Maintaining energy security in the United Kingdom is a major priority of the government. Although the UK electricity market has historically delivered high levels of energy security, it is rapidly changing and in significant ways. Rising electricity costs, increasing demand from industrial and retail consumers, and a shift towards less reliable and intermittent renewable sources, are all factors that are increasing consumer risk for adequate and reliable electricity supply in the near future. In response, the government is working towards reforming its electricity markets to address security of supply concerns alongside decarbonisation and economic priorities.
This research project investigates the government’s proposal of implementing a new capacity market to correct inefficiencies and under supply issues in the existing electricity market. The new capacity market will provide additional fixed-term subsidy to capacity providers interested in extending, refurbishing, or building new generation capacity.
The motivation behind capacity payments is to ensure that investors can recover the full cost of providing electricity capacity. Often, prevailing electricity prices in the wholesale market do not reflect the full cost of building and running generation; hence, there is a general sense of reluctance in the market to invest in capacity. An optimal level of capacity payment is one that allows capacity providers to recover the full cost of investment whilst meeting projected consumer demand.
Contracts for capacity payments are awarded through an auction-bid process whereby participants place bids for the amount capacity they can provide and the amount of corresponding subsidy they seek. In this research project, a mathematical model was developed to represent the future state UK electricity market. While it impossible for the program to predict the exact nature of the bids that will be submitted to the auction, it is possible to determine how subsidies should be allocated to potential providers based on system need and the optimal subsidy amount that maximises welfare for both consumers and electricity producers.
The government is expected to conduct public consultation on the detailed design of the capacity market in October 2013. As such, this research project is timely and relevant, holding the potential to inform the Government on ways to implement the market in a fair and competitive manner.