Capacity Market Proposals

Capacity Market Proposals

CategoryArticles Author Duncan Sinclair Date

Energy Bill 2012 Capacity Market proposals

The snake eating its tail

The image of a snake eating its tail captures the circularity – the self-fulfilling prophecy – which arises out of the Energy Bill 2012 proposals for a ‘Capacity Market’ (Chapter 3 of the Bill).

This is how Government describes its reasons for the proposals (emphasis added):

“Whilst there is no immediate threat to security of electricity supply in the UK, we face a potential risk in the future, as around a fifth of electricity generation capacity that operated in 2011 is set to close over the coming decade and more intermittent (wind) and inflexible (nuclear) generation is being built to replace it.

These changes to our market create an investment challenge, in particular for plant such as gas which can alter its output to meet demand. This is because low carbon plant has lower operating costs, meaning fossil-fuel plant will operate less often than now and be less certain of its revenues. This could lead to under-investment and uncomfortably low levels of reliable capacity. “

The proposed solution is, in brief, to cross-subsidise fossil fuel (notably gas fired) electricity generation, being the major flexible and non-intermittent generation that might be used at short notice to prevent blackouts during peak demand (say, cold days when the wind is not blowing).  The latest Government agenda (assuming the proposals in the Bill are passed) is to consult in early 2013, to pass Regulations in October 2013 to come into force in 2014.

Please turn this programme off to save electricity

The proposals bring to mind newscasters in the former East Germany telling listeners to switch off all electrical appliances for 3 minutes to save electricity[1].  If there is a lesson there, it is perhaps that markets may be the worst means of providing the goods and services we need apart from any alternative means (including decisions taken by civil servants to plan for consumers’ needs).

As rather severe government intervention is proposed in the existing market for electricity generation and supply, it should be noted that DECC’s analysis of a serious security of supply risk is far from universally accepted.  The fundamental predictions of risk are, for example, contradicted by ENTSO-E’s (the European Transmission System Operators’ Organisation) estimates.  Indeed, even DECC only talks in terms of ‘possible’ risks in future decades.

The proposals also largely ignore the European Commission’s current consultation on security of supply, which includes a range of possibilities that may better address any potential risk, perhaps to enhance the 2005 Energy Security Directive or further cross-border action. And measures at this level will avoid the difficult legal issues for Member States arising out of the the EU rules on Public Service Obligations (which for example limit them to proportionate measures only– a tricky legal benchmark to apply to any gas subsidy scheme).

A reign of error?

There is a nice definition by the sociologist Merton of a self-fulfilling prophecy:

“The self-fulfilling prophecy is, in the beginning, a false definition of the situation evoking a new behaviour which makes the original false conception come ‘true’. This specious validity of the self-fulfilling prophecy perpetuates a reign of error. For the prophet will cite the actual course of events as proof that he was right from the very beginning.”

That the capacity market proposals are such a false prophecy was recognised by many during initial Committee scrutiny in the summer of 2012:  investors that might be building the necessary generators today say they are deterred from doing so as they await details of the future ‘subsidy’ mechanism. The proposals are that certain (unspecified) generators will be paid simply for ‘being ready’ as well as being able to profit from electricity sold.  The Committee exhorted the Bill drafting team to add much greater detail regarding the scheme, with no success in the redraft.

Perhaps the reign of error has begun, with the political prophets and Malcolm Tuckers of this world likely seek to ‘demonstrate’ how use of the Capacity Market prevents a cataclysm in future.

Security of supply by this route involves a heavy carbon trade-off – this is not a mere ”insurance policy”

The idea of an “insurance policy” against blackouts – the description used in the Explanatory Notes – is attractive on its face, but it is not an apt description. It suggests that consumers are protected against a dramatic negative outcome at modest cost.

First, as many commentators suggest, the proposals will likely lead to overinvestment and stifle innovation. This will ultimately hit consumers’ pockets. The impact assessment places the cost of the scheme at a relatively modest £1.7Bn NPV, though this is obviously highly sensitive to how accurately one can predict the need for subsidised generation, and indeed the duration of the scheme (again, the need for such a subsidy tends to be self-fulfilling over the longer term too, not least as it stifles innovation in alternatives).

Perhaps the final criticism is the legerdemain involved in suggesting this is simply a question of ‘insuring’ against a risk.  In reality, a dash for gas will occur: as is implicit in the original quote in this blog, no other source than gas is ‘trusted’ by Government. When combined with the lifting in mid-December 2012 on the moratorium of shale-gas fracking, and the recent approval by the Chancellor of some 30 more gas powered generators, it is clear which way energy policy is headed over the next few years: more gas.
[1] Reported in the New York Times, 14th December 1969.  Similarly, food shortages due to central planning were common.

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