This week the UK Government issued a consultation on further tweaks to the Capacity Market, including a possible acceleration of its introduction.  Putting aside the politics behind the proposals, the consultation makes this as good a time as any to consider whether our current thinking on electricity market design for a low carbon generation mix is fit-for-purpose?  The issue is an important one that most countries will have to face over the coming years.  If we get it wrong, governments will have to intervene more and more (I name no names…), and the hard-won benefits of competition will be whittled away.

The core of the market design challenge is straight forward

Most low carbon technologies have a low short-run marginal cost.  That means that when those technologies are generating the wholesale power price is pushed down.  By ~2050 we are supposed to have a power system with little, if any, generation that is not carbon-free.  If we take this to it’s logical conclusion the power price will be near-zero most of the time, with occasional price spikes when more expensive resources such as DSR are called upon.

The economic purist might be quite comfortable with that, but investors and lenders will be somewhat less sanguine

Instruments will continue to be needed to ensure that power sector projects are ‘bankable’.  This is in essence what led to the Capacity Market in the UK being set up in the first place.  But is there a smarter way to do this?  A way that takes Government out of the messy business of deciding how much capacity to buy, and a way that brings low carbon generators – the generators of the future – back into a market that supports them, with no need for subsidy?

So what might a 2050 clean energy market look like, then?

The idea I want to put forward here is one I’ll refer to as a Long-Term Energy (LTE) Market.  I’m not in marketing – sorry.  It’s important to note that this is not a capacity market!  The idea is, very briefly, as follows:

  • (E.g.) once a year all market participants submit bids to an LTE platform: suppliers set expected demand for that year and future years and the market clears on the basis of price requirements submitted by generators. Simply, think of this as an LRMC curve.
  • Results for later years would not be binding (they just set a price signal for investors), but there would need to be some additional balancing arrangements to mitigating the risk of gaming in the front year.
  • The results from the front year determine an allocation of financial instruments we’ll call LTE certificates between generators. These instruments have a strike price set on the LTE platform and they settle against the ‘normal’ power price.
  • Market participants buy and sell power in the ‘normal’ power market as they do now.
  • But for each MWh settled, additional cash flows will be calculated by an LTE Settlement Agent to remunerate LTE certificate holders.

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This essentially provides all generators (that are economic as determined by the LTE market) with something that looks a bit like a CfD, albeit one where the price is not locked in for the long-term.

I know, I know, there are a huge number of detailed design questions I’ve totally skipped over

But they can surely be solved.  One obvious implication of this model is that we would need a very well designed Emissions Performance Standard – that would become the primary policy instrument to ensure we achieve decarbonisation targets.

The market designs that are in place across most of the western world are unable to deliver a least-cost low-carbon energy system

We need a market that strikes a pragmatic balance between providing some additional price security for generators, while restoring the role of the market in determining our future generation mix.  At the moment we are not even close to that.  Today’s power markets are not fit-for-purpose, and tinkering with them is not the answer.