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GB interconnector plans evolve as arbitrage narrows

Over the last 15 years, Great Britain’s power supplies have become increasingly reliant on interconnectors with continental Europe. Now, though, the tide may be turning, as supply and markets evolve.

Gas has always been more international. In the 1980s, even while domestic supplies from the North Sea expanded, consumption moved faster. As a result, the UK has historically been open to international ties.

Electricity has been slower to go international. Until 2011, Great Britain was linked to the continental European electricity grid via a single 2 GW interconnector with France.

The challenges of long-distance power supply and differences in generation mix helped drive cross-border wholesale price differentials.

However, since 2011, the level of electricity interconnection with other markets has stepped up considerably. This may come to be seen as a “golden age” for interconnector project development.

Driving development

The recent development of GB electricity interconnectors reflects a combination of policy, regulatory and commercial factors.

From a policy perspective, electricity interconnectors have helped enhance supply security and they are a valuable source of flexibility. As grids move towards increased reliance on intermittent renewable generation, this becomes more important.

Grids have also won plaudits for their contribution towards carbon abatement goals. However, in practice this may depend on the country with which GB is interconnected.   

The regulatory regime, in part a legacy of European Union membership until January 2020, has been supportive to interconnectors in a number of ways.

North Sea Link Picture shows; Construction barge for the North Sea Link, an interconnector between the UK and Norway. Supplied by National Grid Date; Unknown
Construction barge for the North Sea Link, an interconnector between the UK and Norway. Supplied by National Grid Date; Unknown

These links can and do bid into the GB Capacity Mechanism, securing long-term capacity contracts. This is subject to “derating” factors applied to nameplate capacity, which are designed to reflect the certainty (or otherwise) of their contribution to GB supply at times of peak electricity demand.

They continue to be exempt from the transmission network use-of-system charges which apply to GB generators.

Financial viability

And perhaps most importantly, they have often benefited from what is known as “cap-floor” regulation. This is subject to a case-by-case review of social welfare benefits, before Ofgem offers that supportive framework. The main consideration is that potential interconnector projects should represent good value for consumers and the UK economy. Ofgem also looks at projects feasibility, for example, the likelihood of completion within the current cap-floor window.

Ofgem may withdraw offered cap-floor regulation from development projects that have little realistic chance of timely completion.

Cap-floor regulation involves a minimum rate of return reflecting the cost of debt, as well as a maximum return based on the cost of equity. It has reduced investment risk and allowed interconnector projects to “gear up” with higher levels of debt. This was especially beneficial when interest rates were lower than they are today.  

Commercially, the fundamental use and value of electricity interconnectors depends on wholesale basis price differences between GB and other interconnected electricity markets. In turn, this allows energy businesses to take advantage of interconnector capacity and trade electricity across borders, while generating revenue for the interconnector owners.

Over time, increased interconnection capacity is likely to reduce these price differentials. However, the GB electricity grid remains some way from the high level of gas interconnection, which normally keeps GB wholesale gas prices closely aligned with those in the Netherlands.

Finally, any interconnector projects needs willing investors. These are often electricity grid companies or their affiliates, National Grid Ventures has a stake in six operational projects, for example. But there are several interconnectors that independent private companies have developed.

Market impact

Reflecting the supportive factors outlined above, GB now has nine operational interconnectors with continental Europe or the island of Ireland. These have a combined total capacity of around 10 GW.

To put this in context, nameplate GB generating capacity is around 100 GW. Further interconnectors with Ireland and Germany are currently under construction.

Source: Ofgem Multiyear Strategy, March 2024

Under normal circumstances, Britain is often a net importer of electricity across the interconnectors. However, this varies depending on the interconnected country and market circumstances at the time.

GB will import from Norway almost all the time, for example. Meanwhile, changes in flow direction across the Irish Sea are very common – often depending on the level of wind generation in Ireland.

France is normally a net exporter but this pattern can be reversed – as it was for much of 2022. That year, French nuclear generation was operationally constrained, while at other times cold winter weather drove up electric heating demand in France.

Source: UK Digest of Energy Statistics, 2023

In 2023, GB reverted to the more normal position of being a net electricity importer. Given increased electricity interconnector capacity, net imports rose to account for a record 13% of electricity demand .

Brexit

The UK left the EU at the end of January 2020. The transition period, during which European Single Market rules continued, terminated at the end of that calendar year. There had been concerns voiced ahead of the move, but it has had little impact to date on the development of new interconnectors.

In contrast, Brexit has meant a significant change in the mechanics of interconnector access. In the years before Brexit, all GB interconnectors benefited from the efficient pan-EU system for electricity markets, known as Single Day Ahead Coupling (SDAC).

This mechanism provides for what is known as an “implicit” allocation of interconnector capacity. It avoids the need for energy traders to participate in “explicit” day ahead auctions to secure capacity before they can trade across borders.

