UK “capacity market” is not a market – it’s state aid (£1 billion/year)

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 photo National GridThe UK is the first country in the EU to have started a “capacity market”. Under this scheme, the UK government offers payments to electricity suppliers for making “backup capacity” available. The first auction, held in December for capacity in 2018/2019, has resulted in contracts for £931 million for UK power generators. According to Mike Parr, Director of energy consultancy PWR, most of this money is wasted. He says the scheme is overgenerous because it covers the entire 49 GW of capacity in the UK rather than just the 6 GW peak capacity that needs to be covered. It also fails to encourage new-build generation and demand response.

When is a market not a market? When it is a “capacity market” in the UK.

In December last year, the UK announced the results of its “Capacity Market” (CM) auction. The idea behind the auction is to ensure that the UK has enough generators connected to its power network to meet peak (winter) demand. A key intention of the auction was to encourage new build generation. A number of other EU member states are considering CMs and thus there is a lot of interest in what is happening in the UK. The CM was allowed by the EU’s competition authorities (DG Competition) in mid-2014 (on the basis that it is not state aid).

Winners of the auction were awarded contracts to provide a specific amount of power at 4 hours’ notice (for at least 4 hours) to National Grid, the national transmission system operator . The first auction covered the year 2018/2019. 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. Similar costs may be expected in the years thereafter.

Perverse result

The first question that arises is why the government auctioned for the entire power generation capacity the country needs rather than just the part it may be short of at any one time. Peak power demand in winter in the UK occurs between 1600hrs and 2100hrs weekdays. Power demand varies over a winter day between a low of 30GW (2300hrs to 0600hrs) and the evening peak of 49GW. During the day demand is around 43GW. The actual “peak” is thus roughly 6GW above day-time levels. As we will see, because the auction tendered for the whole of the 49GW and not just the peak element of 6GW, this produced a perverse result.

DECC needs to answer this question: “why did demand response get 1 year contracts and new generation capacity get 15 years”?

Of the 49GW of capacity procured, 44 GW 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). Furthermore, there are additional payments for producing energy.

The reason the auction attracted only small amounts of new build was because the final price (£19.4/kW) was low. The reason the price was low was 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.

Winners and losers

So who where the winners – and losers? EdF bid in part of its nuclear fleet (which would run anyway) and will be given roughly £150m in 2018 for doing what it would have done anyway (i.e. run its power stations). Drax, another large station, won £26m for doing exactly what it would have done anyway. The large utilities trousered around £698 million for doing what they would have done anyway.

Other winners included providers of STOR (Short Term Operating Reserve) services to National Grid. STOR is used by National Grid in time frames of up to 2.5 hours and has a 5 minute to 22 minute call-up time. Clearly, anything that can provide STOR is also able to meet the CM conditions. Key point: STOR providers now get paid both for STOR and for CM.

There were also some losers. Demand response got just 174 MW of agreements with one year contracts. According to the team of the Department of Energy and Climate Change (DECC) that set up the rules, the auction would be “technology neutral”. (Source: private conversation with DECC. See also this policy document.)

That being the case, DECC needs to answer this question: “why did demand response get 1 year contracts and new generation capacity get 15 years”? Both take time and effort to set up, neutrality should mean that both are equally rewarded.

DG Competition should have seen that a perverse result would happen with respect to the capacity market auction, given that DECC tendered for the whole 49GW and that all generators were allowed to take part

Other losers include the UK population. In 2018, each UK household will write a cheque for £15 (residential demand is roughly 33% of UK demand, there are around 20 million residential properties & 33% of £931m is around £310m) which will go mostly to generators that would have generated anyway.

DG Competition could have and should have seen that a perverse result would happen with respect to the CM auction, given that DECC tendered for the whole 49GW and that all generators were allowed to take part. The money being provided to the large generators thus looks like…. state aid, albeit it is the UK Tories volunteering the UK population to provide it. Was this a case of the European Commission pandering to the whims of UK Tories?

At this point it is worth noting that Ofgem (supposedly the UK “energy regulator”?) estimates that demand response could reduce UK peak demand on a winter weekday by up to 4.4GW. Notice how this is not far off the 6GW that constitutes real peak demand. Put another way, if 4.4GW of demand response was used plus the 2.6GW of new generation there would be more than enough generation to meet peak demand. Furthermore this would cost less than £130 million per year. The £15/year free gift from households to existing generators would then turn into roughly £2/year for funding a mix of new generation and demand response. This seems a reasonable amount to ensure that the “lights stay on” even when there is high demand.

Legal action

Tempus Energy, a UK-based provider of demand response services, has announced it will go to the European Court of Justice with a claim that the UK capacity market unlawfully prioritizes fossil fuel generation over demand response. If it wins, the hope is that the European Commission’s DG Competition will have to hold a formal inquiry into the UK CM. Given the perverse result, the question is, why has DG Competition not already, and on its own volition, re-opened the case?

