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Electricity Market Reform: Capacity Market design

This was published under the 2010 to 2015 Conservative and Liberal Democrat coalition government

The final aspects of the Capacity Market design have been confirmed, ahead of the first auction being held later this year

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DECC has today confirmed final aspects of the Capacity Market design ahead of the first auction being held later this year. The Capacity Market will help keep the lights on by driving new investment in gas and demand side capacity, as well as getting the best out of our existing generation fleet as we transition to a low carbon electricity future.

The Capacity Market is part of the Electricity Market Reform programme, which is being introduced to deliver green, reliable electricity for the future, at the lowest possible cost. New Contracts for Difference will incentivise investment in a diverse range of low carbon electricity, including new nuclear, wind, solar and biomass.

The Capacity Market will ensure the future security of our electricity supply by ensuring that sufficient reliable capacity is in place to meet demand. This will include the new gas capacity which DECC’s Gas Generation Strategy identified as critical for ensuring future security of supply.

The Capacity Market works by offering all capacity providers (new and existing power stations, electricity storage and capacity provided by voluntary demand reductions) a steady, predictable revenue stream on which they can base their future investments. In return for this revenue (capacity payments) they must deliver energy when needed to keep the lights on, or face penalties. The cost to consumers for this capacity will be minimised due to the competitive nature of the auction process which will set the level of capacity payments.

Government consulted on the final design of the Capacity Market in October 2013. DECC can now confirm that:

  • 15 year capacity agreements will be available to new capacity. This will provide sufficient certainty to unlock investment in new gas plant, which we expect will include a range of new independent providers;
  • Existing capacity will be able to access rolling one year agreements – although three year agreements will also be on offer to plant which needs to undertake significant refurbishment. This will ensure we get the best out of our existing assets for the consumer;
  • Penalties for unreliable capacity will be capped at 200% of a provider’s monthly income and 100% of their annual income. This will provide a strong incentive for capacity to be there when we need it; and
  • The capacity auction will be capped at £75/kW to protect consumers from excessive costs.

The first capacity auction will take place in December 2014, subject to state aid clearance being received. Capacity will be in place by the winter of 2018. In advance of this, the Government has already announced that it will also run two transitional auctions for demand side capacity in 2015 and 2016. This will help grow the demand side industry and ensure effective competition between traditional power plants and new forms of capacity; driving down future costs for consumers.

National Grid and Ofgem have also already taken action to make certain the lights stay on before the Capacity Market begins to deliver the investment we need. National Grid is in the process of contracting new balancing services – either reserve power plants or capacity provided by voluntary demand reductions – to ensure there is enough supply to meet demand at any given point. These services will, if needed, be in place by the winter of 2014.

Full details of the Government’s response to the consultation on Electricity Market Reform, including Capacity Market design, will be published in late Spring, as secondary legislation is put before Parliament.

Further information

  1. Electricity Market Reform (EMR) is the programme that will deliver the Government’s commitment to transform the UK’s electricity system and ensure that our future electricity supply is secure, sustainable and affordable.

  2. A major component of EMR, the Capacity Market is an intervention to ensure the lights stay on in an electricity system that will be increasingly dependent on intermittent wind and inflexible nuclear generation.

  3. The Capacity Market is intended to ensure sufficient investment in the overall level of reliable capacity (both supply and demand side) needed to provide secure electricity supplies. It will bring forward new investment and get the best out of existing assets by competitively setting a price for capacity through annual auctions. Capacity agreements will be offered to investors in existing and new capacity four years ahead of the year capacity must be delivered, giving them certainty over part of the future revenues they will receive. The Capacity Market will operate alongside the electricity market.

  4. The consultation on draft Capacity Market legislation and design proposals, closed on 24 December 2013.

  5. On 23 December 2013 Government published the first EMR Delivery Plan, alongside an impact assessment and analysis on the potential costs to consumers of EMR and the Capacity Market. This suggested domestic consumers would pay an additional £15 annually on average to 2030 for the security of supply benefits that the Capacity Market will deliver, although costs could be lower as a result of competition in the auction driving capacity prices down, and the true costs, taking into account the dampening impact of the capacity mechanism on electricity prices, could be lower still. 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.

  6. Electricity Market Reform delivery plan and impact assessment.

  7. National Grid has is developing two new balancing services, Supplemental Balancing Reserve (SBR) and Demand Side Balancing Reserve (DSBR). These will be used if necessary to procure additional capacity to ensure the grid can be balanced over the coming winters. National Grid plans to run a tender process in May so that further capacity can be procured, if needed, in time for winter 2014/15. Ofgem is currently consulting on the funding arrangements that will be used to support these services. Further information can be found on the National Grid and Ofgem websites.

Published 19 March 2014