EXPLORER special on generation - LBD-Beratungsgesellschaft mbH

XPLORER markttrends
SPECIAL 11.2006 S P E C I A L
SPECIAL 12.2010 GENERATION
The wholesale electricity market
from the perspective of both
producers and sellers
A fIvE-yEAR SETbACk: TOugh TImES AhEAd fOR ELECTRICITy PROduCERS
Electricity prices have fallen back to the 2005 level due to very intense competition which has been caused by
growing overcapacity in electricity production, a very flat merit order for all natural gas combined cycle and coalfired
power plants along with changed market behaviour among players. The market outlook for 2011 and 2012 is
sidewards. Electricity prices are not expected to recover until power plant capacities have been shut down on a
large scale, raw material prices have risen sustainably and buyers in fear of rising prices on the futures markets will
be »long« again. The producer margin is not expected to recover either until a sustainable increase in prices sets
in. From a producer perspective, there is a residual risk that margins will still fail to recover and policy intervention
will be necessary in order to enable margins that foster sustainable investment incentives. There are three key factors
that drive electricity prices: fuel prices, prices for carbon certificates (EUA) and competition intensity.
Euro/MWh (Ho)
Euro/MWh (th)
50,00
45,00
40,00
35,00
30,00
25,00
20,00
15,00
10,00
5,00
0
07. 03 01. 04 07. 04 01. 05 07. 05 01. 06 07. 06 01. 07 07. 07 01. 08 07. 08 01. 09 07. 09 01. 10 07. 10
API#2 front year natural gas front year
figure 1: Development of fuel prices; source: Reuters, natural gas price: from 2 July 2007: EEX, EGT or NCG market
territory, prior to that TTF, as per: 30 November 2010.
fuel prices
Since 2008 coal prices have risen relative
to prices for natural gas. Since mid-2008,
there has been a relatively parallel price
curve pattern for both fuels compared to
the time before. Prices doubled, reaching
their peak in mid-2008 after which time gas
prices fell more strongly than coal prices. In
the second half of 2010, the price for natural
gas is on the same level as in the second
half of 2007, however, the coal price is at a
higher level. Figure 1 shows this clearly.
The gas market is marked by persistent
overcapacity. At the same time, the market
regime is shifting from long-term, bilateral,
oil-indexed contracts to procurement portfolios
that are based on standard products
on the wholesale markets. LNG is networking
regional markets. Once an importer of
natural gas, the US has become a largely
independent producer. Declining import
demand is upping the pressure on LNG and
competition between pipeline gas and LNG
in Europe is also becoming stronger.

