A Beginners Guide to the UK Capacity Market

Set out in the UK Energy Act 2013, the Capacity Market (CM) is one of the UK government initatives for ensuring security of electrical energy supply for homes, businesses and industry. The CM not only secures additional electricity supply for use during grid stress events – which is increasingly important as energy demand increases, and the UK moves to more intermittent, less flexible renewable generation – but also creates an opportunity for those with generation capacity to earn additional income.

What is it and how does it work?
Businesses can participate either individually, or under an agreement with a specialist demand response company, and receive payment for the electrical generation capacity (in MW) that they pledge to the market.

Auctions occur annually to secure capacity, determined by the Department for Business, Energy and Industrial Strategy (previously the Department of Energy and Climate Change) based on National Grid recommendations, for delivery in 4 years’ time; allowing planned additional capacity to be pledged. There are also Early Auctions which pledge capacity one year before delivery. If successful in the auction, firms receive a Capacity Agreement stating the amount they will be paid per MW of generation they have pledged. This generation capacity must be available and brought online when called upon.

Capacity Market payments encourage investment in further generation capacity, so increasing UK energy supply security.
The CM presents an opportunity for those with generation capacity, including building owners, occupiers, and landlords, to earn additional income. Not only that, but CM payments encourage investment in further generation capacity, so increasing UK energy supply security. However, the CM has been criticised for encouraging ‘dirty power’ as non-renewable generation is rewarded.  Indeed, there has been an increase in the number of diesel generators pledging to the CM, and these are heavily criticised for their detrimental effects on air quality and human health. Further regulation to the CM market has been proposed by the UK government, including emissions limits, making it likely that diesel generators will play a diminished role in the CM in the future.

What capacity can be pledged?

• Electricity generation from non-renewable sources, including, but not limited to, diesel, combined heat and power (CHP), coal, and gas.
• Both existing sources of generation and planned developments.
• Generators without Short Term Operating Reserve (STOR) contracts, or who have not received a Low Carbon Exclusion or Grant within ten years.

Benefits of participation

• During the generation delivery year, generators with Capacity Agreements receive monthly payments for their agreed obligation at the auction Clearing Price.
• CM payments vary according to the Clearing Price agreed at auction – the December 2014 auction (for capacity during 2018/19) had a Clearing Price of £19.40/kW and meant that a 1.3MW diesel backup generator could earn a cash payment of £25,220 during the delivery year.
• There are no financial losses for not being able to deliver the pledged capacity. If generators do not engage their capacity when required they will be penalised at no more than 100% of the CM payment, therefore the financial benefits available to generators through participation are significant.

UK vs. non-UK schemes
The Capacity Market in the UK is similar to several other national schemes, including those in EU countries. In France and Italy, for example, the capacity market focuses on securing generation from power plants. In the USA, capacity markets have been formed by individual grid operators, creating a diverse electrical generation market where the market drives investment and delivery.

What’s next?
The next round of Capacity Market auctions in the UK take place in January 2017 – this will include both Early Auction pledges for 2017/18, and pledges for 2021/22. Associated documents to participate in this auction need to be submitted very soon.

For further guidance on Capacity Markets, click here to get in touch.