Suspension of Britain’s capacity market creates the opportunity to focus on more cost-effective and forward-looking solutions for safeguarding the country’s security of supply, which are likely to leave the capacity market surplus to requirements.
At the Institute for Energy Economics and Financial Analysis, we have argued that Britain’s capacity market – which has served as a model for a similar scheme in Poland – may have provided an unnecessary windfall for energy incumbents, and principally existing gas, coal and nuclear power plants.
In a surprise ruling on Thursday, the European Court of Justice ruled that the European Union’s executive, the European Commission, had incorrectly approved the UK scheme in 2014, failing to investigate properly its impact on the wider energy sector.
The case had been brought by companies that reduce electricity demand at times of system stress – called demand-side response (DSR). They had argued that Britain’s capacity market unfairly favours providers of electricity generation over DSR.
Britain introduced the capacity market in 2014 to boost investment in the conventional UK energy sector, to provide back-up for rapid growth in wind and solar power, and to cope with expected rapid falls in coal generation, under coal phaseout plans.
The capacity market has provided an entirely new, regulated source of revenue for conventional power plants, as well as providers of storage, DSR and interconnection. Capacity markets sell – via auction – contracts to make capacity available months or years head of delivery, regardless of whether they actually generate electricity.
Under the UK scheme to date, there have been seven such auctions, awarding a total of £3.8 billion.
Combining the results of these seven auctions, 83% of contracts were awarded to existing generation, rather than new-build, and 72% were awarded to gas, nuclear and coal power plants. In other words, the scheme has favoured incumbents, supporting centralised rather than distributed generation, perpetuating the grid that already exists, and favouring generation over DSR.
But in the meantime, Britain has also carried out many other market reforms. I will mention two in the balancing market, where the grid operator the National Grid balances demand and supply in real time. First, participation in the balancing market will shortly be extended to aggregators of small-scale renewables and DSR, with as little as 1MW of combined capacity. And second, also in the balancing market, charges have been raised for electricity suppliers and power plants that fail to meet their forecast demand or supply.
These two reforms are different to Britain’s capacity market in three critical ways.
First, by focusing on matching short-term demand and supply in real time, they incentivise flexibility, a characteristic which will be the cornerstone of electric grids of the future.
Second, by operating via existing energy markets, they use energy price signals to drive efficiencies, in contrast to creating a new scheme and an extra cost, which is also passed to energy consumers.
Third, also by operating via energy markets, they will drive innovation, in an energy sector which is transforming rapidly, especially through digitalisation, to cope with distributed renewables and soon electric vehicles. Digitalisation will make both demand and supply more automated, local and connected – in a word more intelligent. We have seen rather little of such technologies rewarded, after four years of capacity market auctions, and £3.8 billion spent.
The UK’s energy ministry (BEIS) says that the new ruling has not affected its commitment to the capacity market, and that it will work to sort things out with the European Commission. It looks likely it will have to tweak the scheme to favour DSR, which could be a good thing depending how’s it done. Scaling back the scheme altogether may be better.