The EU has now gone on to apply electricity market-coupling on an intra-day basis, as well as day ahead.

Post-Brexit Britain has lost access to SDAC. It now faces three different interconnector access regimes – all of which are somewhat less efficient than the pan-EU system for market coupling.

The most significant change relates to the “channel” interconnectors, with Continental Europe, other than Norway. These have reverted to the old model of explicit “capacity” allocation based on day-ahead auctions of interconnector capacity. 

The three current interconnector access regimes are summarised in the chart below:

Loose coupling

The UK-EU Trade and Co-operation Agreement of December 2020 proposed that GB interconnector access should move to a new system, known as Multi-Region Loose Volume Coupling (MRLVC), from April 2022. 

This would be less efficient than SDAC, but an improvement on the current arrangements. In fact, little progress has been made. The main reason is that a workable MRLVC system requires a change to the timing of some of the SDAC activities. There is little political or industry appetite for this within the EU.  

The estimated economic cost of less efficient interconnector access is substantial in absolute terms. However, it is only a small percentage of the wholesale electricity price. In 2022, for example, consultants Baringa estimated the value impact of lost market coupling at £440 million per year by the end of 2022. This added roughly 0.7% to total wholesale electricity costs.  

The lost value is likely to have risen further since then, as further interconnectors have come on stream.

Unconventional connections

As mentioned earlier, two further interconnectors are already under construction. These are the 500 MW Greenlink from south Wales to southern Irelandand the 1.4 GW NeuConnect link to Germany. Both of these are led by independent private infrastructure investors.

Looking further ahead, it is likely more projects will follow. However, the pace of “conventional” interconnector development seems likely to slacken as compared with the last 10 years or so. There are several reasons for this.

First, are economic fundamentals. The more interconnection capacity installed, the lower the likely level of basis price differentials – all other things being equal – which would make the next generation of projects less attractive than the last.

Second, Ofgem appears to be much more selective in offering the benefits of cap-floor regulation to new interconnector projects. In its latest review, for the third cap-floor window, Ofgem’s “minded to” position was that only one of seven potential interconnector projects merited acceptance for that supportive regime.

The only project winning Ofgem’s support was the proposed 1.4 GW Tarchon link with Germany. This compares with five projects accepted for the first window in August 2014, all but one of which have since gone ahead.

Third, industry may well shift from conventional shore-to-shore interconnectors, towards what are known as multi-purpose interconnectors. These link up with other countries while also providing cost-effective connections for new offshore wind farms.

North Sea interconnector

The main reasons behind Ofgem’s revised stance are a mix of insufficient UK economic benefits and specific project feasibility issues. Underlying that is probably a greater risk that new projects could test the floor rate of return and thus require support from GB electricity consumers.

New interconnector projects could, in principle, proceed without cap-floor regulation. However, they would face much more commercial risk and most likely a higher cost of capital. Few infrastructure investors are likely to see that as an attractive prospect.

One policy area that has remained active in the wake of Brexit is North Sea Co-operation, particularly around the development of offshore wind farms.

To date, most project development work on multi-purpose interconnectors relates to the southern North Sea. National Grid Ventures is involved with partners in two potential projects. These are the 1.8 GW LionLink, to the Netherlands, and 1.4 GW Nautilus, to Belgium.

Given the involvement of new offshore wind projects, developments timescales will be fairly long. LionLink, for example, is currently slated to be onstream in 2030.

The idea is that offshore wind producers will be given the flexibility to deliver electricity to either connected market. Operators would take choices on where to supply depending on spot electricity prices and other relevant factors.

This is not impossible under the current imperfect interconnector access regime. However, there is no doubt arrangements would be more flexible and efficient under some revised form of market coupling.  

Multi-purpose interconnectors will require higher capex, as compared with either a single offshore transmission link or a conventional interconnector. However, they also access two revenue streams, from a transmission service to offshore wind generators and cross-border electricity trading.

Changing trajectory

With the benefit of a supportive cap-floor regulatory regime, GB interconnector development has been a significant success story over the last decade and more. Total interconnection capacity will rise from only 2.5 GW in 2010 to around 12 GW, once the two projects currently in construction come on stream.

There have undoubtedly been material benefits in terms of GB supply security, grid management and energy costs to consumers.

Recent development suggest a changing trajectory. The latest Ofgem review of cap-floor regulation accepted only one new interconnector project to qualify for that regime. Fundamentally, greater interconnection is likely to reduce cross-border price differentials, which makes future interconnector projects less attractive.

Meanwhile, offshore wind development is a key element of future grid decarbonisation in GB and elsewhere. The development focus appears to be shifting towards multi-purpose interconnectors, which will facilitate grid connection for offshore wind farms as well as cross-border arbitrage trading.

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