SPECIAL
CO2 price
in Euro/t
60,0
55,0
50,0
45,0
40,0
35,0
30,0
25,0
20,0
15,0
10,0
5,0
0,0
07.05 01.06 07.06 01.07 07.07 01.08 07.08 01.09 07.09 01.10 07.10
EUA price front year (EEX)
net efficiency of substituted coal power plants - market opinion
figure 2: Development of the EUA price and efficiency of the coal-fired power plants substituted in line with market
opinion (due to coal, natural gas and EUA prices); source: EEX, Reuters, LBD analyses; as per: 30 November 2010.
[ ] =
CO 2 euro t
[ ]
(APgas − APhc) euro
MWh
⎛
emission factor t ⎞
hc
⎜
[ MWh]
⎟
⎜ WG ⎟ hc
⎝
⎠
− emission factor ⎛
t ⎞
gas
⎜
[ MWh]
⎟
⎜ WG ⎟
gas
⎝
⎠
formula 1: Equation to determine the fundamental value of EUAs according to the fuel-switch method.
net
efficiency
60%
APgas €
– marginal costs, excluding carbon costs, of the ousting combined
cycle power plant
APhc – marginal costs, excluding carbon costs, of the coal-fired
power plant last ousted
emission factor – tons of carbon emissions of each fuel heat volume used, natural
gas or hard coal, respectively
WG gas – efficiency of the ousting combined cycle power plant
WG hc – efficiency of the coal-fired power plant last ousted
55%
50%
45%
40%
35%
30%
25%
20%
1 5 %
1 0 %
5%
0%
2
<strong>EXPLORER</strong> markttrends
December 2010
Lbd-beratungsgesellschaft
As the global economy picks up, coal
prices will increase. A weak US dollar will
soften the price increase in euro per tonne.
The intensity of competition on the European
gas market will remain high, at least
until new growth markets in Asia boost
demand for LNG and as long as importers
are unable to cut down on their long
positions under long-term procurement
contracts through price reviews without
adverse effects on the market.
In the near future, there is no expectation
that the competitive strength of coal will
improve compared to natural gas.
Prices for carbon certificates (EuA)
EUAs are priced on the market according
to the fuel-switch concept. This concept
is based on the assumption that the European
carbon reduction targets can only
be reached when electricity from natural
gas ousts electricity from coal. For this
to happen, the marginal costs (clean) of
natural gas power plants must be lower
than those of coal-fired power plants.
The fuel-switch concept enables the fundamental
value of EUAs to be determined.
If the gas price rises in relation to the coal
price, the price for EUAs also rises. If the
gas price falls in relation to the coal price,
the EUA price also falls.
What’s decisive for competition between
fuels is the efficiency of coal-fired power
plants most recently ousted in the merit
order. The reliability of this concept can be
verified on the basis of the calculated efficiency
of the coal-fired power plant ousted.
Figure 2 shows that from mid-2007 to
mid-2009 efficiency ranged between 30 %
and 35 % and then rose to and remained
above 35 % (refer to the blue time series).
EUA prices will only rise when the price of
natural gas increases in relation to coal. A
contrary trend is mostly likely to be seen in
the near future.

<strong>EXPLORER</strong> markttrends December 2010 3
The fuel-switch concept leads to a very
flat merit order for all natural gas combined
cycle and coal-fired power plants. Figure 3
shows an increase in marginal costs of
just 10 euro per MWh in the demand range
from 36,000 MW to 70,000 MW (vertical
grid load in the transmission grid). Natural
gas combined cycle power plants are used
before coal-fired power plants. Gas-fired
steam power plants usually range behind
coal-fired power plants. This very flat structure
leads to very low producer margins.
With an actual power peak of less than
60,000 MW in the transmission grid, neither
natural gas combined cycle power plants
nor coal-fired power plants competing on a
marginal cost basis can cover their operating
costs not to mention generate contribution
margins for capital costs.
Producer margins as the best
indicator for competition intensity
Producer margins have fallen drastically.
The contribution margins to be generated
do not fully cover the fixed operating costs
of older power plants (price basis: spot
market 2010, futures market 2011).
Figure 4 shows the development of
producer margins since 2005 which were
generated in order to cover fixed operating
and capital costs. Power plant use (8,760 h)
is analysed on the basis of daily trading settlement
prices for electricity, gas, coal and
EUAs for the front year. The result is the
sum of expected contribution margins.
The contribution margin level in November
2010 (for the front year) is comparable
with the level in mid-2005. Today, combined
cycle power plants generate a contribution
margin level comparable with that of
coal-fired power plants with an efficiency of
39 %. This is also a consequence of the fuelswitch
price concept on EUA markets. The
Euro / MWh
100
90
80
70
60
50
40
30
20
1 0
0
gEnERATIOn
Demand range (vertical grid load 2009)
0 5 1 0 1 5 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90
GW
Nuclear energy Natural gas Hard coal Lignite Others
figure 3: Merit order of available power plants feeding into the transmission grid to cover vertical grid load in Germany;
source: Platts 2009, 50Hertz, Tennet, Amprion, EnBW, LBD analyses; Stand 30.11.2010).
Euro/kW(el)
300
250
200
150
100
50
0
07.03 01.04 07.04 01.05 07.05 01.06 07.06 01.07 07.07 01.08 07.08 01.09 07.09 01.10 07.10 01.11
fixed costs CCGT power plant fixed costs coal power plant new
clean dark spread
coal power plant (34,0%)
clean dark spread
coal power plant (44,5%)
clean dark spread
coal power plant (39,0%)
clean spark spread
CCGT power plant (55,0% (LHV))
figure 4: Development of specific contribution margins of various power plants with domestic sites in the NCG market
territory. The grey and light green bars in the background show the bandwidth of fixed costs for coal-fired or combined
cycle power plants; source: EEX, Reuters, LBD analyses; as per: 30 November 2010.

