The European Commission has given the green light to a proposed UK capacity market that aims to ensure enough electricity is available to cover consumption at peak times. This is the Commission’s first assessment of a capacity market under new EU guidelines on energy and environment state aid that entered force on 1 July. The Commission says the aid is justified because it will contribute to the UK’s security of supply “without distorting competition in the single market”. But some stakeholders fear exactly the opposite is true and that it could spell the end of demand response, for example. Sonja van Renssen reports
First, a caveat: when the European Commission announced its decision to authorise the UK’s plan for a capacity market on 23 July, it did not publish the text of this decision. Nor indeed, of a second decision on the same day to authorise the UK’s proposed subsidies for renewables (Contracts for Difference); a decision on record subsidies for a new nuclear plant at Hinkley Point C remains outstanding. The text of the two state aid decisions of 23 July, taken at the last meeting of all 28 EU Commissioners in Brussels before the summer break, will only be published a few months from now, after confidential information has been removed. This means that any analysis of them must remain incomplete until then.
Specifically, what stakeholders want to know is what changes the Commission has requested to the UK’s plans in return for granting them the green light. Energy Post understands the UK has made some commitments. But what these are, will only be known once the decisions are published. Nevertheless, there is serious cause for concern, warn stakeholders including ClientEarth (an organisation of activist environmental lawyers), the Regulatory Assistance Project (RAP, a global, non-profit team of power and gas experts advising policymakers on energy and environment issues), E3G (an independent, non-profit think tank focused on sustainable development), the Smart Energy Demand Coalition (SEDC, representing the demand response industry) and campaigners WWF.
“In the name of energy security […] the UK is planning on providing illegal subsidies and preferential treatment to existing coal plants via the capacity market. The intention is to keep old coal in the mix into the 2020s, with consumers paying the bill for coal plants to upgrade to meet air pollution regulation.”
-E3G, 23 July 2014
If the Commission has not demanded adequate changes – and some of these stakeholders suspect it hasn’t – the UK capacity market decision could set a very bad example for future state aid decisions, warns Maria Kleis from ClientEarth. She and colleagues at RAP question the UK’s need for a capacity market and state aid at the level proposed; E3G and WWF criticise the open door to long-term subsidies for old coal plants that they say fly directly in the face of decarbonisation and do not represent value for money for consumers. Jessica Stromback from the SEDC says the plans will decimate the demand response industry.
“This is going to severely damage the demand response industry long term throughout Europe. Right away in the UK, I fear that several of the aggregators [companies who offer demand response services] will leave as of next year. This damages competition: if you do not own generation assets, you now cannot compete on an equal footing.”
-Jessica Stromback, Executive Director, Smart Energy Demand Coalition (SEDC)
The UK Plan
What is the UK proposing? Great Britain’s transmission system operator (TSO) National Grid (Northern Ireland is not part of the planned capacity market) will run annual, centrally-managed auctions for the level of capacity required to ensure generation adequacy – critics already say this should be “resource adequacy” to put demand on an equal footing with supply. Auctions will be open to new and existing generators, demand side response operators and storage operators, confirms the Commission. The UK has also committed to opening participation to new interconnectors from 2015, it adds. The whole scheme will run for 10 years.
The UK plans to hold its first auction in December this year, for 50.8 gigawatts (GW), to be delivered in 2018-19. Successful bidders will be required to provide capacity at times of stress on the electricity market, or face financial penalties. New generators would be eligible for a 15-year capacity agreement; others, a 1-year agreement, with the exception of existing generators requiring significant refurbishment – these could win 3-year or 15-year contracts if they spend at least £125/kW (€158/kW) or £250/kW (€316/kW) respectively. Or at least this is what all the publicly available information suggests. Energy Post understands however, that in reality only new generators would be eligible for 15-year contracts; refurbished plants would get 3-year contracts at most. In return for being on standby, successful bidders would get steady payments, the aid paid out as a function of the capacity they have to hand. The money will come from a levy on electricity suppliers.
“The UK capacity market embraces the principles of technology neutrality and competitive bidding to ensure generation adequacy at the lowest possible cost for consumers, in line with EU state aid rules.”
-Joaquín Almunia, Commission Vice-President in charge of competition policy
In its press release on 23 July, the Commission says that as required by its state aid guidelines, the UK “has only introduced the capacity market following a thorough investigation of its necessity and the potential for alternative measures”. Further, the market will be “open to a range of technologies, including demand side response and interconnection” and the use of auctions “should ensure aid granted is limited to the minimum necessary”. Growing demand for electricity and the imminent closure of much existing generation capacity create the case for a capacity market, the UK says.
