The Capacity Market is being considered for early opening, further increasing the risk of legislative costs to consumers.

Recent announcements on generation closures have caused DECC to go back to the drawing board on the Capacity Market scheme – causing a financial risk to consumer energy bills earlier than planned.

Given the recent announcements of coal generation closure, the UK market is currently under significant pressure to balance the network. With a 5.1% capacity margin across the UK expected for the forthcoming winter 2016 season, fears over the security of supply run high. Risks are heightened due to the reliance on naturally resourced renewable generation and consumer led demand reduction schemes.

The Capacity Market, introduced in 2014, was initially introduced as a mechanism to incentivise flexible generators to remain available, which would otherwise shut down due to lack of sufficient return. This involves offering a capacity subsidy to remain available, with the subsidy negotiated through an auction. Two main auctions were held in December 2014 and 2015 with the award of £2.8bn in subsidies, mainly to existing power stations. These auctions were to secure generation for the winter of 2018/19.

 

How has the Capacity Market performed?

The capacity market has had mixed results. It has delivered a level of certainty for future periods of tight demand, complying with the Government’s ambitions on security of supply. However, it has come under scrutiny on the Governments decarbonisation goal, due to subsidising fossil fuel generators and in particular highly flexible but polluting diesel plants. The scheme has also been questioned in relation to the goal of affordability.

However, debate is on-going as to the true benefit of the Capacity Market as it largely goes against the Government’s decarbonisation objectives and across the two auctions so far £153m was awarded for 2018 and £136m awarded for 2019 to generation plant which is almost certain to remain open during those years without a subsidy. The scheme itself also directly competes with demand reduction schemes which incentivise consumers to reduce demand without additional generation support.

Currently the scheme is under consultation with the following aims:

  • Ensuring more new gas-fired generation is contracted – which is the preference over coal.
  • Aligning the scheme to make it more affordable to consumers.
  • Splitting the auctions for new generation and existing generation, ensuring the scheme incentivises new build capacity.
  • Introducing an Emissions Performance Standard to prevent highly polluting plant from bidding for capacity.

Proposal to bring the Capacity Market forward a year to 2017/18

Given the current demand balancing risks prior to the first contracted winter of 2018/19, DECC are proposing making two more changes:

  • Bringing the scheme forward to include a capacity auction in January 2017 to remunerate plants for the winter of 2017/18. This early implementation will only offer 1-year capacity agreement as opposed to the traditional 15-year capacity agreements in the 2018/19 year.
  • Buying more capacity and increasing the target level for the future periods post 2021.

The early implementation of the Capacity Market will replace the much criticised Supplemental Balancing Reserve (SBR) which is the current mechanism for securing capacity for the current winter 2016/17 (of which 3.5GW of capacity has been purchased for this year).

Why is this important to energy consumers and what is the risk?

The cost of the Capacity Market (CM) subsidy is directly recovered from consumers of energy through energy bills by your suppliers. Therefore, as this scheme grows and continues to increase the cost of subsidy the CM cost will continue to play a more influential part of a fully delivered energy bill.

It is envisaged that the early implementation of the Capacity Market will result in a further £1.25bn of support for generators being recovered from consumers of energy.

Currently consumers of energy are being passed through a CM cost of 0.006p/kWh which is forecast to rise to 0.239p/kWh in 2017, 0.438p/kWh in 2018 and 0.384p/kWh in 2019. This has increased from an initial 0.001p/kWh included in supply offers from late 2015 into early 2016. These costs are subject to change by each supplier and are based on a fundamental view of the current CM scheme and may be subject to on-going change.

New capacity market costs

A further auction for the winter of 2017/18, to be held in January-2017 will further increase the costs in the early years of this forecast – thus forcing additional costs on end consumers.

The increase in CM costs sits alongside the wider issues around the total increase in non-commodity costs than UK consumers are experiencing. The key issues for consumers currently considering their options are:

  • The CM value has increased from an initial 0.001p/kWh to a much higher charge as we move into 2016 – and is subject to change if they do bring forward the scheme to 2017/18 (see above).
  • Suppliers are nervous over the changes to the scheme and correspondingly may either refuse to offer a fully fixed supply contract or may build in significant premiums to cover the risk to their business.
  • Pass through contracts whereby the value of the scheme is passed through at cost may be beneficial – subject to a good understanding of future risk.
  • The future of this scheme will depend on a number of variables and it is expected that further changes will occur – consumers should be ready to understand these through their consultant.

How can Beond help your organisation understand the best way to navigate the complex future?

Rising CM costs are part of the wider concerns over the increase in non-commodity costs which now make up an average of 52% of an average I&C consumers energy bill. Beond has, for some time now, been recommending that consumers identify the current, short term and longer term risks associated with legislative, regulatory and environmental charges as these are not negotiable, are subject to significant volatility and cannot be avoided in totality.

We believe consumers of energy can benefit from:

  • Understanding what the CM and wider non-commodity charges mean to your portfolio and how these are likely to change the costs as we move into 2021/22.
  • Plan and implement an energy efficiency and technology study to consider how these charges may be minimised based on demand reduction. In addition, any current technology projects must be measured against a credible long term view to maximise their benefits.
  • Ensuring that all consumers have an opinionated and informed view of all energy and carbon market changes.

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