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UK's Capacity Market set to launch October 1 with 54 GW under contract

This weekend sees the introduction of capacity payments in the UK for the first time since the Electricity Pool was replaced by the NETA new trading arrangements in 2001.

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As of Sunday, some 50 GW of the country's existing generation, plus interconnection and new capacity, will be paid to guarantee availability on request of system operator National Grid.

The government's aim, prompted by the failure of the wholesale market to provide an investment signal, is to ensure security of supply by keeping existing power stations available, while encouraging construction of new ones.

The mechanism is seen as contentious because of its likely deadening effect, over time, on scarcity pricing in energy-only markets.



Criticism of this regulated approach is that capacity mechanisms have a tendency to over-procure capacity, exacerbating the "missing money" problem they seek to address.

This is worsened by allowing mechanisms to run on year after year, with investment decisions increasingly focused on capacity fees, irrespective of wholesale market signals.

This then creates a "missing market" problem, killing innovation in new products to deal with the flexibility needs thrown up by the transition to renewables.

Last winter supply tightness in Q4 2016 saw prompt and balancing prices in the UK spike dramatically, with half hourly prices rising over GBP800/MWh on the evening of November 2.

The capacity market is specifically designed to avoid these supply scares, the threat of which was deemed serious enough to bring forward the mechanism for launch this weekend.

An Early Capacity Market auction was held in February, clearing at GBP6.95/kW/year.

Contracts were awarded to 54.4 GW of de-rated capacity, for delivery from October 1, 2017 to end-September 2018.

Three quarter of awards by capacity went to existing CCGT, coal and nuclear power stations. Less than 2 GW of awards went to new capacity.

UK capacity market auctions held over the last three years for capacity four years in advance have cleared at prices below market expectation, failing to bring forward the government's hoped-for investment in large new gas-fired power plants.

This has led generators to warn that power stations will close, further reducing the UK's dwindling power generation margins.

As the capacity market makes its debut, however, the wholesale market is providing a strong enough signal itself to at least delay some closure.

In September utility SSE confirmed it was making its 1.2 GW Peterhead CCGT plant available again, despite having no capacity market contract.

While SSE said improving market economics were behind the return of Peterhead, there is evidence that the UK's capacity mechanism may have dampened the price response to availability concerns this winter.

The UK November peak contract has been trading consistently below that of France through September, assessed by Platts at Eur69.29/MWh Thursday compared with Eur73.10/MWh in France.

--Henry Edwardes-Evans, henry.edwardes-evans@spglobal.com
--Edited by Jonathan Fox, jonathan.fox@spglobal.com