SPECIAL
GW
140
130
120
1 1 0
100
90
80
70
60
50
40
30
20
1 0
0
figure 5: Power plants of German TSOs and plants under construction. The plants and the load in the transmission grid
are used as a basis for comparison because they are competing on the wholesale market in order to cover the load of
must-run power plants for EEG and cogeneration on the lower grid levels. Sources: Platts 2009; LBD analyses, as per:
30 November 2010.
GW
60
55
50
45
40
35
30
25
20
1 5
1 0
5
0
87,3 14,6
installed net bottleneck capacity Capacity under construction
installed: Nuclear energy installed: Lignite
installed: Hard coal, old installed: Hard coal, new
installed: Gas installed: Hydro
installed: Others under construction
0 1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000
annual load duration curve of vertical load 2008
annual load duration curve of vertical load 12.2009/11.2010
by load sorted hours per year
Year Vertical grid load Work Full use time
2008 12–56 GW 343.7 TWh 6,139 h
2010 13–55 GW 323.3 TWh 5,870 h
difference ø 2.32 gW 20.4 TWh 269 h
figure 6: Comparison of vertical grid load in 2008 and 2010 (past 12 months); sources: 50Hertz, Tennet, Amprion, EnBW;
as per: 30 November 2010.
4
<strong>EXPLORER</strong> markttrends
December 2010
Lbd-beratungsgesellschaft
latest-generation coal-fired power plants
(efficiency of approx. 45 %) generate a contribution
margin of around 80 euro per kW
p.a. New construction projects are entering
a hard-fought market, there is no sign of the
required contribution margins for full costs
of between 220 and 250 euro per kW p.a.,
an economic fiasco in the years to come
seems certain.
Over-capacity feed-in into the transmission
grid calls for 22,000 mW to
be shut down
This is due to significant overcapacity
combined with a steep increase in feed-in
from regenerative power plants. Figure 5
shows installed power capacity (around
87,300 MW) and power plant capacity
under construction (around 14,600 MW).
The analy sis is limited to feed-in on transmission
grid level. This power capacity is
opposed to demand (vertical grid load) of
55,000 to 60,000 MW.
This ultimately means that over the next
two years, installed power capacity of
80,000 (- x) MW will have to be reduced,
i.e. around 22,000 MW will have to be shut
down. Such a volume of shut-downs will
mean an additional loss of power on the
market for the big producers.

<strong>EXPLORER</strong> markttrends December 2010 5
Reduced price spread for hours with
identical demand power on the spot
markets
The height of vertical grid load is determined,
on the one hand, by electricity
demand, but also to a growing extent by
the supply of regenerative power. Figure 6
shows a comparison of the annual load
duration curve of vertical grid load for the
years 2008 and 2010.
What becomes clear is the relationship
between hourly vertical grid load
and hourly spot market price. Figures 7a
and 7b show a comparison of the values
for the third quarter of the years 2008 and
2010. While a huge price spread in spot
market prices was reached in Q3 2008, with
demand remaining flat (vertical grid load),
the price spread in Q3 2010, however, was
only slight. The volatility of spot prices has
declined significantly. The diagrams indicate
that 2008 was marked by speculation
and 2010 by intense competition.
gEnERATIOn
spot prices spot EEX prices Q3.2008 EEX Q3.2008 in Euro in / MWh Euro / MWh
160,00 160,00
140,00 140,00
120,00 120,00
100,00 100,00
80,00 80,00
60,00 60,00
40,00 40,00
20,00 20,00
0 0
0 0 5 5 1 0 1 0 1 5 1 5 20 2025 2530 3035 3540 4045 4550 5055 5560 60
spot prices EEX Q3.2010 in Euro / MWh
Grid load Grid in GW load in GW in GW
spot prices EEX Q3.2010 in Euro / MWh
140,00
160,00
120,00
140,00
100,00
120,00
80,00
100,00
60,00
80,00
40,00
60,00
20,00
40,00
20,00
0
160,00
0
spot prices spot EEX prices and EEX grid and load grid Q3.2008 load Q3.2008
0 5 1 0 1 5 20 25 30 35 40 45 50 55 60
0 5 1 0 1 5 20 25 30 35 40 45 50 55 60
spot prices EEX and grid load Q3.2010
Grid load in GW in GW
figures 7a and 7b: Dot clouds of value pairs from spot prices vertical EEX grid and load grid load and Q3.2010 the spot market price at the Grid same load time. in GW For in GW
reasons of scale, prices above 160 euro per MWh in 2008 are not shown; sources: EEX, 50Hertz, Tennet, Amprion,
EnBW; as per: 30 November 2010.

