Result of Capacity Market auction shows the need for reform

Result of Capacity Market auction shows the need for reform

It was anticipated by most commentators that the price would be lower than the £22.50/kW clearing price of the 2016 T-4 auction, with the smart money on £15/kW or thereabouts. The eventual clearing price of £8.40/kW therefore came as something of a shock.

As well as the low clearing price, the auction result was also notable for how few new-build generating plants were successful. Of the 50.41 GW of capacity awarded a contract, only 762 MW comprised new-build generation. The bulk, over 43 GW, went to existing generating capacity. The technology that received the greatest amount of capacity was CCGT with 23 GW; whilst nuclear received 7.9 GW. Battery storage received only 153 MW (despite having 1.5 GW prequalified).

At first sight, this latest CM auction looks to have worked well by producing a bargain clearing price delivering fantastic value for money, and the Government will be pleased. However, the fact that the auction delivered such a low number of new-build plants should be a real cause for concern. The purpose of the CM T-4 auctions is not only to provide available capacity for the particular year four years ahead, but to encourage new build capacity.

As the former Coalition Government stated in the White Paper which was the basis of the Electricity Market Reform (EMR) that established the CM:

Around a quarter of our existing capacity – mainly coal and nuclear power
stations – will close in the next decade. Keeping the lights on will mean raising a record amount of investment…That investment must build an electricity system fit for the future.

The real problem with the T-4 auction is that it comprises a single auction in which all types of bidders bid for the same pot of GW capacity regardless of whether they are new-build, existing generators, refurbished generators, interconnectors or the other permitted categories of bidder. In a nod to the fact that new-build generators will need a return on the investment in capital expenditure, the contracts are for fifteen years compared to three years for refurbished generators and one year for existing generators. But the longer period doesn’t help if you can’t get a contract because the price is too low.

If the CM is not working to deliver new-build generating capacity, how best to fix it? One solution would be to look at the other part of EMR, namely Contracts for Differences (CfDs), the subsidy system which was introduced for renewable energy. In the case of CfD auctions, it has been explicitly recognised that different technologies need to be kept apart. Thus, in the first auction, less-established (and thus more expensive) technologies, such as offshore wind, bid in a different pot to established (and cheaper) technologies such as solar and onshore wind. The CFD auction rules also permit the creation of a discrete pot of money for specific technologies which need additional protection, for a minimum number of MW (known as “minima”).

The principles underpinning the CfD auction could be applied to the CM; thus there could be a separate pot of GW capacity made available specifically for new-build generators. There could be some mixing of bidders, e.g existing generation and interconnectors would seem logically to go together because there is no need for the bidder to incur capital expenditure in either case.

The need for reform is clear. Without it, there is a clear risk that new generating capacity will not be built to replace the plants that will be decommissioned in the next decade. Ofgem’s preferred option has been to encourage large-scale CCGT. This was the driver behind the decision last year to cut triad avoidance benefits to embedded generators which, in Ofgem’s view, unfairly favoured small-scale generators in the CM auction at the expense of large CCGT plants. Ironically, it is clear from the current auction that not only has this action not provided any benefit to new-build CCGT, it has made the economics of small-scale generation less attractive and thus compounded the problem of lack of new-build capacity.