As we transition to more renewable power generation, balancing the electricity grid to ensure we have continuous supply to meet demand is becoming a more challenging task. And as the results of last month’s Capacity Market auction demonstrate, an expensive one too.
The Capacity Market (CM) was introduced by the government in 2014 to ensure we have future generation on standby to keep the system balanced during times of stress. For example, if the wind drops, or we have an unplanned nuclear power station outage.
It operates as two auctions each February:
- The T-4 auction to secure the bulk of capacity – mostly from generation – for four years in advance.
- The T-1 auction to secure top-up capacity – from both generation and also demand turn-down – for the following CM year (which runs 1 October to 30 September).
February auction delivers highest-ever price
Last month’s T-4 auction recorded the highest-ever price, closing at £63/kW (£6300/MW) for the 43,000 MW procured. This is more than double last year’s T-4 auction price, which was the previous highest at £30.59/kW.
Consumers will see this cost appear on bills from 2026/27, when CM charges will be around £12.05/MW. This compares to their current price of £9.14/MW.
The T-1 auction closed slightly lower at £60/kW (£6000/MW) for 5783 MW capacity. This is less than the record £75/kW achieved in last year’s T-1 auction – although this was attributed to a last-minute increase in the target capacity. But it’s still significantly higher than the T-1 auction in 2021 (£45/kW).
As the T-1 volume is far lower than T-4, this translates to a smaller share of the overall CM charge on bills – around £4.83/MW.
Fall in participants pushes cost up
A number of factors are contributing to increasing CM auction costs, not all of which are easy to explain.
For starters, the volume of operational generation assets entering this February’s T-4 auction continued to decline, falling below the capacity levels set by National Grid.
This meant an increasing share of contracts had to be awarded to generation still in construction. As generators usually need higher prices to cover their construction costs, they won’t bid too low – so the auction closed at a higher rate. And that’s then the rate that every bidder receives (see below for more on how the CM auction works).
The volume of nuclear capacity competing also fell, as many nuclear plant approach end-of-life decommissioning.
Despite the UK’s changing generation profile, gas-fired generation still secured two-thirds of the overall capacity procured. But the volume of battery storage increased to 3%, up from just 0.3% in the 2019 T-4 auction.
What’s interesting is that a significant volume of capacity providers that went through the extensive pre-qualification process, then didn’t choose to participate in the T-4 auction on the day.
Why this happened is unclear. But it reduced the overall competition – with 93% of the T-4 auction participants awarded a contract – which pushed the cost up.
What can we expect in future auctions?
Current trends are likely to continue, with older generators dropping off while new generators come online to replace them.
This means new generators with higher costs are likely to make up a growing share, which could drive prices higher if nothing else changes.
However, there is currently a consultation to look at allowing those with existing CM contracts to exit early (National Grid will then secure replacement volume).
The thinking is that this is likely to attract more participants, because the penalties are less. It also gives generators who committed a smaller volume some time ago, the opportunity to exit – and potentially re-enter offering a higher capacity.
The hope is that these adaptations could lower prices.
We cover some more detail about the Capacity Market below. And if you’d like to know more the about non-commodity charges contributing to your overall electricity costs, do speak to your Client Lead or Account Manager (existing customers). Or get in touch with us via Contact us | npower Business Solutions.
Capacity Market: 30-second briefing
What is the Capacity Market?
The Capacity Market (CM) is an auction held by National Grid to secure future capacity to keep the system balanced at times of stress – for example, when there could be too little generation to meet demand on the system.
Who can participate?
Generators who can deliver a certain amount of energy to the system – or large consumers who can turn down demand to use less than normal. If successful, participants are paid regardless of whether they are called upon to fulfil their contract. But if they fail to deliver when requested, then they are financially penalised.
How does the auction work?
The auction is ‘Dutch style’, so it starts at a top price – in this case £75/kW – and those who are competing to secure these contracts will bid lower and lower, until enough have dropped out and only a sufficient number of bidders are left to meet demand. These remaining bidders are then awarded the price of the highest remaining bidder.
What is the timeline?
National Grid holds two auctions every February – one aimed at securing delivery for the next Capacity Market year, which starts the following October (the T-1); and one for delivery four years ahead (the T-4). Bidders in the T-4 auction can enter for generation that hasn’t yet been built – so if a plant is part way through construction, they can secure some income ahead of time.