Writing this in the week that National Grid has issued its first ever Capacity Market Notification helps to focus the mind on how important the effective operation of the Capacity Market is going to become. A current concern is that in order to “fix” the capacity market auction for 2016 to support more new gas capacity, policy makers are in danger of jeopardising future investment in a wide range of decentralised and flexible generation and storage solutions.

The Capacity Market (CM) has been designed to provide additional revenue incentives (some would say a “subsidy”) to ensure that existing electricity generating plants remain available on the network when they would otherwise be shut-down, and to encourage investment in new generating plant  in order to provide sufficient capacity to meet future peak demand loads.

Unfortunately, like the Green Deal, Renewable Obligation scheme, Carbon Reduction Commitment, Carbon Trading and the NFFO scheme in the nineties, “mock market” mechanisms have a tendency to either fail outright or produce unexpected outcomes.

In the case of the Capacity Market, the scheme, which it was hoped would finance the next generation of large scale gas fired power stations, has instead channelled revenue almost exclusively to existing thermal plant, and to the deployment of small scale diesel and gas reciprocating engine generators. Critics of the scheme are concerned that it has been badly designed and may be wasting millions of pounds unnecessarily without providing the long term energy security the UK need.

The 2015 CM auction, which was declared a success because it secured capacity at an unexpectedly low £18-19 per KW, supported only one new gas CCGT generator. Instead over 650 MW of diesel generators picked up CM contracts (at a reported cost of £175m) to add to their already profitable business case based on peak transmission (Triad) and distribution (DUoS) network charge avoidance.

What’s wrong with diesel? Dirty, inefficient and probably not the answer…..

Free market proponents might well argue that the market worked perfectly well. Diesel generators won because, in a straight auction, they were able to outcompete gas, and so the UK has secured additional capacity at a lower cost to the consumer.

There is a debate to be had about the role of diesel and it should be acknowledged that for some companies, and energy reliant organisations, diesel generators can be a valid form of (seldom used) backup generation; but that doesn’t mean that they should be part of the UK energy mix, and standalone diesel farms should almost certainly have been excluded from the capacity market from the outset. 

There is the obvious issue of diesel’s high NOx pollution emissions, an issue also highlighted this week by the High Court ruling that the UK has made an abject failure to address its legally binding emissions targets.

Added to that, many diesel plants have severe limitations on when and for how long they can be used; 200 hours per annum is a typical planning restriction for new diesel farms which, given that they are already being used to avoid peak time network charges, doesn’t leave much generating time to provide network capacity. Another disadvantage is that diesel – of which the UK is now a significant net importer – is probably the least secure energy resource if we really did have an energy crisis. Think about an especially harsh winter, refinery shutdowns, coupled with dwindling fuel reserves and tanker driver industrial action. Think about the 1970’s perhaps.

Diesel is also a less efficient form of thermal generation which would have high operating costs if used in earnest. So from the perspective of the UK’s long term energy security diesel generators are probably not the answer to meet the UK’s energy demand over the duration of a genuine energy crisis.

What has the government done?

After the 2015 auction outcome it might be hoped that the Government would have sorted out the diesel problem well ahead of this year’s auction.

But it’s been an odd year, what with Brexit and the rest, so we are now in a position that the pre-qualification for the 2016 auction has been announced with a great slug of diesel capacity (potentially up to 4 GW) once more in the mix.

The stakes are getting pretty high. If diesel wins again at a low price, and in the process prevents new large scale gas capacity coming forward, the UK is going to struggle to meet its aspiration to have 7 GW of new CCGT gas capacity by 2022[1]. Coupled with the delay at Hinkley this would leave a big gap in our energy strategy for the 2020’s.

To be clear, as a champion of low carbon energy Regen believes that much of this gap could be plugged by reinvestment in renewable energy combined with energy storage and more flexible low carbon solutions, but there is also an argument that new gas generation will be needed as a short term solution and is preferable to retaining coal.

Gunning for Diesel

Having left it very late in the day, policy makers have not been able to tackle the diesel issue directly but have instead tried to dissuade diesel generators from participating in the CM auction by a number of other means.

