High risk of underinvestment in power generation in current climate of uncertainty

(Paris) — 3 May 2007

“A heavy investment cycle in power generation is looming in most IEA countries, and governments need to play an assertive role in reducing uncertainty and making sure appropriate investment takes place,” said Claude Mandil, Executive Director of the Paris-based International Energy Agency (IEA), today at the launch of the new publication Tackling Investment Challenges in Power Generation in IEA Countries.

Considerable investments will have to be made during the next decade, which will undoubtedly also see climate change and security of supply as key policy priorities. “A window of opportunity now exists to push for a cleaner and more efficient generation portfolio that will have significant impact on the energy sector and the environment for the next 40-50 years,” Mr. Mandil said. However, the many uncertainties now inherent in the power sector create risks for investors. These risks may lead to underinvestment – too little, too late, in the wrong location and with the wrong technology.

Some of the most serious direct risks in the current investment climate result from government policy. “Uncertainty about policy on climate change and CO2 abatement is the principal risk factor when investors choose technology today,” Mr. Mandil said. Uncertainty about government support for specific generation technologies also creates considerable risks. Furthermore, no market signals or policy-driven incentives will have effect if investors cannot get permission to build new electricity infrastructure. Mr. Mandil underlined that delays associated with regulatory approval of new power plants frustrate markets, increase costs of projects and may undermine security of supply. This is particularly true for new nuclear power plants and new transport infrastructure which require several years to go through the regulatory process.

Competition is a strong and necessary instrument in creating an efficient investment climate, provided that a clear and stable policy framework effectively reflects environmental costs. Liberalisation, introducing cost-reflective prices, has delivered considerable benefits to many markets. It has, however, proven to be a process that carries considerable uncertainty for investors. “A successful liberalisation process, which allows for better management of investment risks, critically relies on wholehearted implementation backed by ongoing government commitment,” Mr. Mandil said.

The lion’s share of new capacity additions in IEA countries during the past decade has been in natural gas-fired generation and in subsidised wind energy. “Combined cycle gas turbines and wind power are necessary, but a continued almost exclusive focus on these technologies is a cause for concern for the future generation mix,” Mr. Mandil said. Diversification is a sensible business strategy, and commercial investors are showing signs of a shift in focus towards other technologies such as high-efficiency coal and nuclear power. However, as long as policy and regulatory uncertainties force investors to be short-sighted, natural gas-fired generation may be the default low-risk option.

Government action is urgently needed to significantly reduce political and regulatory uncertainty. This would serve to establish effective competitive markets and provide firm policy directions in those areas in which markets fall short. Governments should implement policies that create long-term incentives for technologies which provide security with low CO2 emissions, but without picking winners. Governments must also clarify and simplify power plant licensing procedures to accelerate the approval of new generation units. “Public debate is essential to create acceptance of necessary new electricity infrastructure, particularly so for nuclear power and new transport infrastructure,” concluded Mr. Mandil.

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