Consumers are overpaying for the capacity market due to the “flawed” methodology used to determine the de-rating factors for interconnectors, a new report from FTI Consulting has argued.

According to the analysis commissioned by National Grid Ventures, the current de-ratings factors are “unduly conservative,” creating the risk of over-procurement in capacity auctions.

Capacity market de-rating factors are designed to reflect expected availability of different technologies during system stress events. Participants bid and receive payments according to their de-rated capacity.

The de-rating factors for interconnectors are decided by the energy secretary (or sometimes an energy minister) based on the recommendations of a panel of technical experts. These recommendations take into account the historical availability of interconnectors in Great Britain as well as modelling of energy markets across Europe by the electricity system operator (ESO) at National Grid.

Last July, energy and clean growth minister Claire Perry lowered the de-rating factors for interconnectors bidding in the T-4 auction due to take place earlier this year from 63 per cent to 56 per cent on average.

But the report from FTI says these de-rating factors undervalue the contribution of interconnectors to security of supply. They are “considerably below” the levels implied by the historical availability of interconnectors alone, which instead suggests de-rating factors of between 75 and 95 per cent for all except those to Ireland.

The figures are derived from analysis of price differentials between Great Britain and interconnected energy markets during periods when supply margins are tight or power prices are high. The report says these are suitable proxies for a system stress event, which has yet to occur since the creation of the capacity market.

Source: FTI Consulting

It says there are multiple problems with the current methodology for setting de-rating factors. The modelling by the ESO typically results in the energy secretary receiving a wide range of recommended de-rating factors to choose from, meaning the process is “to a large extent subjective”.

The modelling also gives too much weight to the ESO’s base case and too little to the four future energy scenarios which it publishes each year. Furthermore, the decision by the energy secretary lacks transparency.

The report therefore calls for de-rating factors for interconnectors to be set primarily on the basis of historical availability. This could be used as a baseline and then adjusted by a set factor to account for uncertainty over the future and the “degree of caution and conservativeness that policy makers wish to apply”.

“Whilst perhaps arbitrary, it is likely to be less arbitrary than the current modelling approach,” the report states. “It does, however, have the advantage of being transparent in the inherent trade-off between cost and cautiousness.”

A more radical approach would be to strengthen the penalties for non-delivery and let participants, “who are arguably best placed to understand and manage the risk”, decide their own de-rating factors.

National Grid Ventures owns stakes in multiple interconnectors, including the 1GW Nemo Link which entered commercial operation in January.

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