The Great British Capacity Market Suspension (Industry Insights)

In November of 2018, the Great British Capacity Market was suspended by the European Court of Justice, after it annulled the European Commission’s decision not to object to the Capacity Market[1]. In this Industry Insight, Powerstar summarises why this decision was made and what it means for the future of the Great British Capacity Market.sadasdasd

What is the Capacity Market?

The British Government introduced the Capacity Market (CM) in 2014 to provide an insurance policy against the possibility of future energy-related failures, such as brownouts and blackouts, to ensure that consumers continue to benefit from reliable electricity supplies[2].

This insurance policy is provided by the design of the CM which ensures sufficient reliable capacity is available by providing payments to encourage investment in new capacity or to incentivise existing capacity to remain open. These payments are awarded to capacity providers that are successful in CM auctions, with the main auction being held 4 years in advance of delivery and a secondary auction held 1 year in advance of delivery. The agreements made at auction confirm the CM obligation of the successful providers and the level of the capacity payments that they are entitled to receive, these payments are based upon the clearing price at auction2.

The payments that eligible technologies can receive from CM account for part of the revenue stack for assets that perform Demand Side Response (DSR) which are currently not available during the suspension.

Why has the Capacity Market been suspended?

The suspension of the Great British Capacity Market came in November 2018, as the European Court of Justice annulled the European Commission’s decision not to object to the CM1. This suspension has effectively made the CM illegal and prevents the UK Government from holding future auctions and making payments under existing agreements.

This came to the attention of the European Court of Justice following a challenge by Tempus Energy, a clean energy technology provider, on the decision to grant the Great British CM with state aid approval. This challenge was based around the belief that the CM privileges generation over Demand Side Response (DSR) in a discriminatory and disproportionate manner[3].

Tempus Energy argued that the length of the CM agreements are unfair. This is because DSR providers, who provide this service to the grid through assets such as energy storage solutions, are eligible for 1-year contracts, whereas new build or refurbished generation are eligible for 3- or 15-year contracts, depending on the level of capex.  This essentially means that less sustainable types of generation receive greater rewards than low-carbon alternatives, a key factor in Tempus Energy’s decision to challenge the ECJ. The difference in the treatment between the two was based upon detailed examination of the expenditure and financing needs of generation, but no scrutiny of this kind was applied to DSR3.

A further reason why the CM is deemed to be unfair is the cost recovery method. The cost recovery in the CM is based on electricity consumption between 16:00 and 19:00 (the peak energy demand period) on each weekday in winter, opposed to consumption during Triads (a period of the 3 highest demand peaks in the winter). It was argued that this mechanism failed to sufficiently incentivise businesses to reduce their consumption during demand peaks and therefore does not promote the most efficient use of energy possible and requires the Capacity Market to provide greater backup than necessary3. This again shows a less favourable outcome for smarter, cleaner technologies, such as energy storage, which can manage demand based on the changing needs of the grid to deliver more energy or reduce consumption.

Additionally, it was claimed that additional barriers to entry exist for Demand Side Response assets. This claim highlighted that DSR providers must bid for open-ended capacity events and must procure a bid bond at the same level as generation3. (A bid bond is a debt secured by a bidder for a job in a bid-based selection process which provides a guarantee that the bidder will take on the job if selected[4]). The current requirement for DSR providers to procure a bid bond at the same level as generation could be seen as unfair due to the likelihood of DSR providers being smaller organisations.

What are the implications for energy storage?VIRTUE business case

Due to this ruling, the Great British CM is likely to be amended before its suspension is lifted. A potential amendment could follow the shape of the changes that the European Commission requested the French and Polish Capacity Markets to make, which were to allow power plants in other EU member states to enter the markets, giving preference to low-carbon generators and giving greater access to DSR asset owners.

This potential for greater access to the CM could be of benefit to those organisations with energy storage solutions. This is because energy storage can be used as an asset to participate in DSR and therefore there is likely to be a positive correlation between the greater access to the CM and the revenues that energy storage solutions can gain from CM.

This potential for greater revenue through the CM further enhances the business case for energy storage due to the fact it already has a comprehensive business case derived from the savings it achieves through peak shaving and with revenue generating functions such as energy arbitrage and DSR, additionally, bespoke leading-edge solution can also offer energy resilience allowing user to derive even greater value. Therefore, a fairer CM which provides more opportunities for DSR will boost the financial benefits of energy storage even further.

Conclusion

Whilst the suspension of the Great British Capacity Market in November 2018 came as a surprise, the arguments that led to the suspension are convincing and arguably look better aligned with the wider Governmental objective of decarbonisation than the current CM does. Although the suspension has led to a period of uncertainty surrounding the CM and a slight reduction in the revenues available for Demand Side Response, ultimately it could prove the case that this is a necessary period of pain in order to reform the CM and make it more suitable for the UK’s wider decarbonisation objectives.

11 February 2019

[1] https://www.energy-storage.news/news/uk-capacity-market-suspended-following-landmark-ecj-ruling

[2] https://www.emrsettlement.co.uk/about-emr/capacity-market/

[3] https://www.nortonrosefulbright.com/knowledge/publications/171502/tempus-energy-and-the-capacity-market-in-the-uk

[4] https://www.investopedia.com/terms/b/bid-bond.asp

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