All of the above raises a number of governance questions with respect to the UK’s ability to organise an energy policy focused on its subjects (known as citizens in other countries). It also raises the question, “was the CM deliberately designed to provide state aid to incumbents?” Given that DECC is 50% staffed by people seconded from power companies, and that these same power companies directly benefit from the auction, the conclusion is that DECC supervises the UK power industry for the benefit of power companies not UK citizens and that the UK’s CM is state aid.

Editor’s Note

Mike Parr is Director of energy consultancy PWR. He previously worked for one of the UK’s distribution network operators as a systems engineer running their network Merseyside. He then moved into industrial engineering running the services (and energy saving activities) at Sony’s Bridgend TV plant. In the late 1990s he founded PWR Consultants which undertakes research in the area of climate change and renewables for clients which include a G7 country and global corporations.

Comments

  1. Lyn Harrison says

    Great article. Very well said, Mike. And about time too. I have raged against the concept of capacity markets for the past couple of years as being an unncessarily expensive solution to a problem that does not exist when the facts are closely studied. Promotion of CM is little more than an attempt to keep legacy power generation assets solvent well past their sell by dates. There are better options. See: http://www.windpowermonthly.com/article/1218191/trouble-capacity-markets
    Since writing that particular investigative article I have been infuriated to see Eurelectric abandon its originally sensible position on CM expressed to me to be cajoled by its fossil members into pushing for a standardised CM market across Europe. Fossilised thinking.

    • says

      Thanks for the kind comments. I see the French have just signed into law a CM – although it seems ro be more focused on demand response – which is probably the first step to take before then funding more generation. In the case of Eurelectric, “well they would say that wouldn’t they” style of thing.

    • says

      Can I ask a naive question? Is there a role here for real public education? Most people, even environmentalists, have no idea when peak hours are. It may not change the very big picture but surely there’s a role for persuading people to turn off office equipment at the end of the working day and not doing their washing/drying/vacuuming on winter weekday nights? Our use of electricity now is a cultural/behavioural issue, not very sensitive to price changes. Could public education be a partial answer?

  2. Phillip Bratby says

    The long list of insanities of DECC carried out at the behest of Milliband, Huhne and Davey must be brought to an end: Climate Change Act 2008, ROC, FiT, CfD, RHI, strike prices, capacity mechanism, offshore wind, onshore wind, solar, AD, wave, tidal. The list of insanities is endless.
    The only solution seems to be to vote UKIP, who have a policy to get rid of DECC; the country will be much better off without DECC. We could then have a sensible energy policy.

  3. Stew Green says

    Demand Response might be me agreeing to turn down megapower furnaces for a couple of hours.
    I might be able to able to commit to one year. But who could commit to 15 years ? Especially in a market with Davey tinkering and DECC idiots. Most rational businesses will continue their move abroad. And then politicians will claim wow the UK CO2 is reduced. I wonder if people committing to 1 year contracts are in their last year of operation anyway.
    – In answer to : DECC needs to answer this question: “why did demand response get 1 year contracts and new generation capacity get 15 years”? Both take time and effort to set up.

    • says

      I think you misunderstand how DR works. Aggregators sign up companies and these contracts can vary, typically they would be for 5 years – perhaps more. The key word is “aggregation”. Doubtless, companies will come and go, but the aggregator remains and is the one responsible for delivering DR to NG.
      BTW, the UK has lower elec’ prices than Germany, almost no German companies have off-shored. Furthermore, energy prices are usually a small (less than 5%) element in a (manufacturing) company’s operations & thus are unlikely to be a significant factor wrt staying in the UK, or not.

  4. Oliver Duce says

    Good article overall. N.B error re. STOR
    STOR providers don’t get paid for both STOR and CM. Its one or the other i.e. STOR providers had to declare that they either did not currently hold, or would opt out of any existing STOR contract in order to qualify and bid in the CM auction.

    “Other winners included providers of STOR (Short Term Operating Reserve) services to National Grid. STOR is used by National Grid in time frames of up to 2.5 hours and has a 5 minute to 22 minute call-up time. Clearly, anything that can provide STOR is also able to meet the CM conditions. Key point: STOR providers now get paid both for STOR and for CM.”

    • says

      Thanks Oliver for the clarification. “STOR providers had to declare that they either did not currently hold, or would opt out of any existing STOR contract in order to qualify and bid in the CM auction” – my guess is that they will opt in and out as they see fit – Triads are largely predictable – I have no doubt that ditto NG declaring it needs capacity in Jan/Feb – opt out of STOR for those months, still bid for STOR in the others. I don’t blame them for doing this – btw – the problem is the way in which the system is implemented.

      • says

        Plutus is the company that is bidding to install two diesel and one gas plant in inner city Bristol. Their ‘Interim results for the six month period ended 31st October 2014′, published Jan 2015, states that they expect income from multiple streams – ‘a Power Purchase agreement, STOR revenue, Triad avoidance revenue, and potentially, from 2019, the capacity market mechanism’. They seem to expect to benefit from both STOR and CM.

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