Capacity Market results: keeping the lights on at lowest cost

Alex Harrison responds to the results of the Capacity Market auction in the midst of broad policy uncertainty and increasing emphasis on low cost security of supply.

The provisional clearing price of the second Capacity Market auction was announced this morning at £18/kW/year (in 2014/15 prices), securing 46.4 GW of capacity for 2019/20.

That compares to £19.40/kW/year (in 2012 prices) in the first Capacity Market auction last December, securing 49.3 GW of capacity for 2018/19 at a total cost of nearly £1 billion.

The result is not surprising (and nothing like the shock of last year’s outcome), with many forecasting a clearing price of around £20/kW/year, although it may come as a relief to those who had quietly wondered whether the auction would clear today instead at below £15/kW/year. What does the outcome tell us?

For the Government, the result will be evidence that energy policy is working and delivering security of supply at least cost to consumers.

Critics will argue that the auction was destined to produce a lower clearing price, with the capacity auctioned lower than last year (46.4 GW compared to 49.3 GW) and the supply available to meet that demand increased, for example, through 2.4GW of interconnector capacity (IFA, BritNed and Nemo) that was eligible and pre-qualified to bid into the auction for the first time. In the end, only 1.8GW of that capacity was successful, with Nemo missing out.

There are also those who view the auction as inherently flawed: for providing subsidies to generation that would be there anyway or that is already being subsidised; for allowing marginal cost existing plant to compete for subsidy against new build; and for failing to disqualify small scale embedded diesel and gas generation.

The results will also provide little solace to more than 11.3GW (20 per cent) of pre-qualified capacity (5.4GW of it CCGT) that was unsuccessful.

It is true that the first capacity auction was not a success for developers, with only 2.8GW (5 per cent) of capacity awarded to new build and Carlton Power’s 1.8GW Trafford CCGT project, the only large scale success, still to secure finance. That is hardly surprising given that the Government’s own estimate of the Capacity Market revenue required by a new entrant is still £49/kW/year, and many in the market viewing a clearing price below £35/kW/year as insufficient for new build. This year’s auction saw 1.9GW of capacity awarded to new plant, with Carrington Power’s 880MW CCGT the biggest success and 5.1GW of pre-qualified new build capacity losing out.

It is also true that the market appears to have cottoned on to the advantages of bidding small scale thermal generation into the auction, particularly when combined with the other sources of revenue potentially available to such plant, for example, through embedded benefits and National Grid’s short term operating reserve. A recent study by the Institute for Public Policy Research estimated that 375 MWs of new diesel generation was successful in the first capacity auction at a cost to consumers of £109 million. In this auction, 1.5GWs of diesel power pre-qualified, although it is not yet clear how much of that was successful.

In the wider context, the auction results sit alongside the apparent new dash for gas (with unabated coal set to be closed in 2025 and restricted from 2023), the cancellation of the CCS commercialisation competition, the withdrawal of LECs for renewable source electricity, the news that we are likely to miss our target of generating 15 per cent of energy from renewable sources by 2020, the withdrawal of subsidy support for onshore wind, the early closure of the Renewable Obligation (RO) to solar, the end to the grandfathering of small scale solar RO subsidy levels, the retrospective withdrawal of grandfathering for biomass conversion and co-firing subsidies, the mooted removal of pre-accreditation from small scale FITs and the indefinite postponement of both the second Contract for Difference auction and the announcement of the Levy Control Framework budget post 2020/21.

The majority Conservative administration has certainly been busy since it took office with the net result that the DECC energy trilemma is at risk of turning into a dilemma, with Government’s focus on lowest cost and security of supply pushing low carbon firmly down the agenda. The uncertainties in current UK energy policy are also not helping drive investment in the new build baseload capacity that we need to replace existing coal-fired plant.

The good news is we won’t have to wait another year for more excitement. The first ever Transitional Arrangements Auction, designed to facilitate the participation of Demand Side Response in the enduring Capacity Market, is scheduled to take place in January, with contracts awarded from October 2016. Watch this space!