Keeping the lights on

This week’s one year ahead (“T-1”) capacity auction closed almost as soon as it opened adding a cool ￡375m to consumers’ bills this winter for 5GW of capacity at the maximum price of ￡75/kW.?Of course, we’ve known this was inevitable since Ministers decided to increase the target capacity, in order to buy all of the available capacity in the auction, adding an extra 300MW on top of the system operator’s technical recommendations.

The Secretary of State justified his decision due to the “broader uncertainties in the power sector”.??There may well be valid reasons for a late revision to these targets.?It has been a turbulent winter and Ministers may have information which wasn’t available to the system operator at the time they set their methodology back in the summer.

Yet it is still striking that Ministers would decide such an expensive option during a cost of living crisis.?Last year’s auction cleared at a record ￡45/kW.?If that had been repeated – and Aurora’s forecast was that it would have cleared lower – then the 4.7GW which the system operator assessed as sufficient to meet the statutory security of supply requirements would have cost ￡212m. ?So that extra 300MW generation capacity cost consumers ￡164m at a marginal price of ￡545/kW.?To put that in perspective, that one year availability payment is more than the total capital cost needed to buy that amount of brand new gas peaking capacity outright!???

Are we building the right kind of capacity?

The latest T-1 auction has continued to focus on providing security of supply through gas-fired power stations. Of the 5GWs of contracts handed out, a total of 3.4GWs was gas-based, including 1.8GWs of existing CCGTs, one new build CCGT (SSE’s Keadby 2), and nearly 800MWs of peakers and CHP. This continues the trend of capacity market auctions to date, which in total have brought 18GWs of new capacity on to the system, of which 6.9GWs was gas-based.

The low CAPEX of these technologies means that they can be a cheap way to ensure security of supply, with one main flaw – the associated carbon emissions. With the Government setting a target for GB to achieve a Net Zero power system by around 2035, this raises tough questions about how we can continue to ensure security of supply without those emissions. So, what are the alternatives?

A new report from Aurora Energy Research published today shows that 24 GW of Long Duration Electricity Storage (LDES) – equivalent to eight times the current installed capacity – could be needed to integrate renewables into a secure Net Zero electricity system.?These include established technologies like pumped storage as well as innovations like liquid air, compressed air or flow batteries, each with their own technical advantages which could help balance the system geographically and temporally because they are able to discharge continuously for more than four hours.?Our study concludes that introducing significant quantities of LDES by 2035 could reduce carbon emissions by 10 MtCO2 p.a., reduce system costs by ￡1.13 bn p.a. (2.5%) and reduce reliance on gas by 50 TWh p.a.?However, LDES is unlikely to be deployed at the full scale required without market reforms which reflect its true value to the system by providing stability, storing surplus renewably generated power to use when it is needed, and managing network constraints.

That brings us to next week’s four year ahead (“T-4”) auction which will buy the vast majority of the capacity needed in 2025/26. ?We’ve now reached an inflection point for the capacity market.?9GW coal and 8GW of nuclear plants won agreements in the first capacity auction to deliver in 2018/19; of that 17GW, only 1GW remains to compete this year’s auctions.?Moreover, in the remainder of the decade we will start to see demand rising for the first time in two decades, as vehicle electrification gathers pace.?That means that, for the first time since the capacity market began in 2014, the target for this auction is higher than the amount of existing capacity on offer - meaning that the capacity market will need to commission new firm capacity next week to ensure energy security in 2025/26.

So what will happen in next week’s auction??This year’s auction introduces a positive new flexibility for larger scale pumped storage, which typically takes more than three and half years to deploy: developers in this auction are able to take an agreement but defer delivery without penalty.?This, coupled with a strong strategic case, may be sufficient to encourage investors to take the long view and build long duration storage ahead of market reforms.?

However, an alternative scenario is that most investors continue to prefer new gas generation and we see significant new capacity agreements out to 2040.?It is certainly better to have spare flexible capacity available than let the lights go out. But there is a risk that the UK will pay a high price to buy the ‘wrong’ type of capacity now, as peakers will increasingly price in the assumption they won’t be able to run many hours in a net zero world, pushing up capacity market clearing prices to compensate. Government is already considering a range of proposals to amend the Capacity Market – to limit running hours, offer shorter contract lengths, or split the auction into separate high carbon and low carbon pots. Whilst these reforms will only kick in from the 2023 auctions at the earliest, the writing is on the wall that the days are numbered for unabated gas generation – and prudent operators will price this in.

Next week will reveal much about how investors and developers currently view market incentives and regulatory uncertainties. The proposed reforms to the Capacity Market are heading in the right direction. But we also need to reform our power markets to reflect the system needs as we head for net zero and enable low carbon flexible assets to compete to complement growing renewables.

Dan Monzani, Managing Director (UK & Ireland) and Richard Howard, Research Director, Aurora Energy Research