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Featured Insights

Changes to UK Capacity Market Auction Are Designed to Spur New Gas-Fired Facilities

It will soon be revealed which developers and utilities across the UK are eligible to take part in the country's latest auction aimed at keeping the lights on.

For those bidders that do prequalify, they look likely to be involved in the first UK Capacity Market auction to actually deliver meaningful levels of new electricity generating capacity. While the capacity auction will take place in December, prequalified bidders are set to be announced on 14 October.

Through the auction process, the government essentially asks power generators to commit to make generating capacity instantly available at times of high demand for the grid. In return for promising to do so, generators receive an annual capacity payment based on the number of kilowatts they make available. These auctions are becoming of increasing national importance for the UK as more of its existing generating capacity retires.

Capacity Lost to Retirements

According to the government's own figures, the UK lost 11.4 gigawatts (GW) of coal and gas generation capacity in the three years ending in 2015. The 2016 Digest of UK Energy Statistics (DUKES) reveals that 8.8 GW of coal-fired plant came off the transmission system, alongside 2.6 GW of gas.

Over the same period, around 3.5 GW of renewable generation was connected to the transmission system, comprised of 1 GW of onshore wind, around 1.3 GW of offshore wind and 1.25 GW of bioenergy.

Peter Hughes, Black & Veatch Business Development Director for Europe, says that while the new capacity that has begun generating in recent years is extremely welcome, it is too little and inadequate – given the associated intermittency – for ensuring security of supply and keeping Great Britain's power switched on.

“Having renewable generation sources, such as wind and solar, is a step in the right direction," Hughes said. “But what happens when the wind stops blowing or the sun stops shining?”

An Aging Nuclear Fleet

To compound matters, much of the UK’s nuclear fleet has passed its original design life, so a number of those plants will close during the next decade. They will not be replaced by new nuclear in the short-to-medium term.

“These plants take a considerable amount of time to build, and even longer if you add in the generic design assessment process and the time required to secure a contract for difference to get to financial investment decision stage,” Hughes said. “It's a long process, as evidenced by the iconic Hinkley Point C project."

Hughes added that emissions legislation like the EU's Large Combustion Plant Directive and the UK's commitment to lowering greenhouse gas emissions means the country is also rapidly closing coal-fired plants. Coupled with the fact that much of the existing gas-fired fleet is aging and generally inflexible, one can see that a void is forming.

That means the best alternative is for new natural gas-fired plants.

“In the absence of large-scale, commercially viable energy storage for electricity, new gas-fired plants are the only way the UK can ensure a sufficient supply of electricity to consumers at times of peak demand."

Third Time's a Charm

The Capacity Market mechanism was introduced to incentivise the construction of new generating plants that could be held in reserve for times of peak demand. However, it has so far failed to deliver. The capacity auction that takes place in December 2016 will be the third of such annual auctions.

Previous T4 auctions – so-called because they secure capacity that will be made available in four years' time – in December 2014 and December 2015 secured 49.26 GW and 46.3 GW, respectively, but this capacity predominantly came from existing power plants.

Established generators, having already absorbed all of their construction costs, were able to bid for capacity payments at a far lower level than those bidders considering building new plants. As a result, the clearing price – the price level at which the government secures all of the capacity it was looking for – in 2014 was just £19.40 per kW, and even lower a year later at £18 per kW.

Changes to the Auction Process

The government acknowledged that it had a problem, and that these clearing prices were nowhere near the level needed to build new electricity generating capacity. In response, it has introduced several changes to the way the capacity market mechanism operates.

First, it has doubled the level of credit cover per megawatt (MW) that each bidder must have in place for the capacity it makes available. Those wishing to take part in this December's auction must now have credit cover of £10,000 per every megawatt they make available, up from £5,000 per MW in previous auctions.

Secondly, it has raised termination fees – the charge for a plant choosing to exit the capacity mechanism – from £2,500 per MW to £10,000 per MW, so that any fee would be covered by the credit line the generator has in place.

Those generating units whose capacity contracts are terminated by their operators will also be barred from re-entering the capacity market for two years.

All of these measures are aimed at discouraging what the government terms “speculative projects" – pre-design stage schemes with little in the way of funding in place; and existing operators that treat the capacity market as an optional extra source of revenue where the call for capacity can be easily ignored.

In addition to these steps, the government has announced that a second auction will take place in January for just one year ahead. It has announced targets of securing 52 GW of capacity for delivery in 2020-21 in December's auction, plus a further 53.8 GW for 2017-18 in January's auction.

It is anticipated that all of these measures will increase the clearing price in December's T4 auction, as the barriers to entry will be higher due to the credit cover and termination fee changes. In addition, by seeking more capacity, the government will likely have to accept a higher price to secure the capacity it wants.

Open for Business

A higher clearing price at December's auction could mean many new-build power plants, especially gas-fired ones, coming online.

“All of the dynamics are pointing to this, and we expect the capacity auction will make investing in new gas plant commercially viable," Hughes said.

In approaching the capacity market option, two types of gas-fired plant appear on the horizon: open cycle gas turbines (OCGTs) and combined cycle gas turbines (CCGTs). While there are advantages to both types of configurations, OCGTs are far simpler than CCGT, employing just the primary process of burning gas.

OCGT plants are much quicker and cheaper to build than CCGTs, and can start generating electricity quickly in response to a capacity call. Hughes says he expects several new OCGT plants to successfully secure capacity payments in December's auction.

“Open cycle will fly this year," he says.

“The auction doesn't distinguish between configuration and technologies, and the capital cost is significantly less for open cycle. In additional, open cycle plants generally take around 18 months to two years to build, whereas for CCGT it is typically three years or more."

As an EPC (engineering, procurement, construction) contractor, Black & Veatch has extensive experience in delivering gas-fired power plants globally, including several in the UK:

  • ConocoPhillips' VPI Immingham, a 1 x 1 450 MW natural gas-fired combined cycle cogeneration power plant;
  • The Isle of Grain 660 MW gas fired 2 x 1 combined cycle power plant; and
  • The AES Barry Power Project 230 MW 1 x 1 gas-fired combined cycle power plant.

Hughes and his colleagues at Black & Veatch are eagerly awaiting this December's capacity auction in anticipation of new gas-fired plants that they can help utilities and developers deliver.

Subject Matter Expert
Peter Hughes: HughesP@bv.com

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