But RAP and ClientEarth believe that the UK’s analysis of its generation adequacy problem is “probably incorrect”, ongoing balancing market reform discussions in the UK further mitigate the need for a capacity market as proposed, and that competition will be harmed more than is necessary. There are other, more appropriate solutions to security of supply, they suggest. More specifically, the two groups argue that the UK is overly pessimistic about peak generation availability, support via interconnectors and the potential contribution of demand response. The UK has also chosen a tough security of supply standard against which to assess the amount of capacity to be tendered, they say.
“We believe that DECC [the UK’s Department for Energy & Climate Change] have made the wrong choice and that the decision to introduce a market-wide capacity mechanism which will commit electricity consumers to underwrite 15-year contracts for capacity, is simply not supported by the available evidence.”
-RAP and ClientEarth
Starting with plant availability to cover peaks, RAP and ClientEarth cite evidence that actual availability is more than what the average data used by National Grid suggests; for example 92% vs. 85% for coal-fired plants. The data used by National Grid also covers the period since 2000, which corresponds they say, to a time when generators had no commercial incentive to maximise peak season availability. Such incentives can make a difference: combined cycle gas turbine (CCGT) availability is estimated at 85%, but the figure was over 96% for CCGTs in the PJM wholesale electricity market in the US where strong incentives to maximise peak availability exist.
Second, no electricity imports are assumed from continental Europe, despite recent and projected increases in interconnector capacity and the existence of emergency support arrangements with neighbouring TSO, the groups say. This denies the reality of the EU internal energy market – and threatens much-needed future investments in interconnection. European bodies such as ENTSO-E, which unites TSOs across the bloc, are at this very moment working towards regional resource adequacy assessments. “The proper coupling of intra-day and balancing markets, as mandated by the Third Energy Package, will only increase the statistical contribution to resource adequacy by cross-border interconnectors.” RAP and ClientEarth say. They argue that a final report by UK Electricity Market Reform experts supports their view. The experts stress that interconnectors should be treated identically to generators and that doing so could result in 2.6GW of imports.
Third, RAP and ClientEarth call the estimated demand side contribution to winter peaks “very conservative”. “Ample experience in other markets demonstrates it [demand response] could deliver as much as 10% of all capacity requirements at a far lower cost than new generation and at least as reliably.” Yet the proposed design for the initial capacity auction “seems almost deliberately to be designed to foreclose this”. Demand response is not due to participate in the December 2014 auction, with discussion of a set-aside of 400-900MW to be filled by it in subsequent auctions. This assumes a contribution of demand response of just 1% of peak demand, with no prospect of that changing any time soon because capacity contracts will be handed out for 15 years. Demand side bidders incidentally, can only bid for 1-year contracts. This adds up to 4GW of unnecessary new power plant investments, calculate RAP and ClientEarth, and raises the overall cost of security of supply.
“I am highly disappointed in this ruling. This is a rubber stamp approval of a subsidy for fossil fuel based generation assets. It damages small new entrant retailers who do not own these assets and it damages demand response. Worse, this structure is now likely to be copied in France, Germany and Poland.”
-Jessica Stromback, Executive Director, Smart Energy Demand Coalition (SEDC)
“In this instance, the European Commission is a judicial organ. Its decisions should therefore be based on legal considerations and in particular on state aid rules.”
-Maria Kleis, ClientEarth
E3G and WWF have singled out potential subsidies to coal plants for particular criticism. Just as the UK government announced it will not revise its 4th Carbon Budget, i.e. it will stick to its commitment to reduce emissions by 50% from 1990 levels by 2025, it also welcomed a new lease of life for coal plants from Brussels.
Coal plants will be able to win 15-year capacity contracts if they spend at least £250/kW (€316/kW) on upgrades, and 3-year contracts for spending £125/kW (€158/kW). This is a real possibility: Ratcliffe-on-Soar, operated by E.ON, recently spent £800 million (€1000 million) on refurbishments, WWF believes, enough to have won it a 15-year deal. Baroness Verma, the UK government’s energy spokesperson in the House of Lords, argued on 24 July however that in practice existing coal plants would not bid for 15-year contracts because the investment threshold is too high – similar to that for building a new plant. The carbon price will make coal uneconomic anyway in the 2030s, she added.
