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The Future of Electric Competition: Concentrated Power

Fortnightly Magazine - February 2005
  • time of new plant.
  • For a new developer, a critical factor will be the time to the first peak occurring post commissioning. A study by Smith Barney (2002) investigated these factors for a new CCGT (costing £400/kW). The results, shown in Figure 4, suggest that the most crucial factor concerning a developer is that of commissioning (T1). If a station commissions just after a peak (such as happened to International Power's stations in Texas), the consequences for cash flow and the net present value (NPV) of the project are disastrous. The NPV of the cashflow is lower than the investment and value is destroyed, because in this idealized model, returns to capital can only be enjoyed when there is a shortage.

    Given this outlook, it would take a very courageous developer to proceed with a new plant in England and Wales, were it to rely on revenues from the spot market. Avoidance of a shortage of capacity therefore may have to rely on a demand response to price, rather than capacity.

    Other Commodity Markets

    Other commodity markets that respond to price signals appear capable of bringing forward capacity in time to meet demand, so perhaps there is something the power sector can learn before it is overwhelmed. The key to the avoidance of shortage may be seen in Figure 5. This chart shows the returns on capital enjoyed by the commodity sector over a 10-year period to 2002, with the market share of the four largest companies in each market.

    The chart demonstrates how the average returns enjoyed by companies in these markets are extremely sensitive to the market shares enjoyed by the leading players. The annual returns may well deviate from the averages shown above. Indeed, when there is a shortage of steel capacity, returns will rise dramatically. But they will fall as soon as additional capacity comes on line. Companies with a significant position in iron ore, on the other hand, are able to enjoy prices that allow a handsome return on capacity-even when there is surplus supply-because they can control it.

    Indeed, Figure 6 shows the spot prices of the various commodities shown in Figure 5. The volatility of the iron ore prices is an order of magnitude lower than the others. This suggests that a high degree of control offers stable prices and attractive returns on investment.

    A crucial issue is how much market share will provide "control." This is a difficult question and is likely to be very market specific. On the one hand, Figure 5 suggests there may be a smooth relationship between market share and return. Whether this is the same as "control" is an entirely different matter. For power markets, it is doubtful that a simple market share measure would work, such as the four forms' ratio, or a Herfendahl index. For the power sector, it is likely that control over the marginal plant will be a highly important factor-but this is a possible area for further research. Indeed, the remarkably fast transition from oligopoly to competitive market shown in Figure 1 suggests that,