SPECIAL
Spot prices
in Euro / MWh
250,00
200,00
150,00
100,00
50,00
0
Q2.2010
Q3.2010
Q1.2010
Q4.2010
40.000 42.000 44.000 46.000 48.000 50.000 52.000 54.000 56.000 58.000 60.000
Average of the 100 most expensive hours per quarter of 2005 until 2009
Average of the 100 most expensive hours per quarter in 2010
Grid load in MW
figure 8: Value pairs from mean values of the 100 most expensive spot market prices per quarter vs. the mean value of
the grid load at that time; source: EEX, 50Hertz, Tennet, Amprion, EnBW; as per: 30 November 2010.
1,80
1,70
1,60
1,50
1,40
1,30
1,20
1,10
1,00
2003 2004 2005 2006 2007 2008 2009 2010
Peak/Base ratio – yearly average value Phelix Year
Peak/Base ratio – daily values of front year product at future market
figure 9: Peak-to-base ratio of the Phelix year and daily values of the front year products on the futures market;
sources: EEX, as per: 30 November 2010.
6
<strong>EXPLORER</strong> markttrends
December 2010
Lbd-beratungsgesellschaft
Figure 8 shows this for the 100 most
expensive hours of each quarter prices for
the third quarter in 2010 were much lower
than the previous years’ prices. The analysis
also indicates that vertical grid load has
fallen strongly in the most expensive hours.
Figure 9 shows the peak-to-base ratio with
regard to the spot market and the front
year. The value of 1.48 recorded for 2003
compares to the value of 1.23 recorded in
2010.
The »collapse« in super peak prices is
due to the high level of feed-in from wind
and solar electricity during peak times.
More and more fossil fuel power plants are
competing for lower demand.

<strong>EXPLORER</strong> markttrends December 2010 7
vERTICAL gRId LOAd
gEnERATIOn
Vertical grid load is the sum (expressed by a mathematical sign) of all power transferred
through directly connected transformers and power lines to distribution grids
and end consumers. After consideration of all feed-ins by must-run plants (EEG,
cogeneration) on downstream grid levels, it represents the remaining demand in the
transmission grid. Price formation at the major trading markets primarily takes place
through competition between power plants on this grid level.
EEg 1) direct marketing on an hourly
basis dominates the market
One of the main drivers is EEG direct marketing
of transmission system operators
(TSOs) on the European Energy Exchange
(EEX). At the beginning of 2010, there was
a sudden increase in supply liquidity (refer
to Figure 10). During certain market hours,
EEG electricity at times dominates the spot
market. Due to the feed-in volume, it influences
the price. The open price bid distorts
the formation of market prices. The direct
marketing mechanism will have to be developed
further in the 2012 revision of the
Renewable Energy Sources Act.
Pain felt by producers will be bearable
in 2010. But the future looks tough. Large
volumes have been sold forward. The spot
markets have been used to optimise use
with the aim being to optimise the last euro
in marginal costs. This has increased competition
intensity because nobody took a
price-supporting stand. After all, the money
had already been earned on the futures
1 EEG – Renewable Energy Act.
20
1 8
1 6
1 4
1 2
1 0
8
6
4
2
0
TWh
01.05 01.06 01.07 01.08 01.09 0 1 . 1 0
Trading volume EEX spot market base
Trading volume EEX spot market base with introduced compensation machanism
ordinance
Trading volume EEX spot market peak
Trading volume EEX spot market peak with introduced compensation machanism
ordinance
figure 10: Development of liquidity on the EEX and EPEX spot market, respectively, according to base and peak hours;
sources: EEX; as per: 30 November 2010.

