Capacity Markets: Keeping fossil fuel fires burning

How does the capacity market mechanism work? In order to ensure that there is an electricity supply during volatile periods, governments ask electricity suppliers to name the minimum price they would accept. They are paid a certain fixed amount in exchange for guaranteeing a certain electricity supply during periods of peak demand, in addition to market rates for the electricity that is actually produced. If they do not provide the required levels of power, they face financial penalties.

The UK has the most mature capacity market, established in 2014, but other countries (Belgium, Croatia, Denmark, France, Germany, Ireland, Italy, Poland, Spain and Sweden) either have, or plan to implement, one. Portugal was also an early implementer but has since dismantled its capacity market. The country’s electric sector regulator (ERSE) and the grid manager (REN) stated very clearly that there is no reason to subsidise the ‘availability’ of power, since there was an “excess of energy produced in the Iberian Peninsula”. Availability of power is not an issue for much of the rest of Europe either, since by the Commission’s own admission, “the EU as a whole is currently in a situation of over-capacity”. However, the UK was not connected to this over-capacity, and thus needed to address very real concerns over security of supply.

The capacity market wasn’t initially the UK government’s preferred option. At first, they considered a Strategic Reserve (which takes capacity outside the market and gives a lump sum to stay in reserve in case of problems). And from the beginning, the capacity market has come under criticism. In a 2016 report, The Progressive Policy Think Tank found it to be “providing poor value for money for bill-payers, working against the government’s decarbonisation objectives, and too focused on large power stations at the expense of more efficient, demand-side solutions”.

The UK National Grid's Control CentreDept of Energy and Climate Change, UK
The UK National Grid’s Control Centre

Greenpeace’s Sebastian Mang told IE that the type of capacity market adopted by the UK “is really problematic because it’s providing an incentive to fossil fuels over other forms of electricity”. He explained that when Greenpeace compared how much money was going to renewables in the EU compared to fossil fuels through capacity mechanisms, they found that almost €58 billion – 98% of these subsidies – is being added to energy bills to prop up coal, gas and nuclear plants.

But in 2014 the system was challenged in the courts, Tempus Energy, a DSR company (Demand Side Response schemes reward companies for reducing their electricity consumption during peak demand seasons) challenged the European Commission’s state aid approval (an advantage conferred on a selective basis to undertakings by national public authorities) of the UK Capacity Market. In 2018, the General Court of the Court of Justice of the European Union ruled in favour of Tempus Energy. The judgment had the effect of annulling the EC’s state aid approval for the capacity market scheme, which was then suspended. However, in 2019 the European Commission confirmed its original decision to grant state aid approval and the scheme was reinstated.

Press release about the Tempus litigationGeneral Court of the EU
Press release about the Tempus litigation

Sophie Yule-Bennett, former General Counsel of Tempus Energy, told Investigate Europe that the reinstatement of the scheme wasn’t as clear cut as it has been presented. “[The] General Court judgment has been appealed by the EU Commission and that appeal is awaiting judgment in the European Court of Justice,” she explained. “In the meantime, the UK government has mostly ignored the November 2018 judgment and carried on with the capacity market, regardless.”

The EU litigation concerns the circumstances under which the EU commission has to hold an investigation. This investigation will look specifically at the detail of the scheme’s state aid compatibility – something that has relevance for all European capacity markets (Tempus also has a legal challenge in Poland). Yule-Bennett also stressed that it is the pending European Court of Justice judgment that is significant for the future of Capacity Markets across the EU.

She explained that “Tempus had brought legal action in the UK to force the government to comply with the General Court judgment, [the one that annulled the European Commission’s state aid approval] but the Commission’s formal investigation conclusion rendered that challenge unwinnable (because the UK High Court is bound by the Commission’s conclusions)”.

The final judgment from the ECJ is expected in the autumn.

London on a snowy day
On paper, the capacity market is designed to ensure electricity supply during peak demand seasons, like the winter

Sara Bell, former CEO of Tempus told IE, “Our company was a real company trying to incentivise customers — electricity customers big and small — to be flexible with their use of electricity, because we know that renewables plus flexible customers equals rapid decarbonisation.

“Obviously the flip side of that is the death of fossil fuels, and quite understandably, those companies don’t want to die, and they’re doing absolutely everything they can. They still have extensive resources in order to be effective at lobbying, and they are very effective,” she added.

The influence of the fossil fuel lobby in the creation of the capacity market is examined in a report from Exeter University. The report found that although there was support for DSR (Demand Side Response), the incumbent generators “lobbied heavily against measures that would have given the development of DSR greater support”.

But it is not lobbying alone that that led to policies favouring fossil fuels, the report says, adding that “political incentives on the government produced an approach that erred strongly on the side of caution in the capacity decisions, in ways that aligned with the interests of incumbents with older assets”.

Speaking to the Independent, Jonathon Porritt, a former chair of the Green Party, describes a situation where there are “a whole generation of civil servants in the Department for Energy and Climate Change (DECC) who can hardly move without consulting with the ‘Big Six’ [companies, which are SSE, EDF Energy, British Gas, Npower, E.ON UK and Scottish Power] first”.

One former civil servant told IE of a situation where experienced civil servants were taking early retirement to be replaced by staff on secondments or consultants from the ‘Big Six’ oil and gas companies. This served the government agenda, as the salaries came out of a different budget and they were able to show that they had ‘made cuts to a ‘bloated public sector’. But public savings in one area were paid for elsewhere, as many of the energy policies adopted were designed to maximise profits for the big energy companies.

When Investigate Europe put these points to the UK government’s Department for Business, Energy and Industrial Strategy, a spokesperson told us:

“The Capacity Market is technology neutral, which maximises competition and helps keep costs to consumers to a minimum. It is open to all technologies and types of capacity (except for those receiving support from other policies) that are capable of contributing to security of supply, including renewables. Other policies, such as the Emissions Performance Standard, Contracts for Difference and the Carbon Price Floor work alongside the Capacity Market to ensure our future energy supply is low-carbon. As coal comes offline and old nuclear plants are decommissioned, the Capacity Market provides a cost-effective mechanism for bringing forward new capacity as and when needed.

“In November 2018, the Capacity Market’s State aid approval was annulled by the General Court of the Court of Justice of the European Union. Following a new notification by the UK and investigation by the European Commission, the Commission re-approved the CM in October 2019.”

To many, the design of the capacity market is far from impartial, and although it will reassure politicians that the lights will stay on, it was never the only means of doing this. The long-term contracts that tie in the government to fossil fuels at the expense of demand side response will make it much harder to meet targets for reducing carbon emissions, while the contracts mean the public will pay for energy whether they need it or not. The lights will stay on, but the fossil fuels will be burning for some time yet.