Feeling the heat

The need to switch to less carbon-intensive energy sources is widely accepted, but the Combined Heat & Power industry is struggling for survival, reports Simon Napper

The government has set itself a number of energy-related targets for the coming years as part of a programme to encourage more efficient, less carbon-intensive energy use. However, laudable aspirations do not count for much in harsh economic conditions.

The UK is one of the three member states in the European Union (EU) to be anywhere near achieving their targets for greenhouse gas emissions reductions accepted under the terms of the Kyoto Protocol. The EU as a whole is committed to reducing its emissions to a level 8.5% lower than that achieved in 1990. The UK has to achieve a 12.5% drop. Up until recently, it was making good progress.

However, the figures were deceptive. The achievement was virtually all due to the dash for gas in the 1990s, when the electricity generating industry switched from coal-fired power stations to more efficient Combined Cycle Gas Turbines (CCGT). The moratorium on this technology brought in by the Labour government at the end of the 1990s halted this process and emissions began to rise again. As such, it was a one-off saving and further emissions reductions will have to come from elsewhere.

Relying on CHP

This is why the government has been placing so much reliance on Combined Heat & Power (CHP) - it made a manifesto commitment to achieve 10GW of installed CHP capacity by 2010. In conventional electricity generation, the heat that is associated with production is essentially a waste by-product. CHP uses most of this heat for process or space heating applications and so the overall conversion efficiency of the primary fuel is dramatically increased. As such, it is a much less carbon-intensive technology.


ut all is not well in the CHP sector. Colin McNaught, a business manager at the Future Energy Solutions (FES) consultancy, says: "Current investment conditions for CHP mean that the market has experienced a very sharp downturn, apart from specialist applications for schemes serving community heating or using renewable fuels where government support is on offer."

As a mature, relatively low-carbon technology, CHP has the potential to be a major contributor to achieving the country's Kyoto commitments. The importance attached to CHP is reflected by the fact that Margaret Beckett, the environment secretary, repeated the government's commitment in November 2002 at the industry's annual conference.

She laid out a number of measures that are being taken to try to improve the prospects for the industry. It remains to be seen if they are sufficient to prevent wholesale draining of expertise and confidence from this sector.

According to the latest Department of Trade and Industry (DTI) figures, quoted by Beckett, only 38MW of capacity was added to the UK total in 2001 - the lowest increase ever recorded - compared to 840MW in 2000.

What has happened in between to cause such a crash? According to Syed Ahmed, head of research at the Combined Heat & Power Association (CHPA), the 2000 figures represent in part the impact of the moratorium on new gas-fired generation.

Gas-fired CHP schemes were given preference on a case-by-case basis and developers and customers were more attuned to constructing these plants. The following year saw the end of the moratorium, along with the introduction of the New Electricity Trading Arrangements (NETA), which created a series of difficulties for the industry."

NETA imposes severe penalties on suppliers who are out of balance with their contracted demand. Dealing with smaller generators who can only provide power on an intermittent basis is not worth the commercial risk for some suppliers.

"CHP plants tend to be sized according to heat demand," Ahmed says. The viability of many projects is predicated on selling surplus power, or 'spill'. This spill electricity has to be sold within NETA's balancing mechanism. Yet smaller generators are in a severely disadvantaged position here.

"All green generation is facing difficulty because of the unsustainably low price for energy. Current government signals to customers on energy efficiency are wholly confused," he continues.

This, then, is the bind that the CHP industry finds itself in: its fuel is generally natural gas, which has doubled in price over the last 18 months and shows no sign of diminishing. On the other hand, even if operators could sell their surplus electricity, the price is too low to recoup their costs. The proposition is uneconomic.

The result is that there is only one large CHP scheme being constructed in the UK at present - at Conoco's Humberside refinery. Ironically, this will be the largest such plant in the UK with some 700MW of capacity (although such plants are more common in the US).

When it comes on-line around mid-2004, it will increase the UK's total installed capacity enormously, but it is not representative of the industry as a whole. Indeed, other evidence shows how badly the sector is suffering.

Earlier in the year, an American supplier of CHP technology, Sempra Energy Solutions, decided to cut its losses and exit from the UK market after just two years here.

Even the paltry figure of 38MW added last year to the total disguises the real situation. Most plants are not running at anything like capacity. Indeed, because of the bear market conditions, many are being slowed down and therefore production is far below normal operating levels.

Knock-on effects

This is having a knock-on effect in other areas. Climate Change Agreements offer energy intensive industries an 80% discount on Climate Change Levy payments in exchange for guaranteed energy efficiency improvements.

However, some sectors such as chemicals and paper are basing their performance improvements on increased take-up of CHP. Given today's economic conditions, such programmes are unviable and may lead to sectors re-opening negotiations with the government about their future targets.

The fledgling carbon trading scheme is also being affected. "Better performing signatories to CCAs were expected to have excess capacity to sell into this process, adding to the liquidity of the market," says Ken Fletcher of energy markets consultancy ILEX. "However, not only is this less likely to happen, more companies may find themselves forced to buy in a much smaller marketplace, with consequent impacts on trading prices - and on companies' own profitability."

DEFRA produced a draft CHP strategy last May, outlining a number of measures to improve the situation, including full exemption for CHP-generated electricity from the Climate Change Levy, and eligibility for Enhanced Capital Allowances. According to work carried out for the DTI by the Cambridge Econometrics consultancy, the measures outlined would achieve the government's CHP target. Ahmed disputes this: "The authors of that report did not fully comprehend what was going on in the market," he says.

A CHP obligation?

The Association believes that a CHP obligation, modelled on the Renewables Obligation and requiring suppliers to take a certain proportion of CHP-generated electricity, would make a significant difference to the industry. As Environment Business Magazine went to press, it was completing a study on the costs of introducing such a scheme. This will be made available on their website at www.chpa.org.uk. The CHPA believes that powers to introduce this are available under the 2000 Utilities Act.

However, some economists who understand Treasury thinking are sceptical about its chances of success. They argue that the Chancellor is unlikely to accept the case for financial support of a mature technology, no matter how environmentally beneficial such support might be. In such battles, departments like DEFRA rarely come off best, even with the DTI on its side too.

It is clear that merely tinkering with allowances and levy payments is unlikely to prevent a meltdown in this industry. Wholesale reform of NETA is unlikely, as it has delivered lower, stable pricing. That said, the system has been blamed for a range of problems affecting the wider electricity market, such as those faced by British Energy, TXU, and the like.

In fact, the UK has had substantial over-capacity in generation for some years and if the current troubles result in plant closures, this may enable power prices to recover somewhat.

It is the price of electricity, not of gas, which the CHPA sees as the decisive factor. "If CHP and renewables were not discriminated against by the structure of the balancing mechanism, the industry would be better off," says Ahmed. "We can compete with other generators who use gas if we are given a level playing field on which to trade."

The European dimension

With the Energy White Paper not expected to be published until February - and any final Government CHP strategy will have to take its proposals into account - any amendments to the CHP market will take some time to implement. With expertise draining away and companies going out of business because of poor market conditions, will there be a viable industry left to recover this time next year?



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