SPECIAL
Euro / MWh
100,00
80,00
60,00
40,00
20,00
0
2003 2004 2005 2006 2007 2008 2009 2010
front year future base Spot prices moving average 360 days
figure 11: Development of liquidity on the EEX and EPEX spot market, respectively, according to base and peak hours;
sources: EEX; as per: 30 November 2010.
8
<strong>EXPLORER</strong> markttrends
December 2010
Lbd-beratungsgesellschaft
market. The spot markets have dragged
down the futures markets. Compared to the
360-day mean value of the spot market, the
premium of the futures market for the front
year totals around 7–10 euro per MWh or
15–20 %, respectively (refer to Figure 11).
From a producer perspective, the front year
price is too low. Selling forward results
in the loss. From a seller point of view,
the front year price is too high because a
premium of 15–20 % compared to the spot
appears to be far too high considering the
risks that go hand in hand with spot market
volatility. Producers can only be advised
to still cover their backs on the futures
market because it is very unlikely that the
spot market will recover in 2011. The strategy
pursued should be designed to »limit
losses«.
EEg remuneration – outlook
While EEG feed-in volumes are putting
pressure on the market and keeping
prices low there, the EEG levy as an end
customer price component will continue
to rise steeply. Figure 12 shows the historical
development of EEG feed-in and
levies along with the bandwidth of future
developments in the current medium-term
forecast by TSOs. Feed-in of EEG electricity
will increase from approx. 90 TWh in
2010 to approx 150 TWh (lowest scenario)
and 195 TWh (highest scenario). This corresponds
to approx. 37 % of German demand
for electricity. The EEG levy will rise from
approx. 35 euro per MWh in 2011 to 43–65
euro per MWh depending on the scenario.
Figure 13 shows that even with a moderate
increase in electricity market prices along
the lines of current expectations for the
futures market and an increase in the EEG
levy along the lines of the lower scenario
of the medium-term forecast, these components
of end customer prices will rise on
a lasting basis above the previous highest
level recorded in 2008.

EEG electricity in TWh
200
180
160
140
120
100
80
60
40
20
0
<strong>EXPLORER</strong> markttrends December 2010 9
2000 2002 2004 2006 2008 2 0 1 0 2 0 1 2 2 0 1 4
gEnERATIOn
figure 12: Development of EEG feeding and levy on the basis of historical data (until 2009 EEG annual accounting by the TSOs) and preliminary values of the
EEG levy forecasts (for 2010 and 2011) and the medium-term forecast (2012 to 2014) of the TSOs. Sources: www.eeg-kwk-net, LBD analyses.
Euro / MWh
160,00
140,00
120,00
100,00
80,00
60,00
40,00
20,00
0
Spread for EEG electricity generation according to medium-term forecast
Spread for EEG electricity generation according to medium-term forecast
EEG electricity generation - annual accounting (historical)
EEG electricity generation - annual accounting (historical)
EEG levy in Euro/MWh
01.05 07.05 01.06 07.06 01.07 07.07 01.08 07.08 01.09 07.09 01.10 07.10 01.11 07.11 01.12 07.12 01.13 07.13 01.14 07.14
EEG levy (2005 to 2009 adjusted actual values, 2010 and 2011 actual values,
2012 to 2014 forecast values of the lower scenario of the medium-term forecast)
EEX futures baseload
yearly average value EEX front year futures
figure 13: Sum of 12-month mean values of the front year futures (until 2010) or 20-day mean values of the futures market products (beginning 2011) and
the EEG levy. Future development of the levy according to the lower scenario of the medium-term forecast; source: EEX, www.eeg-kwk.net; as per:
30 November 2010.
100,00
90,00
80,00
70,00
60,00
50,00
40,00
30,00
20,00
10,00
0

