The Capacity Market in Great Britain: Results and Reform

In Great Britain (GB), capacity margins are tightening. The Government is consulting to close coal-fired generation plants by 2025. New nuclear is due to come on line that year but delays are always possible with such large projects.

With a view to keeping the lights on, in 2014 the Government introduced the Capacity Market. This provides certain, regular payments to capacity providers in return for which they must be available and producing electricity (or reducing demand) in times of system stress. Failure to comply with the capacity obligation results in penalties, although these are subject to an annual cap of 100% of the annual capacity payment.

Capacity agreements are not, despite their name, private law contracts. Instead they are a bundle of rights and obligations under the Capacity Market Rules and the Electricity Capacity Regulations 2014 (the Regulations). Successful bidders will not enter into a bilateral physical agreement with the Delivery Body (a role fulfilled by National Grid) but will instead receive a “notice” recording certain details of the capacity agreement. The full extent of the rights and obligations of the successful bidder in respect of the relevant capacity and for the delivery year(s) are contained in the Regulations and Capacity Market Rules. The capacity agreement is therefore a creature of the Capacity Market Rules and the Regulations, a feature which raises interesting issues in relation to change in law risk.

The amount of capacity targeted in the auction is determined on an annual basis after National Grid (as Delivery Body) carries out a security of supply analysis on the amount of capacity required to meet the reliability standard set out in the Delivery Plan (currently set at 3 hours of Loss Load Expectation). National Grid’s report is then reviewed by a panel of technical experts and the Secretary of State sets the final estimate for the target capacity in the four-year ahead and one-year ahead auction.

This methodology takes into account the level of capacity that is expected to be available outside of the Capacity Market (for instance renewable generation) and it is adjusted after the pre-qualification process concludes to take into account capacity of plants that have chosen not to participate in the auction process but that will remain operational during the relevant delivery year.

For the T-4 auction 2015 (for first delivery in 2019/20), the Government set a target capacity of 44.665 GW, a lower figure than was set in 2014 when the Delivery Body recommended a volume of 53.3 GW. However, this year’s lower target takes account of 5.5 GW of new and refurbished plant which has already secured a Capacity Market agreement in the T-4 2014 auction.

The 2015 T-4 auction cleared on Thursday 10 December at a price of £18/kW/year (2014/15 prices)¹. A total of 57.725 GW of De-Rated Capacity entered the auction and 46.354 GWs of capacity provisionally secured capacity agreements for first delivery in 2019/2020, against the target capacity of 44.665 GW.

For the first time, interconnectors (rather than overseas generators), participated in the T-4 auction. The BritNed, IFA and Nemo interconnectors pre-qualified, and were allocated de-rating factors following an assessment by National Grid based on the direction of power flows between GB and the connecting country, and the technical reliability of the asset. Both IFA and BritNed were successful in securing 1 year contracts.

The clearing price of £18/kW/year was similar to the level seen last year. At this level, it is widely expected that new build combined cycle gas turbine (CCGT) generators cannot be delivered (which we discuss further below in relation to reform proposals). This was borne out in the T-4 2015 auction as no large scale new build generation was successful and over 5GW of new build CCGT generation, comprising 8 projects, exited the auction before it cleared.

Now that the T-4 auction has concluded, industry will turn their attention to the first Transitional Auction which will take place on 26 January 2016, for first delivery in 2016/17, against a target capacity of 900MW.

Demand side response (including on-site behind the meter generation), together with small scale storage and embedded generation (both below 50 MWs and connected to the distribution system), can participate in the Transitional Auction.

In the T-4 2014 auction, the proposed 1.9GW Trafford power plant in Manchester was the only large scale plant to have secured a 15 year capacity agreement at a price of £19.40/kW/year. However, in October 2015 Carlton Power, which owns the plant, announced that it believed that a long term price of around £72/MWh was needed to secure finance and cast doubt on its ability to secure funding for the plant given the low price secured in the Capacity Market. This compares with the Committee on Climate Change’s estimate of £85/MWh of full costs for new CCGT coming online in 2020 (in a central gas price scenario)².

In her ‘Reset speech’³ Amber Rudd confirmed that the Capacity Market would be reformed so as to further the Government’s long-term goals; to incentivise new build gas fired power stations (rather than to prolong the life of old, polluting plant).

This is one of the main aims of the consultation on reforms to the Capacity Market⁴, published by DECC in October. Government are proposing measures to ensure that larger new build projects are in fact delivered, one of the central recommendations of the Electricity Reform Evaluation Report published by Poyry and Grant Thornton⁵. A package of reforms, focused on non-delivery and improved monitoring are proposed including:

• a requirement for capacity market units (CMUs) above 400 MW to provide evidence that financing (in principle) for 50% of the stated debt level will be available assuming their lowest acceptable clearing price
• a system of checks after capacity agreement award to confirm that finance has indeed been secured, together with higher credit cover requirements and termination fees for those projects which fail to meet one or both of these checks
• bringing the date of the financial commitment milestone forwards from 18 months to 16 months from the date of the auction results, to allow more time to adjust capacity volumes in subsequent Capacity Market auctions
• a ban on both the project which failed to deliver and company directors with responsibility for that project from participating in a future Capacity Market auction for 2 annual auction rounds and 3 years respectively.

Even if introduced though, these reforms focus on ensuring a large new build plant is actually built. They do not address the fact that the auction results are demonstrating (as it was designed to do) that the most efficient economic solution to estimated capacity needs are fleets of smaller build plant rather than large CCGT. For large CCGT to be delivered, the auctions for new build and existing plant may need to be separated, or the auction eligibility adjusted to ensure that only new build plant with only low carbon impacts are eligible (in absence of a meaningful carbon price), subject to State aid compliance.

In practice, due to the low clearing prices seen in the T-4 2014 and 2015 auctions, capacity providers will be looking to capture additional value elsewhere. The Capacity Market operates alongside the electricity market, so participants continue to sell electricity in the market. It is also distinct from the balancing mechanism and so does not affect balancing services.

Long-term contracts to provide short term operating reserve (STOR) are excluded from participating in the Capacity Market unless the capacity provider has made an irrevocable declaration is made to terminate the STOR contracts if awarded a capacity agreement. However, other capacity or balancing services such as fast reserve, firm frequency response, constraint management service and frequency control by demand management can be provided in conjunction with participation in the Capacity Market. Where this is the case the capacity provider’s obligation is lowered to take account of actions required under the relevant balancing services agreement. Whilst capacity providers are also free to participate in Triad avoidance, no adjustments take place in this case, so a provider would need to make a commercial decision about participating in both Triad avoidance and the Capacity Market.