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A Little More Time to Secure New UK Energy Capacity

by Peter Hughes, Director of Business Development, Black & Veatch Europe

After decades of failure to prepare for the retirement of aging coal, gas and nuclear power plants, the United Kingdom (UK) is in a hurry to secure electricity generation capacity.

Renewable energy plays a key role, accounting for nearly a third of all electricity generation in the UK, according to trade association RenewableUK.

To ensure electricity supply can meet demand even when the wind isn't blowing or the sun shining, the UK also runs the Capacity Market scheme.

After what could be regarded as a failure, in recent years, to deliver meaningful levels of new electricity generating capacity, the Capacity Market scheme has been changed to give developers of new power plants more time to make their projects commercially viable.

 

Auction Pre-Qualification

The scheme pays operators to hold capacity in reserve and make it available when National Grid needs it. That capacity comes in several forms: on-demand generating capacity such as gas power plants, storage capacity from technology like batteries, and demand side capacity, where major electricity users agree to switch off their demand from the grid.

Part of the rationale behind the Capacity Market scheme is to incentivise the construction of new generating plants that have the flexibility to cater for times of peak demand. Guaranteeing a fixed income in addition to any revenues new power plants may receive from generating electricity can make the difference when investors consider whether it is financially viable to proceed.

Under the scheme, bidders secure capacity payments by bidding in a T-4 auction, so-called because these auctions secure capacity that will be available to the grid in four years. So far there have been three T-4 auctions, held as a descending clock auction, where the price being offered as a capacity payment is incrementally reduced until the government secures the level of capacity it is looking for.

To date the majority of successful bidders have come from existing power plants. Last year pre-qualified participants representing 70 gigawatts (GW) of new and existing capacity began bidding at the starting price range of £75-70 per kilowatt (kW).

All the bidders, proposing to build new combined cycle gas turbine (CCGT) projects, dropped out by the time the auction had reached its final clearing price of £22.50 per kW per year.

Evolution of the Capacity Market Scheme

Each year changes have been made to the scheme to encourage more new generating plants and to discourage speculative bidding. Probably the most notable change came in 2016, when tougher penalties were introduced for bidders who secured capacity contracts but did not deliver the capacity, be they developers who didn't build their proposed plants, or existing facilities whose operators ignored the grid's call on their power supply.

In 2016, these penalties helped secure 3.3 GW of new generating capacity that will be operational by 2020, up from 1.9GW in the 2015 auction. However, that 3.3GW represents just a fraction of the total 52.4 GW of capacity that secured payments in the 2016 auction.

While there was one open cycle gas turbine (OCGT) plant, several gas engine projects, some battery storage and demand side capacity, the vast majority of successful bidders were operators of existing facilities.

As well as the obvious advantage that existing facilities do not need to raise finances to fund construction, their operators also have time on their side when bidding against developers of new power plants.

Developing a facility like a new CCGT plant is a major undertaking, and many bidders are designing their schemes, awarding contracts and securing financing while trying to bid for the capacity market auctions.

Perhaps this is why, following consultations with by industry watchdog Ofgem, the preparation period of this year's T-4 auction has been extended by two months.

As with previous auctions, pre-qualification began in July, but the auction itself won't take place until February 2018, instead of December as in previous years. This extra preparation time is just what is needed to avoid a further failure to secure meaningful new generating capacity. It will give bidders more time to refine their commercial strategies, making them more likely to survive the auction process.

Future Focused

In the months following last year's auction CCGT developers began refining their strategies to lower the capital cost of the new plants. With these extra two months between pre-qualification and the auction, they may well stand a fighting chance of being able to successfully match a clearing price of £22.50 per KW per year.

CCGT developers bidding in February 2018 should also benefit from another rule change. From April 2018, Ofgem announced a three-year program of removing and reducing benefits paid to electricity generators of 100 MW or less, the type of organisations that comprise the bulk of successful new build bidders in previous capacity market auctions.

Known as embedded generators, these smaller plants connect to the distribution network rather than the transmission network. In so doing they avoid some charges and get paid to generate electricity at times of peak demand. These 'embedded benefits' are estimated to amount to the equivalent of a subsidy of £47 per kW per year.

Under the changes phased-in from April 2018, National Grid estimates the value of embedded benefits will eventually to fall to £3-£7 per KW per year. This will make it harder for many embedded generators to be commercially viable at low clearing prices in future capacity market auctions.

This should help level the playing field between embedded generators and developers of new large scale generating power plants like CCGTs.

Given the changes to the rules of the capacity market, the phased withdrawal of the embedded benefits and the extra time afforded to developers of new build CCGT plants, it appears this year we could see a CCGT or two moving from concept into construction.

 

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