UK’s Capacity Market Lining Energy Industry Pockets

The UK’s capacity market is seeing the consumer paying existing power companies unnecessarily for peak demand power.
Published: Tue 08 Sep 2015

The UK’s capacity market scheme is said to be over-generous and it is not encouraging new generation and demand response.

The UK is the first country in the European Union to have established a capacity market which means that the UK government offers payments to electricity suppliers for making “backup capacity” available.

The first auction, held in December for capacity in 2018/2019, resulted in contracts for £931 million for UK power generators. But, there are concerns that the scheme is over generous since it covers an entire 49 GW of capacity in the UK instead of just covering the necessary 6 GW peak capacity.

The idea behind the capacity market auction was to ensure that the UK has enough generators connected to its power network to meet peak (winter) demand. A goal of the auction was to encourage new build generation. Auction winners were awarded were awarded contracts to supply specific amounts of power in a four hour notice for at least four hours to the UK’s national transmission system operator National Grid.

The capacity market was allowed by the EU’s competition authorities (DG Competition) in mid-2014 (on the basis that it is not state aid). But, the UK capacity market is considered today to be a £1 billion state aid.

The government wanted commitments from 49GW of power generation which corresponds to the forecast maximum demand in the UK in 2018/2019. The auction resulted in a price of £19.4/kW. The cost (to electricity rate payers) will be about £931 million for 2018/2019.

Peak power demand in winter in the UK is between 4pm and 9pm during the weekdays. Power demand varies over a winter day between a low of 30GW (11pm and 6am) and the evening peak of 49GW.

During the day, demand is around 43GW. The actual “peak” is roughly 6GW above day-time levels.

Capacity market failures

Because the auction tendered for the whole of the 49GW and not just the peak of 6GW, this produced a distorted result.

Of the 49GW of capacity procured, 44GW already exists and has been signed up under one-year contracts. A further 3.1GW of existing capacity was contracted under 3 year contracts. 2.6GW of new capacity won 15-year contracts, thus getting £684 million over the term of the contract (i.e. not just for 2018/2019, but over 15 years). There are also additional payments for producing energy.

The auction attracted only small amounts of new build was because the final price (£19.4/kW) was low.  Why the low price? Because any generator could bid and because DECC decided it wanted to have the whole 49GW block bid for – not the part that was the peak above the normal winter daytime demand.

Auction winners include EdF in part for its nuclear power which will supply £150 million in 2018 for doing what it usually does and that is, simply run its power stations.

Drax, a large coal station in North Yorkshire, won £26 million for doing exactly what it would have done anyway.

Other winners include providers of Short Term Operating Reserve (STOR) services to National Grid. National Grid uses this power supply in time frames of up to 2.5 hours and has a 5 minute to 22 minute call-up time. STOR providers now also get paid for both STOR and capacity market.

Large utilities made off like bandits since they basically pocketed approximately £698 million for going about their day to day operations.

As a result, UK consumers will find themselves out of pocket unnecessarily as a result of this auction. In 2018, each UK household will pay £15 which will go to generators that would have generated power anyway.

Demand response pushed aside

What’s interesting is that Ofgem, the UK energy regulator, estimates that demand response could reduce UK peak demand on a winter weekday by up to 4.4GW. However  demand response received just 174MW of the agreements with one year contracts. The auction was supposed to be technology neutral according to DECC but while demand response got 1 year contracts, new generation capacity received 15 years. Both take time and effort to establish. So, 4.4GW of demand response and 2.6GW of new generation could have provided sufficient  generation to meet peak demand. This would have cost consumers less than £130 million per year. This means that the customer would have written a cheque for roughly £2/year instead-a more reasonable amount for peak demand power overall.

The government is to hold a separate demand-side response auction for a mere 1.5 GW in January 2016, which will pay offices and factories to reduce electricity use during the winter of 2016/17.

Tempus Energy, a UK-based provider of demand response services, has already threatened to go the European Court of Justice in response to the fact that the UK capacity market is prioritising fossil fuel generation over demand response.

One has to ask whether the capacity market was established to provide state aid to incumbents in the power sector. It seems as if the capacity market is benefitting the power companies at the expense of the UK consumer.

Britain's second capacity market auction will be open to companies in continental Europe as well as domestic suppliers. The auction will take place in December and seeks to secure 45.4 GW of electricity for the winter of 2019/2020. It will be interesting to see who is awarded this time around.