The Capacity Market is a mechanism introduced as part of the Government’s Energy Markets Reform (EMR). The aim of EMR is to improve the UK’s security of supply and decarbonise power generation, while at the same time keeping energy affordable for the consumer.
The Capacity Market mechanism procures a commitment from generators to provide additional generation capacity that can be called upon when the system is “under stress”, to meet demand and so provide system stability. These reliable sources could be all types of generation plant, with the exception of those receiving low-carbon support or already obligated to short term operating reserve. Other sources that can be included are storage, interconnector capacity, and demand side response (DSR). DSR is when large energy users are paid to reduce their consumption when called upon by the National Grid.
Capacity Agreements of between 1 and 15 years duration are awarded to generators via an auction process. The first auction took place in 2014 for delivery in 2018/19 and the second was held in December 2015 for 2019/20 delivery, with delivery years running from September to October.
A three month qualification period is held before the auction when the operator applies to become a Capacity Market Unit (CMU). The auction is run using a “pay as clear” method starting at the auction price cap and then descending in increments. Bidders submit their bids in units of at least 2MW and set an exit price, which is the price level at which they would withdraw from the auction. The price is reduced until it reaches the level where the remaining capacity meets the capacity demanded and this becomes the clearing price. Successful CMUs are those who have not submitted exit bids above the clearing price level and they take on a capacity obligation under a Capacity Agreement. When there is system stress, a capacity market warning is issued and generators with Capacity Obligations must deliver capacity in four hours’ time. In order to mitigate against the risk of penalties, participants who are unable to meet their obligation can trade their obligation by selling it to a party who is already prequalified. In addition, generators that have over-delivered can reallocate, or sell, the excess volume to another CMU participants.
The second capacity auction was held on 10 December 2015 for delivery in 2019/20. The clearing price was £18/kW/year for an aggregate capacity agreement of 46GW. There has been criticism of the results as, due to the low clearing price, 90% of capacity was awarded to existing generation and only 4% to new build. One of the purposes of the Capacity Market mechanism is to encourage new build and the renewables industry is particularly keen to see support for investment in new energy storage. Criticism has been particularly directed at the inclusion of diesel generators in the scheme and calls have been made for a carbon intensity limit to be included in the Capacity Market mechanism.
In addition to the main capacity auctions, transitional auctions are held for DSR, not more than 12 months before delivery. National Grid will be holding a transitional capacity auction on 26 January 2016, for delivery in 2016/17. The target capacity will be set at 900MW with a price cap of £40/kW/year. Guidelines for the transitional auction have recently been published and can be found here.
While environmental groups raise concerns over the ability of the Capacity Market to encourage new investment, the government argues that the price reflects value for the customer, given that the cost will ultimately be passed through to consumers’ electricity bills.
Written By – Nikki Wilson