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Capacity Market – the first UK auction

By Dave Elliott

In a fully free-market energy supply system there is no direct commercial incentive for generation companies to ensure that the lights stay on long term, by investing in new and/or backup capacity. Given that some old plants are scheduled for closure and more reliance on sometimes variable renewables is planned, the UK government has stepped in to create a new ‘capacity market’ to try to fill the potential gap in terms of reserve capacity and grid balancing capacity.

Competitive market pressures have meant that some existing gas-fired capacity has been moth-balled, and the new market is meant to draw on some of that – by offering an extra cash incentive for making it available for use if needed, the cost of which will be passed on to consumers by an extra levy on energy prices. It was also thought that this could incentivise investment in some new projects, including new flexible gas plants, but also energy storage facilities, to help with grid balancing, as well as demand management projects, aiming to reduce demand peaks.

With maybe 30GW or more of renewables expected on the grid by around 2020, and old coal and nuclear plants being closed, the UK government has adopted a capacity auction approach, seeking to eventually contract for around 53GW of capacity to be available. The first round, in December last year, led to ~49GW of capacity being contracted, out of ~ 65 GW of submissions, for reserve/back up duties from 2018 onwards if required, most of it being existing or refurbished fossil-fired capacity, including around 25GW of gas-fired plant, along with over 9GWof coal/biomass plant and near 8W of nuclear.

DECC had already indicated that ‘The vast majority -perhaps all – of the capacity winning the auction will be made up of existing plant and demand side response’ adding that ‘whether or not any new capacity is brought forward will be determined by price alone’. However, the inclusion, in the first round, of nuclear, despite it not being flexible, and the emphasis overall on existing fossil plants, raised some hackles. Prof. Catherine Mitchell at Exeter University said that it was ‘supporting the status quo’, with the vast majority of payments going to the large, well-known generators: ‘They have done a great job in persuading Government that unless customers pay this extra amount it would be uneconomic for them to keep the power plants running and the lights will go out’. She added ‘All of this money would have been far better used to develop a sensible demand side response market.’

As it was, only a tiny amount went to demand side response (0.35GW), although 2.7GW did go to storage. The success of gas plants, large and small, is not surprising, but the fact that coal (plus biomass co-fired) also got shares is worrying, if you see the aim the Capacity Market as being to reduce emissions. It’s even worse if you think the aim was to back new capacity. Dave Jones, an analyst at Sandbag, said that: ‘The capacity market looks more like a subsidy scheme to keep heavy polluters online, rather than as a mechanism to encourage new investment – only five per cent of auction revenues will go to new investment. The capacity mechanism is actually slowing decarbonisation of the UK power sector.’

Most of the projects (44GW) are only contracted for a year, but there were some longer-term larger commitments. However The Telegraph pointed out that only one large new gas plant was contracted and felt that this was odd given the yawning energy gap and expected plant closures. It reported: ‘critics have suggested the policy is turning out to be poor value for money as it will hand vast subsidies to old nuclear plants that would have kept running anyway, and to old coal plants that are simultaneously being subjected to environmental taxes designed to force their closure.’

Seems no one liked it! But it was cheaper than expected, at £19.40/kW (totaling £990m) down from the initial reverse auction price of £75/kW. When it starts up, in 2018, it will put around £11 p.a. on consumers bills. And if you see it as just a way to ensure supply and demand are matched given expected plant closures and the increase in variable renewables, well it just about makes financial sense: gas plants are cheap, upgrading them is cheaper than building new ones and cheaper than storage. But demand management is surely going to be the cheapest option of all, long term. Interconnectors may also have a role, as DECC recognized. It has opened the scheme to grid links to Europe from 2020:

But what about consumers? Can’t they play an active role? This challenge failed:
Maybe in the next round? Which will take it up to ~51GW.

In this first round, the overall approach was said to be ‘technology neutral’, so in theory all options should have been eligible, although clearly it all depends on costs. Some feared the auction would yield a preponderance of cheaper but less environmentally appropriate options. For example, there had been media stories about hundreds of diesel generators being used. It was also claimed that 2-3GW of small open cycle gas fired plant might be included. In the event something near that has emerged (2.1GW of OCGT and reciprocating engines). Most will presumably be small, near large rural electricity sub stations and away from any heat load, running for a few hundred hours per year. Some have argued that it would make more sense to give priority to stations with cogeneration capacity (i.e. CHP plants) specifically linked to district heating (DH) schemes, at locations where the heat could be used, so they could run for 1000s of hours/year, so being more cost effective and supplying more in effect virtually zero carbon heat. And, separately some CHP/autogeneration was included (4.2GW). But CHP/DH enthusiasts would obviously like more – including full DH schemes. They have argued that a good DH scheme has a significant secondary effect in reducing peak heat load by displacing peak electric heaters which are always called into play in badly heated houses – it was this addition of peak electric heating which causes the large peak which the auction was at least partly designed to address.

Ah well, maybe next time.. But then it all really depends on what the Capacity Market is actually aiming to do, and, as the reactions above illustrated, there are some confusions on that. Some evidently hoped it would add new, ideally greener, capacity rather than supporting old fossil and nuclear plants. Well that’s not what has happened, but some of the plants it has backed will help support the grid given the variable inputs from renewable plants, so, arguably, it is part of an overall green energy approach. Though it could have been greener, if more storage and (especially) demand management was included. And while gas-fired plant can help balance variable renewables, in terms of short-term variations, nuclear is pretty irrelevant- it can’t load follow rapidly or regularly. In theory, if there are long lulls in wind or solar availability or other shortfalls (e.g. due to longer-term plant or grid failures, or cold spells), then nuclear might play a role if it was seen as part of the reserve capacity, along with old occasionally used coal plants. But then that implies that nuclear would also not be used fully at other times, which would undermine its economics. Is that what its inclusion in the capacity market means? Nuclear no longer being seen as baseload, with the capacity market payments being offered as a compensation for lower average operation? But that begs the question of whether it is actually any good in this role. The recent experience with many nuclear plants being off-line does not make it look like a very reliable reserve capacity option. Or for that matter much use for baseload. So, either way, why is near 8GW getting extra support? Similarly for the 9GW or so of coal and biomass plant that was supported. The suspicion is that, as with nuclear, the Capacity Market has just been used to as backdoor way of providing extra finance for it. If extra baseload was needed, why not support it in the normal way, via the CfD?
Plenty of issues to be resolved before the next round!

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