21 June 2006
Energy Supplies and Investment
With the summer weather now upon us, the memories of winter seem a long way away. A recent report, however, commented on the changing energy needs that might occur because of the changes to the Earth's climate. The report suggested that as winters in the UK become milder and summers heat up, there will be a greater demand for energy in the summer to drive air conditioning systems but a reduced demand in the winter. Traditionally, the energy companies have used the summer period when there is less demand to carry out maintenance on plants and equipment. This might have to change.
Centrica, who own British Gas, are taking things one step further. Last week, they announced plans to build a new power station that will help supply energy to over a million homes in the south west. The new plant is the first power station to be built in the UK for almost five years, and will cost around £400 million to build. The construction is due to begin at the plant in Langage, near Plymouth in Devon, later this year.
The plant has been many years in the planning. It received planning permission six years ago, despite the opposition of many local people, but has taken this long to get to anywhere near the construction stage. It is due to enter operational mode in 2008. The company has suggested that the gas-fired power station will be one of the most efficient in the UK.
The time lag between the initial identification of the need for this power station and its eventual operation highlights the problems faced by energy supply companies in meeting changing demand. There is a limit to the existing capacity of power stations; if there is an increase in demand, that capacity has to be utilised. If supply at any one time does not meet demand then the potential for prices to rise exists. There may be complaints that energy companies do not plan ahead but when the lead-time (the time taken to expand production) is so long, it is understandable that volatility in the market can exist.
The plans also highlight the risk involved in beginning the planning process for such a large investment. Given that it will be eight years before the plant begins to operate, the company will have had to consider the issues surrounding an investment that will not even begin to generate revenue for at least eight years!
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Using an appropriate example, explain the meaning of the term 'investment'. (4 marks)
Explain the possible link between investment and productivity for a firm like Centrica. (6 marks)
Given the length of the lead-time for the construction of a new power station, discuss possible ways that Centrica could manage the changing level of demand for energy. (8 marks)
Describe and assess two possible methods of investment appraisal that Centrica might have used in the planning for this new power station. (10 marks)
To what extent should the Government reduce the level of regulation to enable firms to respond to changing demand for energy? (12 marks)