Analysis: Capacity market – location, location, location

No sooner were the capacity auctions over than it was realised the mechanism is not only giving rise to the wrong kind of generation, but much of it is also in the wrong place. Mathew Beech reports.

The government’s much lauded capacity market was designed with the intention of filling in the gaps emerging in the country’s electricity generation portfolio, keeping the lights on and everything running smoothly into the next decade and beyond.

Despite aiming to help the UK transition towards a low-carbon economy, it has proven to be a far from ideal, because the generators winning the auctions have been largely already existing plant, rather than the new gas capacity the government was wishing for. On top of this it has also seen “dozens of dirty diesel generators” win auctions and a subsidy to run for the next 15 years.

However, there may be a further flaw with the capacity market system, and that is the distance between where auction-winning capacity is located and where the areas of highest demand are. This has the potential to be a significant issue because parts of the transmission and distribution networks are already constrained at times of peak demand or generation.

In 2013 in detailed design proposals for the capacity mechanism, the Department of Energy and Climate Change (Decc) stated that it would operate as a single market and that it would be “inappropriate to introduce additional location signals”.

It said it did not anticipate any need for locational pricing “in the near future” because it was unlikely there would be transmission constraints at times of stress.

However, some are unconvinced, and say the need for locational incentives could be required. Bloomberg Intelligence utilities analyst Elchin Mammadov tells Utility Week that as new forms of generation, in particular renewables, come on to the transmission system, the issue will grow as more parts of the system become constrained.

Coupled with this, the UK’s electricity consumption is predicted to increase, especially since the electrification of transport and elements of heat occurs over the coming decades.

This in turn will affect the ability of the generators to cost-effectively produce once network charges have been factored in.

“If you listen to Iberdrola, one of the reasons why it wanted to close Longannet, a perfectly good coal-fired plant, is because of grid charges that put it at a disadvantage,” he said.

A prime example of where this could become an issue is in the northeast of England. As the maps below show, demand from local authorities in this region in typically in the higher range (1,250 to 4,000GWh).

At the same time, only 2.808MW of capacity won a contract under the last capacity mechanism auction. The final factor in the triumvirate of problems is grid constraints, and as the Electricity Networks Strategy Group map shows, the northeast of England features areas with “very strong” and “strong” needs case for potential reinforcement.

New mechanisms, such as demand response, coupled with the reinforcement work that National Grid is undertaking, will help to reduce this impact, but a leading utilities analyst says this is going to become an issue that the government will have to address “very soon”. He adds that new generation will go where it is cheapest to develop, not where it is most needed, potentially exacerbating the constraint problem.

Mammadov is also of this school of thought and suggests the UK looks abroad for a possible solution.

He said: “Look at markets such as Germany to contrast it against, some plants have been prevented from closing even though they are loss making, because they are in electricity constrained areas.”

In the details design document, Decc did say it may look at the potential of zonal auctions in constrained areas, whereby a cap on the capacity in the area is imposed that cannot be exceeded.

Mammadov predicts a decentralised answer to the solution, rather than changes to the capacity mechanism itself, because auctions have already taken place.

“What I think will happen is National Grid will come up with some additional payment to encourage people to keep plants where they need to be.

“It will be a bit cumbersome to change the capacity mechamism because there has already been auctions, so maybe more ad hoc measures will be put in place if it becomes a problem – which I think it might.”

This need for location pricing could be extended down to the distribution network, as network operators try to get to grips with the increasing levels of embedded generation and the growth in electric vehicles.

The smart systems consultation the industry is running with government is exploring the opportunity to give the distribution operators local system operator powers to address this, and it would make sense for them to be able to influence locational pricing in the capacity market as part of this.

Demand-side response may provide a longer term solution to the regional constraint problems, but the issue of not being able to control where new generation is placed looks set to continue.

It seems as though a workaround solution will have to be developed as the problem becomes more chronic.