Why does E.on want to build a new coal-fired power station without CCS?

The existing Kingsnorth power station. Image source: E.ON.

E.ON’s £1bn plan for a new coal-fired power station at Kingsnorth is waiting for approval from the UK government. Other generators have shifted away from coal. Drax, which owns by far the largest coal power station in the UK, is investing in biomass. Other companies have focused on new gas plants. Why is the world’s largest investor-owned utility pushing ahead with a project to burn coal without carbon capture?

The answer, unsurprisingly, is that burning coal to generate electricity is extremely profitable. Very low prices for emissions permits and tumbling coal costs mean that a profit-seeking management team is highly incentivised to try to push for permission to use coal in power stations. This article provides the background calculations for an estimate that the new Kingsnorth will generate an operating profit of about £300m a year if current fuel and carbon prices persist. Additionally, it also tries to show that the cost of fitting CCS equipment and running the plant to capture the large majority of all carbon emissions is likely to add no more than about 1.5p per kilowatt hour to the cost of generating electricity at current coal and carbon prices. This means that a new coal fired power station with CCS may have operating costs only marginally above gas power plants

Nevertheless, E.ON has just asked for government subsidy to install CCS at Kingsnorth from day one. The purpose of this article is to offer an estimate of the maximum the government ought to offer E.ON in order to get it to invest in CCS prior to opening the new power station.

As the UK Climate Change Committee’s report of December 2008 showed, generators will generally wish to develop coal, rather than gas, power stations if carbon costs are low. E.ON’s persistence in the face of the widespread opposition to Kingsnorth is testament to the truth of this assertion. Coal is today’s fuel of choice. Speaking to investors on 3 March 2009, Dorothy Thompson, the CEO of the enormous coal power station at Drax, said that in current conditions ‘coal plants tend to be more economic than gas plants’. The company also said without equivocation that ‘coal remains the most attractive fossil fuel’.

The Kingsnorth project
The new Kingsnorth will be a ‘supercritical’ coal plant composed of two 800 mW units. Total output will therefore be about 1.6 gW when the station is running at full capacity. E.ON has entered the competition for a grant to fit CCS on a portion of the new power station. It has said that it will fit CCS on the rest of the plant when it makes sense financially, and not before.

E.ON has a point. It is in business to make money. CCS will always add – probably significantly – to the cost of generating power. So it wants the UK taxpayer to fund the incremental cost. Other generators around the world have made similar requests, though rarely in so bold a way. E.ON’s great rival RWE has proposed a 450 mW plant with carbon capture at Huerth in Germany, and has made pointed remarks to Chancellor Merkel about subsidy for construction costs. US coal-fired generators have proposed an imaginative scheme for encouraging early CCS projects.

The wily folks at E.ON must have noticed the fixed and discomfited smile on ministers’ faces when talking about Kingsnorth. Which politician wants to go down in history as the person who approved a new unabated coal power station just before the Copenhagen climate change negotiations begin? E.ON seems to have offered a tempting political bargain – give us the cash and we will fit CCS from the opening of the plant. It all comes down to money.

The economics of Kingsnorth
Coal stations need maintenance, both planned and unplanned. Drax managed to be available for operation for about 85% of the time last year. Its position as the lowest cost fossil fuel station in the UK meant that its output was actually asked for about 75% of the hours in the year. Other coal stations were similarly busy. Kingsnorth will probably run about 80% of the year, slightly more than Drax. It is newer and will have a lower marginal cost to operate. (Its position in the ‘merit order’ will be behind only nuclear and wind.)

Drax has already sold much of its output for 2011. The price is about £63 a megawatt hour. If Kingsnorth achieved this price its yearly output of approximately 11.2 terawatt hours would be worth about £702m. (11.2 terawatt hours is about 3% of UK electricity use.)

The primary costs of operating Kingsnorth will be coal purchases, carbon permits, coal transport, and operations and maintenance (O+M).

Coal
Kingsnorth will be very efficient for a coal-fired power station and turn about 42% of the heat value of coal into electricity, but to be conservative I have used a figure of 40%. To generate 11.2 terawatt hours, Kingsnorth will need to buy about 3.4 million tonnes of coal. At current spot prices – which may not be representative of levels in five or ten years, or of prices for long-term contracts – this will cost about £163m. (Although coal prices are currently low, they are still above the costs of extracting the fuel.)

Carbon
Kingsnorth will generate about 8.6m tonnes of carbon dioxide. At today’s European permit prices, this will cost about £103m. (I assume that by the time the station is opened power stations will have to pay for their entire allocations of permits.)

Coal transport
The current cost of shipping coal to Drax from non-UK sources is about $17 a tonne. It should be lower at Kingsnorth because the station is on the Kent coast and can receive its own coal shipments by ship. Nevertheless, I have taken the Drax figures. This adds about £42m to the costs of running Kingsnorth.

O+M
Drax cost about £230m to operate last year. This includes the cost of maintaining the station and keeping it running flat out for most of the year. A substantial problem at one of the six turbines probably slightly inflated this figure. I have calculated an O+M cost for Kingsnorth, pro-rated by the respective electricity outputs of the two stations. This is about £101m.

I estimate net operating profit at just under £300m. (Drax operates at an approximately zero net working capital position, so this figure would be approximately the same as the cash generated by the plant before any tax.)

Summary estimate of the operating profit of the proposed Kingsnorth plant

If these numbers are correct, E.ON can expect an annual return of about 30% on its proposed £1bn investment.This is a surprisingly low estimate; others have produced much higher figures for the efficiency loss. In effect, E.ON is saying that to produce the same amount of electricity it will need about 25% more coal.

The impact of adding CCS
Dr Golby, the CEO of E.ON UK, says that first generation CCS will reduce the efficiency of the plant by 20%. Adding 25% to the cost of coal purchases will cost £41m. This is about 0.36 pence per kilowatt hour. The capital cost of a plant will be much higher if CCS is installed and its operating costs will rise. E.ON has estimated elsewhere that these extra costs total about 2p per kilowatt hour.

But the plant will save most of its cost of CO2 permits. Most power engineers assume that CCS will cut emissions by 90%. Only having to buy 10% of the existing volume of emissions will save E.ON about 0.83 pence per kilowatt hour.

The net consequences of adding CCS to the Kingsnorth project are therefore approximately as follows:

At current gas and coal prices, the prospective future margins for electricity generation are about 1 pence per kilowatt higher for gas than for coal.(It is fair to note that gas turbine power stations are cheaper to construct than coal-fired plants, which will somewhat reduce the significance of this figure.)

The implication of this is that at today’s fossil fuel and carbon prices, and using E.ON’s own estimates, adding CCS to Kingsnorth leaves this coal power station only marginally more expensive to operate than a new gas-fired power station. Coal with CCS may be only about half a pence a kilowatt hour more expensive than gas.

Why does this matter?
E.ON’s recent announcements have opened a negotiating door. The company is clearly signalling that it wants a deal over CCS. It seems to be asking for a guaranteed price premium. Rather than see Kingsnorth open without CCS, the government might be prepared to agree a deal. The purpose of this note is to suggest that the premium should not be large; analysis seems to suggest it can be well under 1p per kilowatt hour.

To the outside observer E.ON’s tactics do not look pleasant. The government knows that the electricity supply situation looks grim beyond 2016. It may have to accept more coal. So E.ON is offering to make that new coal capacity more environmentally acceptable – provided we all pay the additional cost. In my view, the government should do the deal, provided it can keep the cost below 1p.