Capacity market has failed to deliver flexibility, says think tank

Mechanism should be "repurposed" to target flexible new-build capacity

The capacity market has failed to deliver flexibility and reliable new-build generation, a new report by the Institute for Energy Economics and Financial Analysis (IEEFA) has argued.  

Existing generation should be exiled from the mechanism and support reserved for flexible new-build capacity, according to the think tank.

“While the goal of the capacity market was to drive investment in reliable new generation, the scheme—with £3.4 billion in awarded contracts to date—has yet to incentivise a single large new power plant,” the report said.

“This support for existing generation is distorting energy markets and has subsidized outdated investment, including more than £450 million for existing coal-fired power plants.”

This was despite government intervention to increase the volume of new generation contracted by raising the procurement target in the most recent four-year-ahead (T-4) auction.

“The enlarged T4 auction took place in December 2016, but achieved only a tiny increase in new generation as a proportion of the total contracted capacity, from four per cent to seven per cent,” the report said. It noted that the only new build combined-cycle gas turbine to secure a contract was a 370MW replanting of an existing power station in King’s Lynn.

The government should instead “repurpose” the capacity market and hold “smaller, targeted capacity auctions solely for flexible, new-build generation, including gas peakers, demand-side response and storage”.

Britain’s departure from the EU provides an ideal opportunity for such reforms as “there will be less need to achieve EU state approval for auctions that support particular technologies”. 

The think tank said this would reduce both market distortion and consumers’ energy bills. “A strategic reserve of ageing power plants”, similar in nature to the supplemental balancing reserve, could be retained as a last resort.

The report drew attention to the “missing money” problem, whereby subsidised renewables will “near-zero marginal costs” suppress prices in the wholesale and balancing markets. It said the capacity market threatens to distort energy markets further by “suppressing peak demand price signals”.

To resolve the issue, it said there should be continued reforms of the balancing market to boost price signals by ensuring “sharper passthrough” of the balancing costs incurred National Grid.

“Such reform would bolster energy markets by strengthening the price signals that drive investment, driving market participants to invest in flexibility themselves — a more efficient approach —and thus help avoid the large-scale government intervention implied in the capacity market,” said IEEFA energy finance consultant Gerard Wynn.

He added that this approach has been successfully demonstrated in the US, “where some electricity systems are delivering a rapid, low-carbon transition without the need for capacity markets.

“These competitive markets are successfully managing the transition from coal to renewables, while the number of scarcity hours has decreased dramatically.”