SPECIAL
Euro / MWh
100,00
80,00
60,00
40,00
20,00
0
10
<strong>EXPLORER</strong> markttrends
December 2010
Lbd-beratungsgesellschaft
Procurement strategy 2012 based
on the experience from rolling
procurement in 2011
In persistently growing markets, easy
money can be earned with long-term
rolling procurement. When the turning
point is reached, the market experiences a
lasting slump. If no stop-loss limits are set,
the long lead time in procurement triggers
considerable losses.
Figure 14 shows that loss risks are
lowest with market-near procurement and
in the near future, 3-month procurement
(3-3-12) bears the lowest risk. Open items
can be held for the spot market. They do,
however, require mark-to-market limiting
against in-year futures market products.
2005 2006 2007 2008 2009 2010
EEX Base_cal_2011: moving average 20 days; (mark-to-market)
EEX Base_cal_2011: moving average 3 months
EEX Base_cal_2011: moving average 12 months
EEX Base_cal_2011: moving average 36 months
spot price moving average 360 days
figure 14: Moving average values compared to different procurement periods; source: EEX; as per: 30 November 2010.

<strong>EXPLORER</strong> markttrends December 2010 11
POLITICAL InTERvEnTIOn TO SECuRE InvESTmEnT InCEnTIvES
fOR LOW-CARbOn And AT ThE SAmE TImE AvAILAbLE POWER
PLAnT CAPACITIES
It is unlikely to be in the interest of
market players if, due to the structural
conditions of the market, operators of
available power plant capacities are
unable to cover their operating costs
not to mention generate contribution
margins for capital costs. Investments
in Europe’s power plants, which are
geared towards reducing carbon emissions,
also require suitable investment
incentives.
This is where political intervention
is called for. During the further revision
of the Renewable Energy Act (EEG) beginning
in 2012, it should be discussed
whether, by virtue of legislation, the
EEG in its current form creates market
dominance (at least for a large number
of hours in the year) which results in distorted
price formation on the wholesale
market and also to rising EEG levies.
gEnERATIOn
Transmission system operators
(TSOs) in their role as »portfolio managers
of renewable energy« are required
to act in a market-independent manner
in line with their legal function (no bid
at the day-ahead auction on the EEX).
A system that allows operators of EEG
plants to market directly (rather than via
the TSOs) would perhaps lead to less
distorted prices on wholesale markets
and the chance to make way for lower
EEG levies. Moreover, a market model
must be created for the wholesale
market that allows the profitable operation
of low-carbon and at the same
time available power plant capacities to
supplement electricity generation from
renewable energy sources.

SPECIAL
OThER PROduCTS
Procurement risk analysis
LBD has developed a model to analyse risks in procurement. Using a development
method, we can generate the following statements regarding
your procurement:
•
•
•
•
Where do your procurement costs in the portfolio stand in comparison
with the market and other procurement strategies?
Is your procurement strategy geared towards your corporate
goals, the customer segments and your company›s products?
Which requirements exist for venture capital, liquidity and security
as a result of your procurement strategies up to now?
How can the portfolio be improved?
These and other questions will be answered as soon as you complete
and send to us a standardised questionnaire with details regarding customer
segments and quantitative information, portfolio structures as
well as quantities and procurement costs per portfolio.
Contact: Ralph Klebsch
12 <strong>EXPLORER</strong> markttrends December 2010
LBD-Beratungsgesellschaft mbH
Stralauer Platz 34
EnergieForum
(D) 10243 Berlin
COnTACT
Phone: +49 (0)30. 617 85 310
Fax: +49 (0)30. 617 85 330
www.lbd.de
ben.schlemmermeier@lbd.de
Contact:
Ben Schlemmermeier
PubLIShIng dETAILS
Responsible for the purposes of german Press Law:
LBD-Beratungsgesellschaft mbH
Editor: Ben Schlemmermeier
Authors and analysts: Ben Schlemmermeier,
Carsten Diermann, Dr. Eyk Bösche,
Tobias Haberland
PubLIShER LBD has been advising the
energy market since 1988. The company is
owner-run and independent, was founded
in Berlin and employs a staff of around 40.
Our customers are producers and traders,
industry, municipal works, service providers
and municipal administrations. We
are there to help them to boost efficiency
in their business with power and emissions,
during expansion and in end customer
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entire value chain.