UK Electricity Market Reform: An Update - Capacity Market

In our August Alert "UK Electricity Market Reform - what does it mean for future generation projects?" we reviewed the UK Government's proposals, as set out in an energy White Paper1, to achieve its commitment to "transform the UK's electricity system to ensure that our future electricity supply is secure, low carbon and affordable". As noted in our Alert, there was one aspect of the Government's plans which was set out in scant detail within the White Paper and which was in need of expansion: this was the introduction of a "Capacity Mechanism", details of which were to follow.

Some of those anticipated details were provided on 15 December 2011, when the Government issued the Technical Update to its White Paper (the Update). This sets out the UK Government's decision to legislate for a capacity mechanism in the form of a "Capacity Market", intended to provide sufficient capacity security to meet the changing needs of the market and to ensure a secure and consistent supply of electricity to the market, avoiding both surplus and insufficient demand, and removing the risk of blackouts.

Following the publication of the White Paper, the Government has been consulting on two capacity mechanism options: (1) a targeted mechanism in the form of a Strategic Reserve; and (2) a market-wide mechanism in which all providers willing to offer reliable capacity are incentivised to do so. The consultation closed on 4 October 2011, and concluded that option (2), a market-wide "Capacity Market", should be implemented.

The Capacity Market

What is the Capacity Market? - This Capacity Market model envisages meeting supply demands through a central auction system, by a mechanism that (if it works as the Update anticipates) will represent a consistent and forward-facing approach to maintaining supply levels against changes in capacity demand. The Capacity Market approach will provide incentives to suppliers which are intended to ensure that a reliable supply is available, as and when required, to meet changing capacity demands. The incentives will apply both to generation, and also to non-generation supply such as demand-side response and storage.

How will it work? - The Capacity Market mechanism would be market-wide, with the overriding objective of ensuring a determined volume of capacity. It would broadly introduce the following:

Estimating the total volume of reliable capacity that will be required by the market, forecasting a number of years ahead The...