About 18 months ago I posted a blog suggesting that we would need to rethink the design of electricity markets to tackle some of the long-term challenges that will be posed by the future electricity system. The rise of renewables will mean that the electricity price in liberalised markets is low or near-zero for an increasing proportion of the time. This fundamental change in the cost structure of the sector – from variable per MWh costs to fixed per kW costs – means that a short-term energy market alone would not be sufficient to bring forward the required investment. But it is not clear that capacity markets are the answer either.

Capacity markets at breaking point

A recent consultation proposing changes to the GB Capacity Market highlights some of the emerging issues, and is indicative of some of the inherent contradictions in the prevailing market design. The mostly widely talked about change that was proposed by the consultation was a change in the treatment of storage technologies, which would lead to the capacity provided by short-duration storage being de-rated compared to longer-duration installations.

On the surface this is eminently sensible. In the extreme it is obvious that a system with a very large amount of short-duration storage would not be able to meet the energy requirements of the system. And therein lies the rub. This is an energy constraint. Is the capacity market really the right place for this sticking plaster?

Putting that more philosophical point aside, it is worth asking whether this constraint is likely to become an issue and undermine security of supply under the current market design.

It is true that most of the storage capacity currently being developed is short-duration storage. This is primarily because its main target is the ancillary service markets, especially frequency response. But these markets, although they will grow, will only ever be able to accommodate a finite amount of storage capacity. Any more significant growth in the development of storage projects is likely to be led by longer-duration storage projects that can access a wider range of earnings opportunities.

My analysis is presented in the figure below. This estimates the Equivalent Firm Capacity (EFC) of 1.0h and 1.5h storage installations as a function of the total storage capacity online. It has been proposed that the new de-rating factors are calculated using an EFC-based approach. I have made some simplifying assumptions, but the analysis suggests that even for a 1.0h battery no significant additional de-rating should be necessary until >1.5 GW of short-duration storage is committed.

Graph_EFC

What are we buying anyway? Capacity or energy?

So, the analysis suggests that the debate on de-rating may be an unnecessary one. But does the debate itself suggest that a more fundamental rethink is necessary?

During the Electricity Market Reform process, a stable source of revenue was deemed to be required to plug a perceived ‘missing money’ gap. The Capacity Market was the result. But the outcome that consumers care about is energy adequacy. The energy transition is bringing forward an increasing number of solutions to ensure that this energy is then available when it is required.

Capacity is a means to an end, especially when the increasing flexibility of demand is considered. The radical changes that the sector faces over the coming years will mean that an ever-increasing number of patches are required to a market that itself began life as a patch.

It remains the case that investors are likely to demand instruments that provide longer-term certainty than the short-term energy market will be able to provide. But shouldn’t those instruments be focused on market outcomes? Surely we can design a longer-term energy market signal that both ensures we can maintain security of supply and that provides a long-term hedging opportunity for investors.