Power generation - an opportunity or a delusion?
Privatization of the UK electricity supply industry will establish the basis for an independent electricity generat- ing sector. By adapting classic life cycle analysis the paper provides a model to indicate the likely development of the sector. A preliminary phase is added to accommodate the initial investigation of the market prior to schemes being implemented. The model indicates how different approaches will be adopted over the life cycle, reflecting the nature of the independent generators them- selves. The model can be used for other capital intensive sectors where abrupt changes allow new entrants.
Keywords: Electricity generation; Life cy- cle analysis; Privatization
Tony Prout is with the Technology Part- nership Ltd, Melbourn Science Park, Cam- bridge Road, Melbourn, Royston, Herts SG8 6EE, UK.
The privatization of the UK electricity supply industry (ESI) is offering the opportunity for new companies to en- ter the supply market. An earlier attempt to encourage new entrants through the Energy Act 1983 ended in failure, primarily due to self- protection moves taken by the existing utilities.
New entrants to the sector are likely to already have some link to the power business. Hence, plant and fuel sup- pliers have been prospecting the market and large electricity users are considering the viability of in-house generation with the sale of excess power. In addition entrepreneurs from outside the sector are looking for investment opportunities.
If there is to be a significant change in the industry it will be the result not only of the privatization measures but also of technological changes. The de- velopment of combined cycle gas tur- bines has lowered the capital cost, economic unit size and construction time. The privatization process has initiated the change but the availabil- ity of suitable technologies is crucial in defining the nature and magnitude of the changes.
But how will the market change and who will survive? Whilst political and economic changes will have a signifi- cant effect on the long-term develop- ment of the market, it is possible to make considerable progress in map- ping out this development by using a variant of classic life cycle analysis.
Conventional life cycle analysis rec- ognizes five distinct phases:
0 development; 0 growth;
0 shakeout; 0 maturity; 0 decline.
For the purpose of this analysis another phase has been added to the beginning of the cycle - a preliminary phase which covers the feasibility work that is such an important part of high capital cost projects. Figure 1 shows the life cycle in terms of pro- jects completed and feasibility studies. The decline phase has been omitted as it is inappropriate for the current dis- cussion.
Feasibility studies peak in the pre- liminary phase, drop sharply in the development stage when only a hand- ful of the studies are turned into pro- jects, before rising to a secondary, albeit much lower, peak in the growth phase. The number of schemes instal- led rise asymptotically, apart from a small fall back during the develop- ment phase representing failed schemes.
The preliminary phase could be re- garded as initial skirmishing. The rules of engagement are vague and the lack of market knowledge is masked by an infectious enthusiasm. Many are drawn into feasibility studies for tac- tical reasons rather than for a deep long term commitment to independent generation. As Figure 1 demonstrates, the number of feasibility studies rises rapidly and peaks towards the end of this stage. Equipment supplier based consortia take the initiative for many of these studies in order to grow a market for their products. However, initiatives are also made by a wide range of organizations and even indi- viduals.
UTILITIES POLICY July 1992 185
Figure 1. Growth cycle for indepen- I I \
Number of schemes (cumulative) ---
Source: The Technology Partnership.
The end of this phase will be marked by the number of disgruntled and disillusioned players whose schemes have failed to be converted into projects. Although many of these players fail to perceive the underlying reasons for their failure it is possible to categorize the key reasons under three main sub-headings:
0 inappropriate application; 0 risk premium set too high; 0 lack of commitment by enablers.
Given the lack of experience it is not surprising that many of the proposed schemes are non-starters in financial or technical terms. Frequently power generation schemes are site specific and potential developers are unlikely to be able to identify all the key factors which contribute to a success- ful project at this stage in the life cycle.
Many of the remainder will suffer from excessive reassurance being re- quired by financiers and customers. The customers - predominantly distri- buting utilities - are uncertain of their future business prospects and hence require excessive contract conditions to reduce the risk. Some customers are found subsequently to be contrac- tually unable to make the necessary commitment.
At the time of writing, the prelimin- ary phase is coming to an end and there is evidence of a marked fall-off in the number of feasibility studies and the emergence of firm contracts for new power stations.
186 UTILITIES POLICY July 1992
In the development phase, the num- ber of feasibility studies continue to fall, albeit more slowly, as the shake- out of the stock of potential scheme continues. The first few schemes to be implemented will tend to be customer based, either on distributing utilities or on large users. Schemes without an inside track to a market for their pow- er are likely to fail to proceed. During this phase, financial prudence suggests that long-term power supply contracts are essential and these are unlikely to be forthcoming except from distribut- ing utilities or a large user.
The utilities and, to a limited ex- tent, the fuel companies will engage in elaborate manoeuvring to limit the possible competitive advantage to any competitor. The generating utilities will take strategic stakes in in-house generating units to gain additional market share in the large consumer sector and to increase their low-cost generating capacity in order to deter new entrants.
Inevitably, there will be some fai- lure, either through technical prob- lems or from over-optimistic forecasts and the installed capacity curve in Figure 1 will drop slightly.
Success by the surviving schemes will attract new entrants and the growth phase starts. The more restric- tive practices indulged in by the gener- ating utilities are likely to be curtailed by the regulator. The regulator might well refer the two large generators - National Power and PowerGen - to the Monopolies and Mergers Commit-
l Rules uncertain . Enthusiasm
0 High failure rate
l Risk premium
Figure 2. Growth cycle for indepen- Equipment- customer- based based schemes
l Risk premiums
financiers and customers
dent generation. consortia -distributing compames utilities
S5urce: The Technology Partnership. - large users
tee or to curtail their activities. As the economics of the market becomes more clearly understood then confi- dence increases and the conditions set by financiers and customers are re- laxed. It is only at this point, with easier access to the distribution sys- tem, that the independent generating company can gain a foothold in the market. It is likely that designs will become standardized in order to re- duce engineering and construction costs, and also to cut construction time.
The growth phase will be halted by excess capacity or by a change in the relative economics of different gener- ating technologies. In the shake-out there wit1 be rationalization of the generators. Without the looming pre- sence of National Power and PowerGen, who will have been frag- mented or placed under stricter reg- ulatory pressure, there will be no ob- vious nuclei for the others to attach themselves to. Pressure on operating costs will increase and generators will join together to gain economic advan-
IShake-out 1 l Rationali~tion
l Stable operating practices
l Reduced innovation
l No new entrants
Two level structure:
- lame na;ional
- small site based
tage in purchasing key items, particu- larly fuel. The structure of distribution utilities, set up in 1990, will change with some losing their independence or even deciding to leave the distribu- tion business altogether.
In the maturity phase the market settles down with stable operating practices and few if any new entrants. The structure of the industry will stra- tify into two distinct layers with a number of large national or regional generators at one level and a large number of small site-based generating units. Many of the small units will be operated by specialist companies, some of these companies being owned by fuel companies.
Figure 2 sumnlarizes the elements in each phase. This exercise brings out the crucial role to be played by the distribution utilities. These utilities offer the principal market for power and also the easiest access to the dis- tribution network. The distribution utilities have the ability to drive, en- able or destroy projects.
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