  • The Ofgem “Open Letter” on embedded benefits suggests that measures will be taken to reduce the business case for diesel generators (and other distributed generators) by overhauling the transmission charging methodology to reduce the benefits accrued by local embedded generators.
  • National Grid in consulting on code modification - CMP264 – which would temporarily exclude new local embedded generators from demand netting, thereby excluding them from transmission cost avoidance embedded benefits, pending a full review of transmission cost avoidance.
  • Ofgem has announced that it has approved another code modification to the Common Distribution Charging Methodology (CDP228), to be introduced in 2018, which will reduce the level of peak Red Band charging in favour of higher off-peak charges.
  • BEIS is consulting on a proposal to prevent cumulative state aid by excluding finance (used by smaller generators) through the Enterprise Investment Scheme, Venture Capital Trusts and Seed Enterprise Investment Scheme from benefiting from the CM.
  • Not to be left out, Defra are planning to consult on proposals to impose tight limits on NOx emissions from small scale generation which would apply from 2019 for any diesel plant bidding in the 2016 auction. Given this week’s high court ruling on the Governments illegal response to increasing emissions, this really is overdue.

Meanwhile the latest communique from the Energy Security Team at BEIS warns that anyone who decides to bid into the 2016 auction – beyond the cut-off date of 22nd November – and then decides to withdraw from their CM agreements will incur heavy penalties.

It all sounds just a tad desperate, and an attempt perhaps to game the gamers. There is even a proposal that BEIS officials may start ringing around diesel generators to directly explain the commercial risk they face by participating in the auction.

Problems with the current approach

Reducing investment in diesel generators would be no bad thing, however the approach being taken may have damaging consequences for the rest of the energy sector. Aside of whether it will be effective the steps being taken to try and salvage the Capacity Market raise a number of issue which go well beyond the question of diesel generators.

  1. Unintended consequences – reducing capacity margins

Reform is needed but policy makers need to be extremely careful before tampering with the system of embedded generation benefits.

Peak demand has in fact been reducing over the last 5 years, reducing system stress at a time when generating capacity has been coming offline and at the same time helping to save energy consumers millions in infrastructure costs.

If policy makers really do reduce the incentive for distributed generators and high energy users to increase generation and reduce demand during peak periods we would be taking the UK energy system backwards and into uncharted territory.

  1. Transparency and inclusivity

Using code modifications and open letters to enact policy changes does not encourage transparent decision making and proper consultation. The level of communication is typically poor and to be very frank the supporting documentation is pretty well unreadable to anyone outside the inner circle of network charging.  In the past, with just a few generators in a largely closed market this may have been acceptable, but today thanks to the democratisation of energy generation there are many thousands of impacted parties ranging from high energy users to smaller scale generators and community energy groups. Proper consultation and a full impact assessment is needed.

  1. Collateral damage to energy storage and demand side response

It is not just diesel generators who will be impacted by changes to network charges. The business case behind energy storage, demand side response, local energy markets and decentralised low carbon generation schemes will also be undermined if the Government and its agencies make ill-considered changes to the grid charging mechanism.

This is especially damaging at a time when the UK is supposed to be championing smarter and more flexible energy systems and declaring itself open for new investment.

  1. Investor confidence

Allowing far reaching code modifications to be proposed by companies with a strong commercial interest in their outcome has added to the impression that the UK energy system is a high risk sector for new entrants and investors.

Coming on top of a raft of changes to reduce the support for renewable energy, unexpected assaults on revenue streams are sending the wrong message to potential investors. As the UK continues to slip down the investor attractiveness index it will become increasingly difficult (and therefore expensive) to persuade new investors that the UK is the right place to do business.

A better approach

Regen, along with a host of other organisations and companies in the energy sector, has strongly argued that Government needs to take a more considered and holistic approach to network charging. Any such approach should be sustainable in the long term and underpinned by a clear set of principles which give investors a solid basis on which to make their investment decisions. Our recent discussion paper – Network Charging for a Flexible Future goes some way to identify what those principles could be.

The issue of diesel generators outcompeting gas in the capacity market should not be allowed to deflect the UK away from a long term strategy, as set out by the National Infrastructure Commission Smart Power report, to develop a more flexible, smart and ultimately more cost effective energy system. If this means redesigning the way the Capacity Market operates then that is the course which should be taken.

Later this month the Government and Ofgem is expected to issue its long awaited consultation on the UK’s future smart energy system. This should be an opportunity for all parties to stop and think about the wider issues effecting the energy sector, and allow Government to consult the industry on how its current policies need to be adapted to encourage investment in a better energy future. 

If you are interested in engaging with BEIS on their smart power consultation, we are hosting a joint session with them at our annual Renewable Futures conference on Novermber 29 in Bath. Find out more and register here.

Author: Johnny Gowdy

Contact: [email protected] 

[1] National Grid Future Energy Scenario 2016