Nevertheless, around 10GW of old coal capacity could win multi-year capacity contracts later this year, E3G calculates. It labels these subsidies illegal because it says they would be used to upgrade the plants to meet air pollution standards coming into force in 2016 under the EU’s Industrial Emissions Directive. The EU cannot authorise state aid for companies to meet legislative requirements, ClientEarth’s Kleis explains – state aid can only go to companies that go beyond these.
“The capacity market risks pushing up bills and holding up progress towards a decarbonised power sector. it’s hard to believe that a country which has just reaffirmed its commitment to tackling climate change… is about to introduce a policy which could lock in vast payments to its oldest and dirtiest power stations until the 2030s.”
-Jenny Banks, energy and climate specialist at WWF-UK
“Specific restrictions on subsidies to existing coal plants are required to ensure coherence between objectives on climate change, energy security and the completion of the internal energy market,” E3G’s Chris Littlecott writes in his report. “Capacity mechanisms are emerging as a convenient wrapping that disguises recompense to generators as a means of addressing security of supply concerns.”
The news about coal comes just as a coalition of NGOs released a fresh report – Europe’s Dirty 30 – about how coal plants are undermining EU climate efforts. The UK and Germany rank top, with nine of the dirtiest plants each. Separately, Sandbag, a UK-based NGO focused on emissions trading, issued a report – Europe’s failure to tackle coal – showing that coal emissions rose 6% from 2010-13 even as power demand fell and there was massive investment in renewables. Renewables are displacing gas, that’s the problem. Coal today accounts for 18% of EU CO2 emissions, the same as road transport, Sandbag calculates. There is no carbon capture and storage (CCS) option on the horizon just yet and an emission performance standard (EPS) in the UK will only apply to new, not existing, plants. E3G asks: if a 50-year old coal plant effectively counts as “new” when it spends enough to qualify for a 15-year capacity contract, should it not qualify as new for the EPS too?
“The UK is the biggest offender, and unfortunately, the UK’s capacity mechanism is making it increasingly likely that coal is here to stay. Policy changes are needed, including most importantly the strengthening of the carbon market.”
-Dave Jones, Policy Analyst at Sandbag
There is logic to keep coal plants up and running however:
“For the UK, retaining in reserve some old coal capacity is an insurance policy against the failure of its nuclear ambitions. Carbon emissions are not affected, since this is already harmonised at EU level. Such flexibilities mean the UK wins time to optimise its system adequacy auctions, both for quality and quantity, and overall to develop a less lumpy strategy.”
-Mark Johnston, senior adviser with European Policy Centre
What the critics propose to relieve at least some of their concerns is that capacity contracts are limited to just one year. Fifteen years leaves very little room for any flexibility to adapt to changing circumstances or to give new, more innovative offerings such as demand response and interconnectors a chance to prove their worth.
Ideally, critics would have seen the UK go for a so-called strategic reserve rather than market-wide capacity mechanism. The former would have been smaller, more flexible and only deployed in emergency situations. In other words, the market would not have been affected in normal periods. The market-wide capacity mechanism proposed by the UK, on the other hand, effectively creates a new “capacity” product sold in parallel to the normal wholesale market for electricity. In its guidance on optimising public intervention in the internal energy market last November, the Commission warned against the potential high costs and complexity of such a mechanism.
“A strategic reserve… should be implemented in preference to market wide mechanisms unless there is clear evidence that they are unsuited to filling the identified adequacy gap. Mechanisms based on capacity payments should not be implemented as they do not ensure that the identified adequacy gap is filled and create significant risks of overcompensation.”
-European Commission, November 2013, internal energy market guidance
Everyone now awaits the final text of the 23 July decision on a UK capacity market. This is expected to be published in the autumn. What changes the UK has agreed to are crucial because this decision, being the Commission’s first on capacity markets under its new state aid guidelines for energy and environment, will set a precedent for how it handles others: Germany, France and Poland are next on the list with capacity plans to submit for approval. Poland in particular will no doubt take heart from the Commission’s stance towards coal in the UK plan, if that is indeed borne out in the final decision.
The implications of this first decision are momentous: for interconnectors, decarbonisation and demand-side innovation. The ultimate goal of a state aid decision is to promote competition. Critics argue that this decision may do exactly the opposite. Legal challenges look likely – from the demand response and renewables sectors and indeed consumers, who will have to fork out more for a reliable electricity supply as a result. The devil truly is in the detail and nothing less than the future of EU energy and climate policy is at stake.