Post mortem on the first capacity market auction

Lis Blunsden gives her take on the effectiveness so far of the UK’s young capacity market.

“Whether a mechanism which provides payments to existing generators, that would almost certainly have been generating anyway, for remaining on the system during system stress events is effective to address security of supply concerns will not become apparent for a few years.”

The final results of the capacity market auction were published on 2 January 2015, 8 working days after completion of the December auction. 

The first delivery period for capacity does not start until winter 2018, but there are certainly some initial conclusions that can be drawn from the information published by the EMR delivery body (National Grid) in its final results report.

It is worth revisiting the stated aims of the capacity market at this stage.  This is the description on the DECC capacity market web page:

“The capacity market will ensure security of supply by providing a payment for reliable sources of capacity, alongside their electricity revenue, to ensure that they deliver energy when needed.  This will encourage the investment we need to replace older power stations and provide backup for more intermittent and inflexible low carbon generation sources.” (emphasis added).

As discussed in previous articles the essential obligation under the capacity agreements awarded under the auction process is to deliver capacity to the system at periods of greatest system stress, with non-delivery resulting in financial penalties. 

The level of capacity available under the first auction was set by DECC at 48,600 MW, and the auction was oversubscribed. Of the plant awarded a capacity agreement, the greatest proportion (by capacity) of stations receiving a capacity agreement are existing thermal and nuclear stations, with existing CCGT comprising 45 per cent by capacity alone. This suggests that, assuming no unforeseen breakdowns or extraneous events between now and winter 2018, the first year of the capacity market will indeed provide a reliable chunk of capacity when the system is stressed. 

Of course this particular capacity market is not designed to provide a reserve on which National Grid can call for additional capacity at times of stress, so the issue of tight capacity margins has not necessarily been addressed during this process. Whether a mechanism which provides payments to existing generators, that would almost certainly have been generating anyway, for remaining on the system during system stress events is effective to address security of supply concerns will not become apparent for a few years. The majority of existing plant receives a one year capacity agreement under the scheme (or three years if qualifying refurbishment works are being carried out) and will have to participate in the annual rolling Y-4 auctions for yearly capacity agreements.  As the years progress and existing plant is retired the generation mix will inevitably change, but right now it is difficult to predict how that change will affect the market as a whole. 

This leads, loosely, to the second stated aim, the replacement of older power stations with new technology.  The replacement of old technology with new is a central plank of the modelling used to design the capacity auction, due to the role of the Cost of New Entry or CONE. 

The CONE was calculated by DECC at around £49/kW prior to the auction (this figure represents the cost of new entry for a new build CCGT, net of energy revenues) and is used to set the auction price cap, at 1.5 times CONE. This resulted in an auction cap of £75/kW, but the auction eventually cleared at £19.40/kW, around 40 per cent of CONE. 

During the auction process, which used a descending clock model, significant volumes of new capacity withdrew from the process as the price fell. Eventually only one new build CCGT obtained a capacity agreement.

The statistics provided by the delivery body in its final report show that new build generating units were the largest group of capacity exiting the auction but do not break down the new build by size of generating unit, or technology. However, further review of the data from the delivery body website shows that of the new build generation that exited the auction, just over 85% of that capacity was comprised in the 11 auction participants bidding in new build generation with a capacity over 50 MW, the greater proportion of which (in capacity terms) were new build CCGT.

Smaller units in the 20–50 MW range were, broadly speaking, equally divided as to those that obtained a capacity agreement and those that withdrew from the auction, whilst the smallest units show far more units getting capacity agreements than not. This is perhaps not surprising, but given that the clearing price of £19.40/kW/year would provide a 400 MW new build with around £8 million a year, there is clearly little incentive to developers of large scale CCGT to enter into a capacity agreement, given the potential financial consequences of non-performance. Certainly the ability to obtain a capacity agreement is not of itself sufficient to ensure that new build development will take place.

Whatever one’s view of the final results, the capacity market is very much in its infancy, and previous experience in other markets tells us that the rules will develop and change as the market itself develops – indeed DECC had already issued consultation documents about changes to the rules even before the initial auction took place.