Vertical firms should go horizontal to boost liquidity, says Intergen's Mark Somerset

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Vertical firms should go horizontal to boost liquidity, says Intergen's Mark Somerset

7 May 2010

InterGen's UK vice president Mark Somerset says vertically integrated energy companies should be "horizontalised" to boost liquidity and price transparency. Janet Wood talks to him.

InterGen is one of the UK's few remaining independent generators. The fact that the number of independents has shrunk is causing concern, and it is shortly after regulator Ofgem published proposals aimed at encouraging new players - such as improving liquidity - that I meet Mark Somerset, InterGen's UK vice president and general manager. He is quick to say that Ofgem's proposed remedies do not reach far enough. "The biggest change required in the market, which should improve liquidity as well as transparency of pricing, is tackling the vertical structure of the big six [energy companies]," he says. "The current structure allows them to transfer costs from retail over to the generation sector. Because they basically self-supply, they are not too concerned about long-term forward prices, so forward prices are quite depressed." Break up the verticals His remedy is to break up the verticals. "We should horizontalise the sector. The extreme of that is to reshape the companies. That's undoubtedly a step too far - at least initially. But I certainly think there should be measures taken to progressively force the verticals to trade their generated volumes in the wholesale market. That to us will make the true costs of generation apparent, and if you combine that with a separation of accounts [between retail and generation] then we feel that will make it more competitive. It will encourage more people like us to come into the market, and it is going to help the security of supply situation." He adds: "In Project Discovery examination of the energy market now and for the future] this isn't mentioned at all and I am staggered about it, because to me this is an obvious market reform." N2EX He is equivocal about the first change aimed at increasing liquidity - a new trading platform operated by N2EX. He thinks that it will also favour the bigger players. "The reason is that they are trying to do more day-ahead trading, which people like us don't have an issue with," he says. "But we have to post collateral, and while day ahead is manageable, when you are looking at forward curves - which is where N2EX wants to go - you have to post much larger amounts of collateral ... which is much easier for bigger balance sheet guys. If N2EX sweeps all before it, it would make life more difficult for the smaller players because of the credit collateral requirements." However, he thinks that won't happen, because it has existing platforms to compete with. "We think it will fragment liquidity rather than improve it." Project Discovery Somerset says Project Discovery has been useful in opening up the debate. He is in favour of many of the measures proposed by Ofgem - for example, a carbon price floor. "It would certainly encourage renewables," he says. "It would help gas against coal, and gas being the core of our business, we would support that. The problem arises if it is UK-only, when you already have the existing EU trading system." He says the floor price would have to be considerably higher than it is now. "If it is really for renewables and nuclear, you are looking at [a carbon price of] €50 per tonne and at the moment it is €12 or 13. That would eventually make our life very difficult, but that's the whole point of it - to decarbonise the economy." He has some support for capacity payments, which reward generators for being available to supply. He says: "That has some merit, in the sense that if you want to finance a new project then you have a certainty of income. That will make it more financeable. The issue is that a tendering process would tend to favour the big players again, who can cross-subsidise from their retail sector over to their generation sector. So I go back to the statement that the restructuring - horizontalisation - is fundamental." Use of distillate Project Discovery has a couple of suggestions about how to relieve pressure on gas supplies. One is that combined cycle gas plants might use distillate fuel as a backup, but this is an option the company has already considered and discarded. "We looked at distillate in the early days of our current technology and it wasn't a goer," he says. "Our initial reaction is okay, but be aware that the technology may not be able to support it at a substantial scale." The second option is to require generators as well as suppliers to reserve gas storage. He says: "That's not something that inherently we have an issue with, but it will clearly add to the cost." One Discovery option he does not support is the so-called central energy buyer. "We think it's a retrograde step away from a competitive market, and you are putting too much faith in an all-seeing, all-knowing centralised buyer." Political uncertainty Somerset is encouraged by the fact that some measures have support across the political landscape, but he has concerns over whether there is enough political certainty - both in the short and the long term. He says that although the 2020 target is a useful goal, there may not be enough serious weight behind it to make it happen. "In the coming months we may have a government that is not strong enough - you are not going to have the clarity you want. My fear is that there is a hung parliament, or the government muddles through for two years because it has to. But these next two years will be vital for the energy industry to position itself for 2020." Somerset points out that the industry will have a shortage of conventional generation to deal with this decade, as well as the need to shift to low-carbon generation. "The recession has pushed the capacity crunch out so there's a little bit more breathing space," he says. "Eighteen months ago we were talking about a 2013 crunch, now we are talking about a 2014/15 crunch." LCPD He does not see that enough new generation will step into the gap. "Clean coal is way off in terms of having a material impact," he says. "Renewables is growing - these new offshore windfarms are massive, they have incredible ambition - but whether that's all going to be onstream by 2020 we don't know. As for nuclear, I know EDF is saying the first will be ready in 2016/17 but I think that's a little ambitious. I am hearing 2020-plus." There have been suggestions that the government might avert a crisis by allowing plants whose lives are limited by the Large Combustion Plant Directive to stay in operation. Somerset thinks that is unlikely. "I think government would not have an appetite to support that, because they would be exposed to legal challenge by people who have made huge investments on the back of these things closing," he says. "It will be very hard for them - and it's not a good story keeping those dirty old coal plants in operation." Would InterGen be a challenger? He says it might be. "We are investing lots in expanding our two projects, developing two new CCGT gas stations next to our existing plants at Spalding (in Lincolnshire) and Coryton/Gateway (Essex, along the Thames Estuary). We are the type of company that would object to those opted-out plants staying open, because our business case rests on this capacity crunch and if the rules are changed we are going to be miffed. No question. And others speak with the same theme." He expects that eventually gas-fired stations will be required to fit carbon capture. "If it happens to coal, it's only a matter of time before it happens to gas. And frankly, why shouldn't it?" Expanding into renewables He says he does want to decarbonise the company's portfolio, and that means expanding into renewables. "One of my strategic aims is to start to get real traction on wind. We have looked at a couple of wind projects in the UK but we haven't progressed very far. We have also been looking at woodchip-type biomass boilers in the UK - it's rotating machinery, which is our core business - but we are a little resource-constrained at the moment. Once we free up on the two current projects we will be able to take on new projects ... But there the issue is all about the fuel supply chain. Where do you get huge quantities of wood chip from?" The UK wants to attract new players into the market, but I wonder whether the issues aired in Project Discovery, the election, and the upcoming decade's problems make the UK an attractive market. UK attractiveness He thinks the UK is fundamentally attractive, but with caveats. "Regulatory and policy shifts have the potential to increase political and regulatory risk and how the UK is viewed, with regard to investing. If I was a new guy I would think 'hold on'. There is a lot of discussion going on, there may be capacity tenders, there's a lot of documents to review, and wide-ranging debate among political parties, regulators, pressure groups, industry players - in short, a lot of uncertainty." InterGen, however, is already here and plans to stay. According to Somerset: "Now we are one of a small number of UK energy independents. Others have gone but we have stayed. We are still here and we want to invest some more." However, he notes: "To encourage others to come in you need a more consistent longer-term vision for policy and regulation and I don't quite see that at the moment, as Project Discovery attests."
Source: Karma Ockenden

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