Sifting carbon out of the Capacity Market

Utility Week policy correspondent David Blackman examines the government’s call for evidence on how the Capacity Market could be redesigned to sift out high-carbon fossil fuel generation and prevent it from being baked into the energy mix for years to come.

Labour’s shadow energy spokesman was withering in his assessment of the Capacity Market recently.

During a House of Commons debate in July, Alan Whitehead slammed the scheme for furnishing generators with “free money” to provide power they would have provided anyway.

It’s not the first pot-shot directed against the Capacity Market since its establishment by the coalition government in 2014 to ensure security of supply through upfront payments for reliable sources of electricity.

The most serious challenge occurred three years ago when a European Court challenge by Tempus Energy triggered the scheme’s temporary suspension. The brought by the demand-side response aggregator was prompted by its concern that the scheme unfairly favoured fossil fuel plants.

While that particular case ultimately went nowhere, decarbonisation concerns were a key factor behind the publication last month by the Department for Business, Energy and Industrial Strategy (BEIS) of a new consultation paper setting out its thinking on the future of the Capacity Market.

Marlon Dey, GB head of research for consultancy Aurora, says the Capacity Market’s structure is increasingly out of kilter with the UK’s ambition to decarbonise its power supply.

“To date the capacity market has procured and brought forward primarily carbon intensive capacity to guarantee security of supply: it has been predominantly gas,” he says.

Dey points out that the Capacity Market is already locking in about 7GW of flexible gas generation into the 2030s, of which around 3GW is contracted post-2035 when the government has said unabated gas should be phased off the grid.

He says: “If the status quo continues, it will jeopardise our ability to hit net zero. If there is no action, we will continue to procure capacity that is not compatible with net zero.”

The “enormous” proportion of gas in the capacity market means that it is “not aligned to net zero, says Jill Cox, balancing services manager at Flexitricity.

This all adds up to a “very strong need” to reform the capacity market, says Dey: “The direction of travel is very clear that the capacity market has to be reformed so it doesn’t continue to procure unabated gas beyond 2035.”

In addition, the Capacity Market’s role to ensure security of supply will grow during the next two decades as the UK becomes increasingly reliant on more intermittent wind and solar power.

The BEIS call for evidence said around 20GW of existing baseload capacity is expected to retire over the next ten years. Dey points out that is mainly nuclear and gas generation.

This gap is unlikely to be filled by hydrogen and plants fitted with CCS (carbon capture and storage), given the relatively immature nature of both these technologies, which are the main low carbon but ‘firm’ options for providing power, he argues.

The BEIS paper set out the balancing act facing the Capacity Market. The mechanism’s first “immediate challenge” is to help less carbon intensive but still evolving technologies to come forward.

The second is continuing to support more carbon intensive forms of capacity, such as unabated gas, which the paper says will continue to play an “essential” role in maintaining security of supply as its economics become “increasingly challenging”.

How gas plants compete economically in an environment where cheaper renewable prices dictate the market much of the time cannot be ignored, says Tom Edwards, senior modelling consultant at Cornwall Insight.

“There will be periods of low prices so any power station reliant on base load will require some other form of support otherwise it will be switched off.

“Assuming that the underlying market doesn’t change, the Capacity Market becomes more important.”

One of the key solutions suggested in the paper, which is a call for feedback on ideas under consideration rather than a formal package of proposals, is to run dedicated auctions for low carbon capacity. These would run before the main Capacity Market auction with low carbon capacity permitted to qualify for both exercises.

Once the first auction has been run, any low carbon capacity that has failed to net a contract would be able to enter the main one. The paper suggested that running this twin auction process would boost the market’s potential liquidity and encourage competition

The paper said the target in the low carbon auction could be ratcheted up as lower carbon technologies, such as CCS-enabled gas and hydrogen-fired generation, become more widely deployable in the late 2020s or early 2030s.

The scope for “significant” competition in the low carbon auction could result in lower clearing prices for capacity secured through this avenue, the call for evidence explained.

Edwards says these two types of auction will spur the bringing forward of low carbon technologies through the Capacity Market.

“They are essentially trying to redesign the Capacity Market so that they can guarantee the procurement of low carbon capacity,” says Dey.

“For the government to even propose something like that is radical,” says Cox.

The document also shows the government is wary about being locked into long term capacity contracts, which can currently last as long as 15 years, notes Edwards.

The problem identified by the government is that keeping existing maximum capacity market agreement lengths could soon mean committing to supply, which will then be baked into the mix in the 2040s.

This could mean up to 10 to 20GW of new build unabated gas still on the system, which would be “detrimental” for the wider decarbonisation agenda, the BEIS paper warned.

Edwards says: “They are clear that they want to move away from 15-year agreements because they think there is going to be lot of spend down the line. There is a lot of concern about locking in infrastructure.”

The paper suggested that eligibility for 15-year capacity market agreements could be limited to “very low or zero carbon” types of capacity, such as renewables, storage, demand side response, CCS-enabled gas, and hydrogen fired generation.

But while the government is tightening the agreement lengths, it is looking at giving developers more leeway when bringing forward capacity market infrastructure.

Under current rules, the capital expenditure for new build capacity market units must be completed within six and a half years of the day when the auction is announced. The paper said the time this clock start ticking could be postponed until the start of the first year for delivering the project.

Longer lead in times for projects could provide an additional spur for CCS, hydrogen and pump hydro storage projects, says Dey. The latter in particular take a long time to plan and build, which is difficult to accommodate within current the capacity market’s existing timeframe.

In line with this, the government said it intends to review the Capacity Market to ensure that technologies such as new build pumped hydro storage can continue to compete in the market with no unintended barriers to entry.

However, BEIS expects carbon intensive capacity, such as unabated gas generation, will be required over at least the next decade until “alternative” forms of low carbon dispatchable generation are more widely available.

It envisages that the job for gas-fired plants will be to provide capacity to help guarantee security of supply at peak times.

And the paper suggested unabated gas plants may be allowed to continue to access long multi-year agreements if their running hours are restricted in line with an annual cap on emissions.

Edwards suspects that the upshot could be some form of annual emission limit for units participating in the Capacity Market rather than the current system, which bases eligibility on the CO2 emissions produced per kilowatt hour of electricity generated.

The document stated that it could be possible for unabated gas plants to be treated as low carbon capacity if only runs occasionally, such as five per cent of the time.

“As long as the load factor is below a certain percentage, it will be below that,” says Edwards.

He believes that some form of emissions cap will be a feature of a new look Capacity Market alongside shorter agreement lengths.

Edwards says investors’ appetite for the Capacity Market will depend on whether they prefer to take the financial guarantees it offers or gamble on securing very high per kilowatt-hour prices during those short periods when supply is scarce.

But Flexitricity’s Cox believes that the latest paper marks progress. She says: “In the main it’s very good for the Capacity Market and is long overdue. It’s a step forward without a doubt.”