Keeping the lights on
The Capacity Market is one of the main building blocks of the UK Government’s Electricity Market Reform (EMR) programme. Its goal is to ensure adequate capacity within an electricity system that in future will rely increasingly on intermittent wind and inflexible nuclear generation. But what is National Grid’s role in the Capacity Market and how will the process work? James Greenhalgh, EMR Stakeholder Manager, unpicks a complex topic.
Keeping the lights on
“The premise is that generators will benefit from a steady, predictable revenue stream (capacity payments) that encourages them to invest in new generation or to keep existing generation available on the system. They must deliver energy when needed or face penalties.”
As a whole, Electricity Market Reform is expected to reduce annual household electricity bills by an average of £41 (6%) over the period 2014 to 2030 (real 2012 prices), relative to achieving the same level of renewables and decarbonisation using existing policy instruments.
This is a timely moment to reflect on where we’re heading with EMR, and in particular the Capacity Market.
Subject to the final pieces of legislation being put in place, August sees the start of the pre-qualification phase of the capacity mechanism. This is the period when any generators who are interested in participating in the first capacity auction will register their interest, covering the generating units they will enter in the auction, and for which they will ultimately take on a ‘capacity obligation’.
Before explaining National Grid’s role in this significant mechanism, let me first offer a few words on the Capacity Market itself.
The Capacity Market
To deliver a supply of secure, sustainable and affordable electricity, the UK needs investment in new generation projects and innovative technologies. But we must also get the best out of existing assets on the network. The Capacity Market aims to deal with both these issues by bringing forward new investment while maximising our current generation capabilities.
Generators who are successful in the auction will benefit from a steady, predictable revenue stream (capacity payments) that encourages them to invest in new generation or to keep existing generation available on the system.
The capacity obligation means they must be available to deliver energy when needed or face penalties. At the same time households and businesses up and down the country will benefit from greater security of supply.
Subject to the legislation being finalised, the first auction will take place in December 2014. This will require capacity to be in place for the first year of delivery, which is 2018/19. Auctions will take place annually, four years ahead of the relevant delivery year.
National Grid’s role
Part of National Grid’s role is to carry out the detailed modelling and analysis that is used to inform DECC, so that the right decisions can be made on how much capacity needs to be bought in the auction process.
Essentially, that means understanding the total amount of installed generation needed on the network to meet demand plus a margin (the buffer between capacity and peak demand). But what sort of margin do we have and what’s the right capacity therefore to buy at auction?
To make these judgements, we rely on a mixture of our operational experience of running the network and also the insights gained through our Future Energy Scenarios work, where we consult widely to gain an informed opinion from right across the industry.
Our second area of responsibility is to run the mechanics of the auction process itself.
As I said earlier, the first part is the pre-qualification process for participating in the auction, whereby applicants are assessed against a set of rules that have been established by Government.
The auction itself will be a ‘pay as cleared’ auction, sometimes referred to as a Dutch Auction. The auction will start at a high price (capped by Government at £75/MW to protect consumers from excessively high costs). The auction price is then reduced progressively until the amount of capacity required is reached at the lowest price acceptable to bidders.
This cut-off point produces the cleared price, which will be the basis for capacity payments to all those successful in the auction
What about interconnectors?
There’s been quite a lot of debate recently about the role of interconnectors in the Capacity Market.
The current framework does not allow interconnection to play a part. However, the Government is keen for interconnectors to participate in future auctions and is currently looking at ways to accommodate them.
When we’re making recommendations about the volume of capacity to procure in the auction, National Grid’s view is that, while interconnectors cannot participate in the auction itself, a conservative view should be adopted about the level of capacity they would provide during times when the system is under stress.
Theoretically, if the UK energy system is under stress due to high demand and low supply, you would expect prices for energy to be higher in the UK and relatively lower in neighbouring countries, where the energy system might not be under stress.
Interconnected capacity should therefore naturally flow onto our system, but our operational experience tells us that this does not always happen.
Another relevant point is that there are also certain scenarios based around extreme weather where UK electricity demand might be high, but that would also be the case in mainland Europe too – placing stress on interconnected demand.
As always, it’s about striking a balance and, based on our substantial expertise, we believe that the recommendations we’ve made are as accurate as they can be
The Capacity Market focuses on ensuring security of supply while putting in place the right business environment to encourage investment.
National Grid is well placed to deliver the analysis needed by Government and to manage the auction process because of our operational experience and know-how.
All eyes now will turn to December and the start of a new phase in plans to make our electricity market fit for the future.