Capacity market secures some new gas while providing stay of execution to old coal

• Government agrees to pay companies £19.40 per kilowatt to keep fossil fuel power plants available
• Only five per cent of projects included in capacity market are new builds
• Coal and biomass plants account for 20 per cent of the capacity made available under the market
• Scheme expected to add £11 to consumer bills, of which only 54 pence goes towards building new, less carbon intensive, capacity

A new government policy designed to ensure the UK’s future energy supply appears to have successfully incentivised companies to build over two gigawatts of new gas power, to sit alongside nine gigawatts of coal and biomass power. It should ensure the UK will have at least 48.6 gigawatts of fossil fuel power stations available in 2018.

The Department of Energy and Climate Change today released the results of its first capacity market auction. It guarantees new gas plants will get paid £19.40 for each kilowatt of power capacity companies make available at the flick of a switch. The auction’s biggest winner was gas power, with around 25 gigawatts of new and existing gas power plants receiving contracts.

But only five per cent of the capacity that secured contracts will be newly built, leading to concerns that the UK could be locked into using high carbon power sources during the 2020s.

While some have emphasised the lower than expected price as good for consumers, it may also have a knock-on effect on the UK’s decarbonisation plans. We take a look at the auction’s result, and what it may mean for the UK’s future energy mix.

The capacity market

The government introduced the capacity market to try and ensure there is always enough power generating capacity available to meet demand, even when intermittent renewables are generating less electricity. The capacity market offers companies a set price if they promise to keep a particular amount of generation available, should it be needed.

To agree the price, this week the government conducted a ‘descending auction’. The auction took place over four days, with the government and companies eventually settling on a price of £19.40 per kilowatt yesterday afternoon.

The auction worked like this: In the first round, the government offered companies £75 for each kilowatt of capacity they guaranteed to provide. At this high price, the power companies offered much more than the 48.6 gigawatts of power the government wanted to secure for 2018/19. The government then reduced the offer by £5 in the next round, and every subsequent round, until enough companies dropped out to make the bids match the 48.6 gigawatts the government wants.

The government committed to accepting the lowest offer, whichever company it was from, to get the best value for bill payers. It has hailed the settlement price as “great news for consumers.” Not everyone is convinced.

Carbon pricing campaign group Sandbag says that of the £11 that the capacity market is expected to add to consumers’ bills, only 54 pence goes towards paying for new power stations. £7.60 goes to the UK’s big six energy companies to subsidise existing power stations, and £2.86 goes to other power companies. That means only a small part of the scheme goes towards building new, less carbon intensive capacity – one of the principal aims of the scheme.

Gas, coal, and demand reduction

Before the auction went ahead, environmental campaigners warned the government that the way the system was designed could end up throwing a lifeline to old coal. But in the end, gas providers decided the offered price was high enough – despite being  below some market analysts’ expectations – for them to proceed with building new plants.

That’s partly because the 15 year length of the contracts will allow power companies to get cheap loans from banks to build the plants. They are also potentially betting on gas generation becoming more profitable, as gas prices fall due to an increase in domestic production through fracking or a more stringent carbon price makes coal less economically competitive.

Phil Grant, a partner at consultancy Baringa, says in a statement that those companies that asked for a higher price and failed to get contracts in this auction are expected to try again next year, as the government seeks to secure capacity for 2019/2020. Many plants that did secure contracts are also likely to rely on alternative funding sources to make the projects viable, he adds, as the settlement price was lower than expected.

In October, National Grid released a list of power stations planning on participating in the auction. About a quarter of the projects were coal plants, half were gas plants, and the remaining quarter was a mix of nuclear, oil and diesel power plants, and demand reduction projects.

But in the final accounting, coal plants make up only 10 per cent of the successful bids, with gas plants accounting for 55 per cent. About 50 per cent of the power secured under the scheme will be generated by gas power plants. About 19 per cent will come from old and refurbished coal and biomass plants.

Less than one per cent will come from so-called demand side response, where National Grid will ask companies to power down their operations rather than asking power plants to generate more.

Dave Jones, an analyst at Sandbag, says that as a consequence:

“The capacity market looks more like a subsidy scheme to keep heavy polluters online, rather than as a mechanism to encourage new investment – only five per cent of auction revenues will go to new investment. The capacity mechanism is actually slowing decarbonisation of the UK power sector.”

This graph shows which power plants were offered contracts under the scheme. The left chart shows the breakdown by capacity, in thousands of megawatts. The right chart shows how many power plants of each technology type were offered contracts.

A number of large coal plants missed out on contracts. Eggborough, West Burton 3, Rugeley, and Ferrybridge. The Ratcliffe, Cottam, West Burton, Drax, and Aberthaw plants did receive contracts, however.

Oxfam’s climate policy adviser Kiri Hanks says awarded such contracts runs counter to the government’s climate policy goals. She says:

“The days of burning dirty coal should be numbered but instead the UK government is giving two-thirds of the UK’s coal plants a public subsidy.  This undermines our chances of meeting emissions targets because it makes it easier for some coal plants to remain open for longer. This is bad news for the fight against climate change.”

But Matt Osborne, risk manager for consultancy Inenco, says it’s important to see the capacity market as part of a wider suite of policies.

The capacity market “does what it says on the tin” by plugging a short term capacity gap, he says. That gap means “coal will still have a role to play” in the UK’s energy mix in coming years. The capacity market simply secures this while the government’s other policy intiatives, such as offering contracts for difference to renewables and nuclear providers, “are there to encourage more gas and renewable generation in the long term.”

Most of the power plants secured one year contracts under the scheme, meaning they may re-enter next year’s the auction. 59 new power plants totalling 2.4 gigawatts of capacity were offered 15 year contracts. This graph shows what year the power plants offered contracts under the scheme are expected to start generating:

So most of the generating capacity has been secured for only the first year that the scheme comes into force, 2018. That means providers wanting to receive the guaranteed price for longer will have to enter next year’s auction.

This shows the capacity market has failed to hit one of its key goals: securing capacity in the long-term, Professor Catherine Mitchell, professor of energy policy at Exter University, says.

Solution to a non-problem?

The government will hope that its initial success will encourage more operators to build new gas plants, reducing the carbon intensity of the UK’s energy mix. So it looks like the government’s new policy to secure the UK’s energy supply will sit alongside its ambition to decarbonise the sector, to an extent.

But some query whether the capacity market is a solution to a problem that doesn’t exist. Mitchell points to the fact that 65 gigawatts of potential capacity entered the auction in the first place, suggesting companies are willing and able to provide more than enough capacity without the scheme.

So as subsequent auctions are conducted, the government will need to find ways to add more new, efficient gas capacity, making the fossil fuelled element of the UK’s energy sector as low carbon as possible.

Main image: Black smoke from burning of associated gas. Credit: Leonid Ikan/Shutterstock.com.