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All-Party Parliamentary Climate Change Group and Carbon Connect Briefing: The Electricity Capacity (Amendment) Regulations 2016

All-Party Parliamentary Climate Change Group and Carbon Connect Briefing: The Electricity Capacity (Amendment) Regulations 2016

6th July 2016

The Capacity Market

The capacity market is the government’s primary tool for ensuring security of electricity supply. The capacity market was introduced by the Coalition government in 2014 to ‘encourage the investment we need to replace older power stations and provide backup for more intermittent and inflexible low-carbon generation sources’.[1]

The capacity market offers payments to power generators to be available to generate electricity at certain times, and to demand response providers to be available to reduce electricity demand.[2] The amount of capacity that is needed is decided by the Secretary of State for Energy and Climate Change, following a recommendation from National Grid.[3] Participants are paid a per MegaWatt rate for the capacity they offer to the market. This capacity needs to be available when providers are called upon by National Grid at any time during the contracted period.[4]

The market takes the form of an auction, held every year, for capacity to be delivered in four years’ time. Firms bid into the auction at the price they need in order to keep their plant open or build one from scratch.[5] Supplementary auctions will be held a year ahead of delivery, with the intention of capturing capacity from demand-side responders, and to allow any secondary trading of capacity obligations secured in the first round.[6]

The Electricity Capacity (Amendment) Regulations 2016

There have been two main auctions so far, held in December 2014 and 2015. These resulted in the award of £2.8bn in subsidies, mainly to existing power stations. The first capacity market auction was held in December 2014, for delivery in 2018-19 and a second auction was held in 2015 for delivery in 2019-20.

The Electricity Capacity (Amendment) Regulations 2016 make provision for a Supplementary Capacity Auction for delivery of capacity in 2017–18, to insure against the risks to security of electricity supply in 2017–18 and against the risk of a sharp increase in wholesale prices. UK electricity market conditions have changed considerably since 2014 when the capacity market was established. While the reduction in global commodities prices has lowered consumers’ energy costs, it has also made a significant part of generating plant unprofitable, with the result that there have been several closures announced earlier than was anticipated in 2014.

As a result of these unforeseen developments in UK electricity market conditions, the Department of Energy and Climate Change (DECC) are looking to introduce capacity market arrangements one year earlier than planned. In light of these changes, DECC has also significantly revised its estimates of the impact on household bills of the capacity market measures.

DECC has calculated that the gross impact of the “early” capacity market on household bills in 2018 could be between £28 and £38. The Department has stressed, however, that the net impact on bills is expected to be considerably lower due to a reduction in wholesale prices, and that the net impact on an average annual household bill for 2017–18 could be between £10 and £21.

The Regulations also increase termination fees and credit cover payable under the capacity market scheme; make provision in relation to the transfer of capacity market obligations; and make a number of other amendments, including in relation to the second capacity market transitional auction.[7]

Criticism of the Capacity Market

The capacity market has been criticised for subsidising fossil fuel generators and thereby undermining plans for decarbonisation.[8] The Overseas Development Institute (ODI) has argued that capacity markets risk ‘locking in’ dependence on fossil fuels and recommend that governments using capacity markets should:

  • Have a clear understanding of the scale and the nature of the reliability challenges facing their power systems.
  • Consider whether improvements in current market design can help to improve power system reliability.
  • Recognise the potential of demand side response, interconnection and storage in providing economically competitive, low-carbon flexibility.[9]

The Institute for Public Policy Research (IPPR) recently produced a report which identified the following problems with the capacity market:

  • It provides poor value for money: across the two auctions held so far, nuclear power plants have received payments amounting to £153 million in 2018 and £136 million in 2019, despite being almost certain to remain open during those years without receiving these subsidies.
  • It works against decarbonisation: it has provided a lifeline to several old coal-fired power stations, which have received a total of £373 million in subsidies from both auctions. It has also heavily incentivised the proliferation of new diesel generators, which are even more polluting than coal and which were awarded a total of £176 million in subsidies in 2015.
  • It is focussed on generation: the capacity market is designed around the requirements of large power stations, rather than around the needs of smart energy technologies such as demand response and electricity storage, or for actions that would permanently reduce demand for electricity. The National Infrastructure Commission has estimated that billpayers could save £8 billion a year by 2030 if these alternatives were supported.

The IPPR report argued for the following reforms to improve the system:

  • The capacity market should be split into separate auctions for old and new capacity: The capacity market currently awards the same per-unit price for capacity to all operators. This means that existing power stations that would be able to operate without any payments at all receive the same price-per-unit as a new power station.
  • An emissions performance standard should be applied to all capacity in receipt of capacity payments: Carbon-intensive generation should be explicitly prevented from accessing the capacity market through the introduction of an ‘instantaneous’ emissions performance standard. This would effectively prevent any station that has a carbon intensity above a certain level from bidding into the capacity market.
  • New large-scale gas power plants should commit to using carbon capture and storage (CCS) if they are to stay open in the long term: There is a role for new gas plants in replacing coal and providing flexible back-up as the electricity system is decarbonised. However, given the very low levels of carbon emissions that the UK’s electricity supply needs to be producing by 2030, there can be only a very limited role for unabated gas generation. To access longer-term contracts, large-scale gas plants should either be built with CCS, or be required to install it in future.
  • Demand response providers should have access to longer contracts: The capacity market currently favours traditional generation over new technologies that can reduce demand and so limit the number of power plants that need to be built. Demand response providers do not currently have access to the longer-term contracts available to power stations. The disparity in contract lengths available makes it for difficult for them to compete with traditional generation.[10]

It has also been argued by David Newbery of the University of Cambridge that capacity auctions ‘tend to over-procure capacity’.[11]

This briefing was prepared joinly by the All-Party Parliamentary Climate Change Group and Carbon Connect in advance of the Grand Committee hearing in the House of Lords on Electricity Capacity (Amendment) Regulations 2016 which took place on 5 July 2016.