The Capacity Market (CM) is the UK government’s primary policy for ensuring that future electricity supply is secure. However, a recent EU court ruling led the scheme to be suspended and has raised questions about its future.
How the CM works
The CM was introduced in 2014 as part of a wider government reform package called the Electricity Market Reform, which aimed to tackle the UK’s “trilemma” of providing secure, low-carbon and affordable energy. The scheme offers payments to power generators for being available to generate at certain times, and to demand-response providers for being able to reduce their electricity usage to help balance the grid.
The idea behind the CM is to provide payment to generators of reliable sources of capacity, alongside their electricity revenues, to ensure that they deliver power when needed, and encourage investment to replace older power stations and provide backup generation as more intermittent renewables come online.
The CM involves annual auctions for capacity to be delivered in four years’ time, known as T-4 auctions. There are also T-1 auctions for any extra capacity for the coming winter not secured via T-4 auctions. The amount of capacity that is needed is decided by the government based on recommendations from the National Grid. Prospective generators bid into the auction at the price they need to remain open to generate power, or to be built from scratch in time to generate for the specified time period.
Those that can offer the lowest price are then selected until the estimated amount of future capacity required is met. Auction winners must then deliver against their obligation at any time of system stress during the specified delivery year or face a financial penalty.
The CM auctions that have taken place have largely benefitted existing plants, helping them to continue running, rather than supporting new types of generation.
Results for the T-4 auction for 2021-22 were announced in February 2018 with just 762MW of new generation winning agreements of more than 5GW in total. It also cleared at a record low price of £8.40/ kW compared to £22.50 the previous year. Although this lowers energy bills in the short-term, it sparked fears within the sector that the CM was not sending a strong enough price signal to encourage developers of new, cleaner capacity.
However, the scheme was suddenly put to a halt on 15 November 2018. CM auctions and payments were immediately suspended following a ruling by a European court after a case was brought by flexible energy company Tempus Energy. It claimed that demand-side response was treated differently to conventional generation in the auctions and the court ruled that the European Commission had failed to launch a proper investigation into the CM when it cleared the scheme for State Aid approval in 2014. The government said that the ruling did not call into question the design of the CM itself and that and that it would therefore aim to “take forward what we think is a capacity market structure that works”. It added that it was confident that capacity needed for winter 2019-20 was already in place.
On 6 December the government released an update, reporting that National Grid would continue to operate the scheme, despite a suspension in the payments to generators. The update said that this will “ensure that capacity providers may be eligible for deferred payments after the standstill period (subject to State Aid clearance)” with “additional actions” to be taken to “explore continuity” in supplier charging arrangements.
No payments to CM agreement holders will be made while the scheme is suspended and suppliers will not have to recover the Capacity Market Supplier Charge (CMSC) levy from customers. The amount of CMSC originally scheduled to be recovered from all suppliers, based on the CM agreements already in place, amounts to £1.1bn for the 2018-19 delivery year, significantly higher than the revenue collected for the previous delivery year as the auction for the bulk of the CM agreements for 2017-18 delivery cleared at £6.95/kW (for 54.4GW), compared to the £19.40/kW (for £46.7GW) in the T-4 auction for the current delivery year.
In light of this, a government spokesperson told The Times that as “we are no longer taking payments from suppliers for these costs, we’d expect suppliers to do the same when it comes to consumers’ bills.” Energy UK said suppliers would look to see where possible cost reductions are passed on, but also cited rising wholesale prices as a potential hurdle. In a consultation published on 17 December (see p.13), the government proposed to provide deferred payments for capacity providers and is assessing options to collect the supplier charge during the standstill period to avoid price spikes when the scheme comes back into effect.
Possible next steps
Following the suspension of the scheme, the government sought approval from the European Commission to run a “one-off ‘replacement” T-1 auction to cover 2019-20 during summer 2019 and said it planned to run the scheduled T-4 auction as a T-3 in next year’s auction round. It added that it was working with the commission to reinstate the “full CM regime” as quickly as possible – aiming to gain State Aid clearance in early 2019. The Renewable Energy Association (REA) welcomed the clarification, but described the plans to commence the interim T-1 auction in summer as “challenging”. Though the REA considers the CM to unfairly favour fossil fuels, it said that it should remain in place for existing projects in the immediate term.
Speaking at a Parliamentary Renewables and Sustainable Energy Group (Praseg) meeting on 11 December, Founder and CEO of Tempus Energy Sara Bell said that CM auctions would have to be re-run. Recorded on Twitter by Praseg, Bell added: “It is not going to be possible to reinstate the contracts […] the government needs to be honest about that.” Chief Executive of Energy UK Lawrence Slade on the other hand said that, although it was not the “perfect solution”, the CM was capable of evolving and that the government was willing to make the necessary changes to make the scheme work.
While supply is secure this winter, questions remain looking ahead and both generators and energy users will hope for a swift decision on the CM’s future.