this paper is to assess the risks in coal plants' earnings. The whole time horizon spans the Kyoto Protocol's commitment period (2008-12) and the next eight-year period (2013-20).
Methods
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We adopt the viewpoint of a utility which is operating a coal-fired power plant with a long useful life ahead. Assuming it operates under the EU ETS, from the outset we naturally focus on the clean dark spread.
Instead of directly modelling it, we decompose it into three separate elements with simple interpretations, namely: the clean spark spread, the fuel price gap between coal and gas (per megawatt-hour generated), and the price of carbon allowance. Then, we assume a specific continuous-time stochastic process for each of them.
We estimate the discrete-time counterparts of these stochastic processes with actual market data. Our sample consists of weekly averages of electricity prices (PowerNext, France), natural gas prices (at Zeebrugge, Belgium, as provided by Bloomberg), spot carbon prices (on ETS, as provided by BlueNext), and ARA coal one-month futures prices (EEX, Leipzig, Germany). The sample period goes from May 2006 to February 2009. The first two elements to the clean dark spread are estimated jointly, whereas the allowance price process is estimated independently. The relations between the coefficients in the discrete-time equations and the parameters in the continuous-time processes allow us to get numerical estimates of the latter from the former set of values.
Subsequently we use these parameter values in our Monte Carlo simulations of each of the separate inputs to the clean dark spread (and their sum). Assuming that the coal-fired plant operates 80% of the time on average, we get an estimate of the plant’s cumulative income over the two periods, Kyoto and beyond, for a given simulation. Following this process a number of times allows us to assess not only the expected earnings but also the risk profiles.
Results
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Present and future liabilities by EU utilities in relation to CO2 emissions create a setup previously unknown. Current legislation entails new costs and risks to the generating firms. Fortunately they are getting better gauged as markets develop and price series get longer.
Profit margins do remain positive over the Kyoto Protocol's commitment period. Immediately after it, though, they can fall significantly. The size of this fall depends on the drift rate in carbon allowance prices and the potential jump in allowance prices during the transition to the next period. Expected margins can even switch to negative, or remain slightly positive but with a high risk of becoming negative in many cases. In such scenarios, this would lead to shut down the coal plant thus reducing the chances to recover the investment costs.
Conclusions
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The current economic downturn, with a lower demand for emission allowances and lower prices, has momentarily delayed the erosion of coal stations' profit margins. A change in the macroeconomic outlook, with a higher electricity demand and a strong push in allowance prices, may reverse the situation and put plants' profits under risk.
Realization of scenarios involving steep growth in the allowance price would be incompatible with investing in new coal plants. It could even trigger the abandonment of plants currently in operation but with relatively short useful lives as carbon price climbs ever higher. Potential responses from the industry might range from closure to fuel substitution (when possible), to investments in energy efficiency, to adoption of CCS technologies, or others. Note, though, that clean investments are not mandatory, are at least partially irreversible (should market conditions turn, the firm cannot "uninvest" and recover the full expenditure) and their returns are uncertain. Under these circumstances, firms may find it quite reasonable (from a financial point of view) to delay them, and regulators should be aware of it.
In the case of countries not affected by the Kyoto Protocol or similar carbon regulations, the eventual signing and ensuing adaptation could put current investments in this technology at risk. Therefore, the decision to undertake new investments should take this possibility into account.
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