The Capacity Market: a helper or a hindrance on the road to net zero?

The T-4 auction procures the bulk of the capacity for winter 2025/2026. This year saw 49.1 GW of capacities prequalify against a procurement target of 42.1 GW. The auction cleared at £30.59 / kW, significantly higher than the £18 / kW last year and nearly double the average T-4 auction clearing prices so far (£15.5 / kW).

Though the Capacity Market was put in place as a temporary mechanism to assist security of supply in the transition from coal and gas fired generation to a renewable system, it is currently procuring carbon intensive assets beyond 2035 — the date set by the government for a net zero electricity system. Therefore, this blog looks at the current state of the Capacity Market and how it might look in the future.

In the most recent auction batteries comprised most of the new build capacity

Out of the approximately 3 GW of official ‘new-build’ capacity, batteries took the largest share (Fig. 1) despite gas assets comprising 75% of the prequalified new build capacity. However, in nameplate capacity, battery storage dominated, with 3.3 GW of new capacity (Fig. 2) successful (around 1 GW derated). This volume represents double the currently installed battery capacity in the UK. It is also more than five times the battery capacity successful in the last T-4 auction. In the last two auctions, batteries with a 2-hour duration have comprised over 60% of the storage capacity, making 2-hour batteries now the preferred choice. This shift is likely driven by the increased revenues achieved in the wholesale and balancing markets. In addition, a 4-hour duration project successfully secured a contract for the first time. Nevertheless, nearly a third of new build capacity are gas generating assets.

Wind and solar continue to make up a very small portion of the auction volume (9.6 MW of onshore wind) and that is owing to the high de-rating factors and the lost benefit from other government schemes (CfDs).

Figure 1. New build capacity (GW) from the T-4 2025/2026 auction. Note that unproven DSR is included as new build capacity and ‘new build’ interconnectors have been removed if already live.

Figure 2. Procured battery storage capacity and duration over the last six T-4 auctions.

Multi-year contracts were only secured by storage & gas

Although DSR assets can apply for multi-year contracts none of the participants did. This is likely because the CAPEX threshold ensures that multi-year contracts are offered to higher cost technologies. This has the perverse consequence that investments that would allow sites to offer significant demand-side response over a number of years but cost less than the threshold cannot be made because the site can only be sure of securing a Capacity Market contract for one year. Consequently, multi-year contracts were awarded to the gas generating units and battery storage. Specifically, 98% of the gas contracts were multi-year and 90% of them are longer than 10 years — supporting gas assets after the 2035 target.

The Capacity Market has already procured 4 GW of high carbon plants past 2035.

The majority of capacity procured past the 2035 target comes from plants that have a high carbon intensity. This is because, the Capacity Market remains an important revenue stream for smaller embedded gas assets and therefore for the business case to stack up a multi-year contract is necessary. On the other hand, the success of large CCGT assets has declined. There was not a single successful CCGT project in the latest auction, even though 5 GW prequalified. This reflects the growing decarbonisation risk for a large CCGT asset with a life span after 2035 but without an economically viable CCUS solution.

The potential risk with allowing carbon intensive generation to continue to access shorter term agreements is that it negates the immediate need to remove barriers to entry for low carbon technologies to participate successfully.

Figure 3. Procured capacity in the four most recent T-4 auctions (up to T-4 2025/2026) and capacity already locked in past 2035 from these auctions.

Capacity Market clearing prices are rising and the cost to end consumers is increasing

By 2030, the UK energy system will be very different from today. The UK coal fleet will be retired (3 units totalling 4.5 GW) and six out of the seven nuclear plants will have closed (just under 6 GW). In addition, there is likely to be more than 7 GW of ageing CCGTs that will retire. On the one hand, successful renewable support schemes are rapidly boosting intermittent renewables capacity. However, on a derated capacity basis coal and nuclear closures cannot be offset by intermittent renewable generation alone. The limited duration of batteries leaves a key gap for provision of longer duration flexibility (e.g. from 2 hours to 2 weeks).

To keep up with this, the Capacity Market in its current form would need to procure more new build capacity each year, and this comes at a cost. Clearing prices and consequently the cost to end consumers are already increasing significantly and we would expect this trend to continue (Fig. 4).

Figure 4. Cost of the four most recent T-4 Capacity Market to end consumers.

Therefore, investment in flexible technologies must be incentivised. Flexibility in the past has come from dispatchable thermal plants, however in the future, flexibility will come increasingly more from the end consumer (Fig. 5). Currently, the Capacity Market focuses on generation being the dominant source of capacity and does little to support players on the supply side with the onboarding of large portfolios of assets or the ability to access multi-year agreements due to capex thresholds. This does not align with NGESO FES 2021 scenarios and BEIS modelling whereby the ambition for the Capacity Market is for it to be technology agnostic (from both a generation and supply side).

Further updates to the Capacity Market could include changes to the de-rating factors (noting that older technologies will not have the same de-rating factor as a new build), tightening the carbon emission limits where necessary and improving secondary trading markets.

Figure 5. Projected requirement for flexible technologies in 2050.

Conclusion

The Capacity Market was put in place as a temporary mechanism to assist security of supply in the transition from coal and gas fired generation to a renewable system. It is time now to consider if it is the right cost effective mechanism to bring forward low carbon firm capacity and achieve the government’s aims for a zero-carbon grid by 2035 — which in its current form will not. Alternative mechanisms such as reforms to the wholesale market, outlined last week by NGESO could better incentivise efficient dispatch, influence generation locating in the right places and may offer a more certain outcome.

Originally published at https://www.linkedin.com.