The amount of electricity everyone uses varies hugely depending on the time, day, and season. For example, usage peaks during winter with its cold, dark days. The Capacity Market ensures that Britain always has enough reliable capacity to meet demand, and at least cost to consumers. These features produce the capacity needed at minimum cost:
Two auctions are run to procure capacity for each delivery year. The first auction is held four years ahead of the delivery year, to allow enough time to build any new capacity needed. Then a year before delivery a ‘top-up’ auction is run. This allows any adjustments to be made, as it is impossible to accurately predict peak demand four years in advance.
Companies which bid successfully at auction sign a Capacity Market Agreement committing to provide electricity or reduce electricity consumption when required. They regularly submit data to prove they are able to do this. In return they receive a monthly payment, set at the auction price. If they fail to submit satisfactory data, their capacity agreements can be terminated.
A balanced approach to risk – why does it matter ?
Electricity from a new power plant typically costs more than energy from existing power station. This is because new generators have to pay financing costs in addition to the usual maintenance and operating costs which existing power stations pay.
So, to keep consumer costs low it is important that the Capacity Market doesn’t build more new capacity than needed.
Staging the auction in two phases helps to ensure this. Allowing existing power stations to bid also makes it clear how much existing capacity is available.
Using auctions to procure the right amount of capacity
Because it can take a few years to build some of the bigger power stations, the main auction is always run four years ahead of delivery. As much as 95% of the expected capacity is procured at this stage. To make sure the auction doesn’t procure too much, the Electricity System Operator provides estimates of peak demand and the amount of extra capacity needed.
A year before delivery a second auction is run. This allows any last-minute adjustments to be made. It also recognises that some of the new capacity providers which signed up in the first auction might be unable to deliver and need to be replaced at this stage.
How does the Capacity Market Agreement work?
More capacity enters the auction than is needed. This keeps the auction competitive, driving down the electricity price paid by consumers. The agreements vary in length depending on the financing requirements. There are three types of agreement – one year for existing projects, three years for generators in need of refurbishment, and 15 years for building new generation plants.
The agreements vary in length depending on the financing requirements.