Energy transition remains on course in the power sector The European Union’s commitment to its climate-energy objectives continues to drive far reaching changes in energy markets – nowhere is the influence of this transition seen as strongly as it is in the power sector. But the pace at which change is occurring in power has become a substantial test of both commercial market arrangements and the physical capabilities of infrastructure. Weak electricity demand and growth in renewable power supply has placed substantial pressure on the role and economics of conventional generators, particularly those burning fossil fuels, such as gas and coal. The rapidly changing characteristics of supply and significant pressure on the traditional business model of utilities have combined with the conflicting demands of national, regional and corporate priorities – for many the European power sector has become a very challenging place in which to operate. Low carbon growth, sustainably delivered? As wind and solar PV technology costs have fallen and the burden of environmental levies on consumers has become a subject of increasing public (and political) concern, the availability of financial support for renewables has altered substantially. Developments in renewable subsidy arrangements, including changes in Germany, Italy and the UK, have demonstrated a more determined commitment to reducing the costs of low-carbon power and increasing the integration of subsidised technologies into wholesale markets. EU-wide state aid rules require all new or overhauled incentives to be market orientated and cost-effective – signalling the end of over-generous and inflexible payments. New incentive arrangements must feature competitive bidding processes, exposure to wholesale markets and market balancing obligations. Changes to subsidies and the costs of maturing renewable technologies – offshore wind has been responsible for the most recent, high-profile cost reductions – will shape the development of low-carbon power supply, wholesale price formation and the role of conventional generators in Europe. Over time many of the distinctions between the market treatment of renewables and other sources, such as priority grid access and dispatch, will be removed. Wind, solar and thermal renewables will continue expanding their role in European electricity supply, although rates of growth will be lower than those seen in previous years. Renewable power supply by source and market share (EU 28) Decarbonisation is difficult for fossil fuels Investment in conventional, flexible supply has become increasingly difficult (and rare) in much of Europe while the retirement of unprofitable plants is weakening system margins. As Europe’s power supply mix develops and the role of gas and coal generators continues to change, the commercial frameworks of markets is transforming. Wholesale power prices are offering less value to generators seeking to cover the variable costs of traditional thermal plants, with even the most efficient facilities finding it more difficult to achieve an acceptable return on invested capital. These conditions have contributed to an upsurge in the mothballing and retirement of fossil fuel-fired plants, shifting corporate strategies and the cancellation of many (almost all) plans for new coal and gas fired developments. With regional controls on atmospheric pollutants and national policy initiatives, such as Germany’s energy transition and moves by the French government to restrict output from its nuclear fleet, also influencing the generation mix, the maintenance of adequate, flexible supply capability is a major concern for governments and regulators. As large volumes of production from renewables make the management of power systems more challenging, moves to strengthen existing or introduce new arrangements to ensure the adequate reward of dispatchable generators have become widespread. Capacity reward arrangements will increasingly allow operators to realise the value of their flexible generation (and also demand and/or storage based services) – resulting in a greater emphasis on the flexibility and capability of assets ahead of their overall rates of utilisation. A new focus on capacity before output (megawatts as a service) is attracting investors and represents an alternative revenue stream for many existing coal and gas-fired generators. European power supply by source * Note: Hydro generation from conventional sources only, excludes pumped storage production Coal’s bad run continues During 2016, a number of market-specific factors weighed on coal's contribution to supply, particularly as seaborne thermal coal prices strengthened in the second half of the year. UK coal generators were out-competed by gas-fired, resulting in unprecedented periods of zero coal-fired supply on the system. In Spain, low demand and high hydro output (a position reversed in 2017) pushed coal out of the market, while in France competition from gas led to a drop in coal-fired power supply to half of 2015 levels. Only German coal generators saw some upside, resulting from lower production from nuclear but offset by strong renewable output and growth in gas-based CHP generation. Overall, coal-fired generation in the EU fell by nearly 10% last year. Older coal-fired units, already constrained by measures such as the Industrial Emissions Directive (IED) and the growing competitiveness of gas, will continue to face pressure from the efforts of national governments to reduce carbon emissions. The UK intends phase out all coal-fired power by 2025 and Germany has introduced a lignite reserve to remove its most polluting plants from the wholesale market. The combined market share of hard coal and lignite-fired generation will fall from its current 22%, to 17% in 2020 and just 12% by 2035. Across the EU, we forecast coal generation to fall to 353 TWh by 2035, down from 739 TWh in 2016. Gas makes a comeback, but the story changes As coal declines, gas' contribution to supply in the EU will rise from 606 TWh in 2016 to a peak of 760 TWh in 2024, accounting for 23% of generation at that time. But then the story changes and gas-fired supply will begin to fall as competition from renewables intensifies and power demand growth continues to be weak. By 2035, gas-fired production will have fallen back by some 10% from its mid-2020s level. Declining production from nuclear and coal will lend some support to the use of gas towards the end of the outlook. The ability of nuclear to remain one of Europe’s foremost sources of power looks increasingly uncertain. While the UK’s decision to go ahead with the 3.6 GW Hinkley Point C project has provided a much-needed – but also widely criticised – boost to Europe's nuclear industry, policies to phase-out or limit the contribution of the source impact on a far greater volume of potential production. We expect power supply from nuclear to fall by over 20% between 2016 and 2035.