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London — The UK government has opened a review of the Capacity Market to ensure the policy remains fit for purpose five years after introduction, it said Wednesday.

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While the market was "broadly working as intended," the government is considering proposals on two priority issues: Participation of non-subsidized wind and solar; and the treatment of interconnectors.

Participation of wind and solar could increase competition, auction liquidity and value for money for consumers, but unlike other technologies currently in the CM, they are non-dispatchable, the government said.

This raised unique challenges, potentially requiring a revised methodology on the de-rating wind and solar, and changes to the treatment of hybrid projects and on the penalty regime, it said.

De-rating factors reflect how "firm" or reliable capacity is. The lower the de-rating factor (expressed as a percentage of gross capacity), the less National Grid considers a source can be relied on in times of system stress. To reflect this, that source can only bid that percentage of its available capacity into the auction.

The government would have to consider whether arrangements "remain robust to ensure security of supply as increasing amounts of renewables come online and enter the CM," it said.

Hybrid projects (e.g. wind or solar twinned with storage) could offer real advantages on this front, but again would require changes to the legislative framework and consideration of de-rating methodology.

Finally, stronger penalties may be needed in the market to encourage effective secondary trading strategies, as well as encourage renewable developers to consider hybrid projects, it said.

On interconnection, the government said it had already taken account of market feedback when setting de-rating factors for capacity auctions this winter -- but the CM review offered the opportunity to go further and look at the de-rating methodology itself.

Market participants argue the contribution to security of supply made by new interconnectors will diminish as the amount of interconnection on the system grows, and as an increasing regional contribution from renewables made stress events across interconnected markets more likely.

Market conditions had changed since interconnector participation in the CM was introduced in 2015, the government said.

Other EU member states had introduced capacity mechanisms with different penalty regimes, raising concerns of the "double-commitment" of interconnectors during correlated stress events.

"We will consider whether to make changes to the de-rating methodology for interconnectors in order to ensure that interconnectors are not over-compensated relative to their real contribution to security of supply," it said.

If necessary, proposals would be brought forward for consultation later this year, ahead of the auctions in winter 2019/20.

Since 2015 the amount of interconnection with CM agreements has increased from 1.6 GW of de-rated capacity in the 2015 T-4 auction, to 4.6 GW in the 2018 T-4.

The Department of Business, Energy and Industrial Strategy had already moved to limit the success of interconnection in the next CM auctions, with the biggest losers the 1 GW NEMO interconnector to Belgium, heading for operation in Q1 2019, and the operational 1 GW BritNed link to the Netherlands.

NEMO's de-rating factor was cut by 25 percentage points to 50%, while BritNed's was cut by 33 percentage points to 43%.

"These lower values are driven by the tightening of margins across Europe as coal and nuclear plants close," National Grid said in a report to BEIS ahead of confirmation of the cuts. "These countries all have good interconnection with Germany, which plans to phase out their remaining nuclear reactors by 2022."

The mothballing of gas plant was an additional factor in the de-rating of BritNed, it said.

"Interconnection cannot be relied upon in the same way as domestic generation, as interconnector owners do not have control over dispatch and power will simply flow to where the price is highest -- which could lead to unnecessarily high costs to UK consumers," RWE Supply and Trading's chief commercial officer Tom Glover told S&P Global Platts earlier this summer.

Imported power is exempt from paying the UK's carbon price support, unfairly disadvantaging domestic generation, Glover said.

"GB plants are being pushed 'out of the money' by interconnectors," he said.

RWE wants to build a 1.5 GW gas-fired power station at Willington, Derbyshire. The project was pulled from the last T-4 CM auction ahead of clearing. The auction cleared at GBP8.40/kW/year. New combined cycle gas plants are thought to need at least GBP25/kW/year before commercial financing is seen as viable.

National Grid Ventures, Grid's commercial arm that develops new interconnectors, has pushed back on suggestions that interconnection is less valuable to security of supply than currently calculated.

"The right level of interconnection makes it easier to manage the system by providing a flexible and efficient source of energy while also allowing generators in this country to make money by exporting to the continent," it told Platts in late May.

In a recent interview with Platts, Sam Wither, the chief commercial officer of UK Power Reserve, a new entrant generator building distributed generation and storage, said the mechanism "had shown itself to be an efficient mechanism for the customer, with distributed energy, demand response, storage and interconnectors proving more economic new-build solutions than CCGTs."

--Henry Edwardes-Evans, henry.edwardes-evans@spglobal.com

--Edited by Jonathan Dart, jonathan.dart@spglobal.com