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Insights and Stories

Understanding the Capacity Market Auctions

March 25, 2021

The latest T-4 Capacity Market auction took place in March. In perhaps the strangest manifestation of pre-pandemic nostalgia, it provided an odd throwback to the 2015 auction by yielding the exact same clearing price of £18.00 per kilowatt.

On the surface, that might be enough to stir memories of eagerly awaiting a new James Bond film, Clean Bandit, and Leicester City actually having a decent season, but a quick glance at the auction results themselves gives a starkly different picture of how our energy system is going to transform over the next few years.

“But just what is the Capacity Market?” I hear you ask.

For a start, it is very different to other markets – rather than being paid for power generation, it instead awards plant with fixed monthly payments based on the amount of nameplate capacity they win agreements for. The trade-off is that in return, plants make sure they’re available throughout the year and commit to generating in extremely low margin events known as Stress Events. It’s worth saying that these kinds of events are exceedingly rare – the last directly comparable event would have been during the three-day weeks of 1973-74. The 2018 ‘Beast from the East’ and power cuts in August 2019 didn’t even come close.

These agreements are awarded through the yearly Capacity Auctions – typically two are held each calendar year; a T-4 auction, which procures the bulk of capacity needed for four years ahead and a smaller T-1 ‘top-up’ auction, that addresses any shortfall needed for the upcoming year. In this instance that meant 2.4GW was available in the T-1 for 2021/22, and around 40.2GW in the T-4 for 2024/25.”

The drama comes from how the auctions procure that capacity. With only a limited amount of agreements up for grabs, and an oversubscribed list of entrants, it’s a seller’s market, and the auction is conducted in reverse. The auction is held on successive rounds over the course of two days, with the price dropping each round until only enough capacity to meet the target remains.

Initially set up as part of the government’s 2011 Electricity Market Reform (EMR) programme to address fears of a ‘Capacity Gap’ with older plant going into planned closure in the late 2020s, the Capacity Market allows for both single-year agreements for existing plant, and long-term agreements for new and refurbishing capacity. These long-term agreements are intended to bring down the cost of capital for new projects by providing them with a fixed income base for 15 years. This why the Capacity Market was suspended from 2018-2019; Demand Response units were initially unable to qualify for long-term agreements, however, as a result of the European Court of Justice’s ruling, now they can.

Although some plant may choose not to enter or bid competitively in the T-4 auction, the results for the most part give us a good view on what the energy mix is likely to be in the near future.

What do the results of this year’s T-4 auction tell us?

This is the first auction where no coal plant even entered the auction, let alone won an agreement.

Also, come 2024, demand response, renewables, and battery storage will make up a larger percentage of our peak capacity than nuclear plant, as some of the older reactors bid out of the auction above the clearing price. Finally, interconnectors, both existing and new, took a large chunk of the available agreements, making up the second largest tranche of winning technology.

This all bodes well for the Government’s energy decarbonisation goals, but it also underlines the ever-increasing complexity of our energy system.

Capacity on the system is now smaller, more nimble, and more efficient than at any previous time, and increasingly dispersed closer to sources of demand on the distribution network.