Optimised Capacity Market and revamped CfDs backed to decarbonise grid

A revamped Contracts for Difference (CfD) model alongside an “optimised” Capacity Market have been deemed as a better way of progressively decarbonising the grid than big bang options to decouple low carbon and fossil fuel generation in the wholesale market.

As revealed by Utility Week, the government has axed proposals for market decoupling, which would split the wholesale market in two and end the current situation whereby volatile gas prices effectively set the marginal price of electricity on the grid.

The move has now been confirmed within the second consultation document of the Review of Electricity Market Arrangements (REMA).

Among a number of narrowed down options, the follow up to 2022’s initial REMA consultation exercise says that the Capacity Market is being retained as the “primary mechanism” for ensuring adequate capacity in the electricity system.

However, the paper says the government will implement shorter-term reforms to “optimise” the Capacity Market by introducing a minimum procurement target into auctions to bolster investment in low carbon flexible technologies.

The REMA paper says all low carbon flexible technologies receiving bespoke support will be kept under review until the government has confidence that they are able to compete in an optimised Capacity Market, which in the long-term should become the primary scheme for supporting a competitive mix of technologies.

The paper also outlines a range of options for reforming the CfD scheme.

Proposed reforms to the CfD include moving away from the current system of payments based on output.

The paper proposes new deemed or capacity payments in CfDs, based on renewable assets’ potential underlying generation.

It says that proposals outlined in the original REMA consultation to introduce a strike price range and a revenue cap and floor for CfD assets have both been discounted.

The strike price range has been ruled out because it would introduce “significant extra risk” for developers with potentially limited benefits for the wider electricity system.

The paper adds that introducing a revenue cap and floor into the CfD for renewables could lead to “significant gaming risk” or distort generators’ incentives to operate efficiently.

However, the paper stops short of putting forward preferred reforms of the CfD on the grounds that these will need to be taken in conjunction with wider decisions on REMA.

Other moves announced in the REMA second stage consultation include:

• Retaining marginal pricing across the wholesale market
• Discounting options to split the wholesale market or establish a Green Power Pool to separate prices for low carbon and fossil fuel generation
• Ensuring a ‘limited’ amount of new gas capacity in the immediate term because it is the only mature technology capable of providing sustained flexible capacity whilst low carbon long duration alternatives, such hydrogen, scale up
• Strengthening locational signals in the wholesale market, with options including introducing zonal power pricing, reforming network charges and access arrangements, and introducing locational elements to the Capacity Market or CfD schemes
• Ruling out a reorientation of the wholesale market around local, distribution-level markets