This is going to be a bit tedious, I know, but its something that’s been worrying me about how we are going to make Electricity Market Reform work, so it’s just as well for the health of my psyche that I get it off my chest. Apologies if you don’t see it the same way……
I posted some thoughts on capacity payments recently, (here) and suggested that current oil fired power stations running a few hours a year could have their lives extended through conversion to renewable oil feedstock. Probably an idea out of time, but the principle – that where possible we should aim to use existing plants for back-up rather than building new plants designed from the start to lie idle for most of the year is, I think, important: but that doesn’t really seem to be recognised in the Electricity Market Review proposals on capacity payments. I think that is because the Government has got itself quite confused about what it wants capacity payments to do. In general, it is true that there will be some elements of new supply that the market may not address all by itself, and hence some form of ‘market assistance’ will be necessary. But it is far from apparent that ‘capacity payments’ as such cover all angles. There seem to be three categories of possible measures that address ‘capacity’ in the widest sense. Well, two and a half really, but bear with me…
Capacity one (‘shaping’) is the need to ensure that electricity generating capacity that we know we are losing up to 2025 is replaced, but through mechanisms that ensure that replacements are lower carbon than what is going out of commission. Some form of mechanism may well be needed to ‘shape’ these replacements, bearing in mind that the replacements are likely to be gas, gas and more gas if the market is left to its own devices.
Capacity two (‘availability’) is that, in the normal run of things, energy providers would have been expected to ‘migrate’ old and amortised power plants to the margins of the market, providing back up power inputs at peak hours. The retirement of many plants means that this support might have to go towards the development of new plant just for that purpose – i.e. some form of payment from the start of the life of a plant so that it stands there running only a few hours a year from its commissioning onwards. Either way, the imperative is to ensure that there is enough capacity available to ensure bids arrive for peaking power demands.
Capacity three (‘flexibility’) comes in once these replacements are in place, and assuming that they consist substantially of offshore wind (as is currently projected) then there may need to be some kind of payment made to ensure that there is in place sufficient flexibility in the overall capacity of the system to respond (not the same as ‘capacity per se’) when it is compromised by the inevitable variability of the supply of wind that is now factored into new capacity levels. This flexibility could be through a variety of devices that are not ‘capacity’ in terms of generation – it could be storage, interconnection, demand side management, and other elements.
These three categories all look like they are about capacity, but in reality they are about different things. The present position in the Electricity Market Review documents, and in ministers’ minds apparently, is that ‘capacity payments’ sui generis will fit all three eventualities. Chris Huhne said as much in response to a question from me at the last EMR Select committee Hearing. (here.)
The problem is that they won’t, and that they are all clearly different sets of circumstances. Capacity payments for ’shaping’ suffers the most obvious problem. That is that, if you target certain kinds of ‘shaping’ capacity for payment, whilst assuming in general that there will be other investments, it is likely that these other investments will dry up because they are not supported. You will need then to extend capacity payments to rectify this, until soon every new investment is covered, and developers have achieved large amounts of free money for doing what they would have done anyway. It would probably be better to concentrate on shaping replacement plant response by other measures, such as supply arrangements, floor price, market signals on new unabated coal (and perhaps gas) plants and so on.
Building a plant specifically for life on the margins of the market so that it is ’available’ is new territory in that it will not have been amortised by its previous operation, as is the case in present market arrangements. The whole capital cost of the plant would need to be met, therefore, whether or not the plant now standing mostly idle ever actually succeeded in bidding into the system, since no-one is likely to fund a plant for that purpose only. That could, in principle lead to very high capacity payments being expected, probably beyond the ability of the system to deliver. A better way of meeting this category is probably to provide ‘availability’ payment to producers – that is an agreed payment upon being available to bid, whether successfully or not. There may be a little dead weight behind this, but that has to be set against the likelihood that an availability payment, would substantially incentivise the use of existing plants at the margins, and would save greatly on plant development cost.
Real ‘capacity payment’ should then start with the question of how we are to support a variable, decentralised system once those shaped changes to capacity and availability have been negotiated. We most certainly will need a range of mechanisms to make the market flexible and reliable under the new capacity deployment; and putting payments towards storage (pumped reserve capacity for example), better interconnection and reliable demand management or aggregated reserve supply would be very productive.
There, I feel a lot better now. I’m not sure that you do though! It will be interesting to see if and how, the final proposals for EMR get clear of what used to be called in second year Philosophy undergraduate classes a ‘category mistake’. If they don’t it could be very expensive, and in the long run, not very effective.