Analysis - Britain's carbon tax to slow summer coal use from 2016

LONDON Fri Sep 20, 2013 12:49pm BST

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LONDON (Reuters) - British factories and homes, powered by coal for more than a century, are set for a switch as a carbon tax introduced this April begins to swing profits in favour of gas-fired power plants during summer.

Overtaking the oldest coal plants by the summer of 2016, profits at even Britain's newest plants will lag rivals using gas by summer 2020, Reuters calculations show.

Since its first power plant fired up in central London in the late 19th century, Britain has relied on coal to fuel its economy, even using "black gold" to power its Navy during World War One.

Coal's dominance was first challenged after the North Sea oil and gas boom in the 1970s, and is now under fresh threat as the government drives toward emissions-cutting targets in 2020 and beyond.

The carbon tax has already hit profits at Drax (DRX.L), Britain's largest coal-fired power producer, while top coal miner UK Coal entered administration in July hurt by cheap imports from Colombia and the United States.

Still, British coal use in power generation in 2012 hit a six-year high, helped by low fuel costs and cheap European carbon prices.

Coal remains Britain's most important fuel for power generation, producing over 40 percent of its electricity, or around 22 gigawatts (GW) in 2012.

There are eight pure coal-fired facilities and six generators that use a mix of coal and biomass or oil, government and grid data show.

Coal dominates because it is far more profitable than its biggest competitor, gas. Full-year power generation revenue margins of around 30 pounds ($48.19) per megawatt-hour (MWh) dwarf equivalent gas revenues at 3.5 pounds per MWh, Reuters data shows.

Change looms, however, according to calculations based on forward contract prices for coal delivered into Europe, British gas and baseload power prices, EU carbon prices and Britain's new carbon tax.

The latter will more than triple from current levels by 2016, while EU carbon prices are also expected to rise, making gas generation more profitable on some summer days.

"Whilst it is possible that gas plants will be more profitable than coal (on some summer days) by 2016, I think we would expect it to take slightly longer ...to happen on a consistent basis, perhaps another couple of years," said Andy Houston, senior analyst at UK-based consultancy Poyry.

This is likely to leave many of Britain's coal-fired power plants idle during summer days, when slack demand lowers gas prices.

A spokeswoman for Drax declined to comment on the possibility of idling plants in summer but said the company hopes to have converted three of its six 645 MW coal-fired units to biomass in or before 2016.

"It is fair to say that the carbon floor policy supports our biomass strategy, as clearly the financial burden to a coal-fired generator rises on a steep trajectory out to 2030," she said.

Britain has a legally binding target to cut its emissions by 80 percent on 1990 levels by 2050 and has embarked on electricity market reforms aimed at spurring investment in low-carbon nuclear and renewables.

Last year higher coal-fired power generation contributed to a 3.5 percent rise in greenhouse gas emissions.

Because building new nuclear power stations and ramping up renewable capacity will take several years, the government is largely banking on increased generation from gas plants in the short term.

The problem with that is high gas prices have made generation unprofitable in the last two years, prompting some operators, including Centrica (CNA.L) and GDF Suez-owned (GSZ.PA) International Power, to announce closures or mothballing of capacity until margins improve.

CARBON TAX

With carbon prices in the European Union's Emissions Trading Scheme (EU ETS) too low to incentivise utilities to switch to gas from coal, the British government introduced a carbon tax in April.

The carbon tax hits coal harder than natural gas as it emits almost double the amount of carbon dioxide into the atmosphere when generating electricity.

Power companies must pay 4.94 pounds ($7.86) per tonne of carbon dioxide produced and this rises to 18.08 pounds by 2015-16. That is on top of the EU carbon price, which currently trades around 5.5 euros.

The tax is designed to ensure that whatever happens with European carbon prices, power producers in Britain will pay at least 30 pounds per tonne by the end of the decade.

Tony Cocker, chief executive of EON UK (EONGn.DE), earlier this year called for the policy to be scrapped and warned it would lead to excessively high power costs for British consumers compared with their European counterparts.

Some analysts have also said the policy's future is uncertain, noting a change of government is possible by 2016.

"It becomes an increasingly difficult policy to maintain as the UK carbon price rises to levels which are multiples of the EU ETS price," said David Stokes, director at London-based energy consultants Timera Energy.

Still, even a new government might want to hold on to the tax, which is expected to raise more than 1.2 billion pounds during the 2015-16 tax year, HM Revenue and Customs documents show.

($1 = 0.6226 British pounds)

(Additional reporting by Henning Gloystein; editing by Jason Neely)

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