This article was first published by Marsh here.
Electricity interconnectors allow for the transfer and trading of excess power between countries by way of high voltage, direct current (HVDC) subsea cables. With the energy transition underway, interconnectors will play a critical role, both in helping the UK meet its green energy targets and improving the security of electricity supply. In this first of a three-part series on interconnectors, we outline the UK Government’s stance on the industry, how interconnectors benefit consumers, and some challenges associated with electricity interconnectors in the UK.
Electricity trading and decarbonisation
The UK has committed to decarbonising its electricity network by 2035, as a part of its 2050 net zero carbon emission goals. Achieving this goal requires establishing a secure supply of renewable energy. Unfortunately, wind, solar, and water power generation can be intermittent and is subject to the UK’s limited power storage capacity. It is therefore necessary to have infrastructure that can respond to rapid changes in output and demand.
The UK has historically been a net importer of electricity, and interconnectors allow UK residents to take advantage of other regions’ higher solar intensity, convection current winds, and energy storage facilities.
In 2020, the UK Government committed to increase Britain’s interconnector capacity to at least 18 GW by 2030. Britain’s electricity market currently has 8.4GW of such capacity available internationally via France, the Netherlands, the Republic of Ireland, Belgium, and Norway, and via several domestic cables linking different parts of the UK. A further six projects are planned or under construction which would provide an additional 7.5 GW. If the UK Government hits this capacity goal, UK consumers may save up to an estimated £20 billion in energy costs between now and 2045.
National Grid estimates that its interconnectors will help Britain prevent upwards of 100 million tonnes of carbon emissions before 2030. Additionally, interconnectors help reduce potential waste of zero carbon energy. In order to meet any shortfall, the UK would be able to import energy from Europe and Africa via existing and proposed interconnector cables. Conversely, when Britain’s renewable installations eventually generate excess energy, it will be able to export its surplus through the same interconnectors.
An example of this exchange is an interconnector with Norway which enables the UK to tap into that country’s hydropower, while allowing Norway to benefit from electricity produced by British wind farms. The direction can switch multiple times a day, depending on need. Having the ability to direct zero carbon energy from where it is produced or stored to where it is needed reduces the chance that electricity will be wasted or its production curtailed. It also helps make sure Britain has undisrupted access to lower-priced electricity from a wide pool of sources and decreases dependence on foreign oil and gas.
Although interconnectors are vital, as we move towards an economy more reliant on renewable energy, the energy industry has to address a few key challenges:
- Supply and demand coordination: Cables and ships
In order to meet its ambitious targets, the industry must address issues such as the need for supply and demand coordination.
For example, although electricity interconnectors have existed for decades, cable manufacturing capacity is currently relatively limited and there can be considerable lead times on cable delivery caused by insufficient factory space. Additionally, there are not enough cable-laying ships available to install these cables, creating a further bottleneck to book repair or installation works, and adding further cost. This can have a knock-on effect with insurance costs because the quantum of a given claim can be greatly increased by delays.
While all cable manufacturers are presently based abroad, plans to build the UK’s first high HVDC cable factory is moving ahead, with capital already invested.
The need for enabling infrastructure is generally less of an issue for interconnector projects, which often connect into existing substations and well established grids. Converter stations and connections to such substations do need to be built of course.
- Return on investment: Cap and floor
Interconnector projects require enormous capital expenditure, and there is understandable concern around returns on this investment. Interconnector operators make money by purchasing power at the lowest possible price, and importing that power into markets where prices are higher. The capacity market allocates interconnector capacity to market parties via capacity auctions.
The UK government has taken measures to ensure there is sufficient investment in this sector.
In 2014, the Office of Gas and Electricity Markets (Ofgem) introduced the cap and floor regulatory regime to encourage investment in interconnectors, while making sure consumers also benefit. Under this regime, investors are guaranteed both maximum and minimum revenue amounts. If the interconnector does not generate sufficient revenues to hit the “floor”, the British system operator will recover the funds via transmission charges applied to consumers.
Conversely, if the interconnector generates sufficient revenues to hit the “cap”, the British system operator will reward consumers with a reduction in transmission charges. Ofgem sets the level of the cap and the floor by assessing the costs of developing, building, and operating the interconnector, and only approves projects where its analysis has established that the project benefits consumers.
Alternatively, investors can take the merchant approach by requesting exemptions from regulatory requirements. Investors using this method will retain the total revenue from the interconnector, but will not have the benefit of consumer underwriting.
- Policy and regulatory uncertainty: Brexit impact
As interconnectors depend on negotiations between parties in two countries, there is a need for robust trade agreements and regulations to make sure operations run smoothly. Despite fears that Brexit might put a stop to interconnector development, it has not ultimately inhibited it; the rationale behind their development exists regardless.
Other countries share the UK’s intention to achieve net zero emissions in the coming decades, and understand that using interconnectors to their full potential helps achieve that goal. For example, the EU has set an interconnection target of at least 15% by 2030.
However, leaving the EU means the UK also left the Internal Energy Market, which enables EU member countries to trade electricity almost seamlessly. Following Brexit, the UK is subject to the trading arrangements outlined in Title VIII of part two of the EU–UK Trade and Cooperation Agreement (TCA), which are less efficient and more costly.
Meeting the challenges
Interconnectors provide many benefits, such as aiding in decarbonisation and enhancing energy security. Still, there are many risks associated with their development and operation.
The next blog in the series will discuss these risks and what can be done to mitigate them.