Out-Law News 2 min. read

Ofgem proposals for electricity capacity monitoring could influence energy market prices, expert says


Plans to monitor the capacity of UK power stations so that enough electricity is produced to guarantee security of supply could influence energy market prices, an expert has said.

UK energy regulator Ofgem has issued a consultation on the best way to monitor the difference between the maximum energy which can be generated and user demand. It will be charged with reporting the figure to the Government from September next year.

The report will be used as part of a 'capacity mechanism' designed to ensure that power stations are kept on standby to cope with demand in emergencies under the Government's White Paper on Energy Market Reform (EMR) (142-page / 1.8MB PDF).

The UK will lose around 25% of its electricity generation capacity in the next decade due to aging plants and environmental regulations, Ofgem said. In addition, an increasing amount of the country's power will be generated from intermittent sources such as wind.

Simon Hobday, an energy law expert with Pinsent Masons, the law firm behind Out-Law.com said that predicting capacity requirements could influence energy market prices, which are currently dictated by supply and demand on wholesale markets.

"The electricity price when the industry was privatised comprised an energy and capacity component that was replaced by a pure energy price in market reforms introduced by the then Labour Government in 2001. The approach now being put forward in the EMR marks some form of return to where things were before," he said.

In July, Energy Secretary Chris Huhne described the EMR as "the most significant reform of our electricity market for 30 years".  It will introduce a capacity mechanism designed to ensure that power stations are kept on standby to cope with emergency demand surges and the unreliability of some renewable electricity generation methods, such as wind power. The Government is consulting in a separate exercise on the exact model of capacity mechanism to be adopted.

However, under plans in the Energy Bill currently before the House of Lords, Ofgem will from 2012 have to assess the level of electricity supply capacity needed to meet existing and future consumer demand. It will also have to monitor risks to the security of that supply.

Ofgem will be charged with delivering a report containing estimates of capacity and demand over the next four years to the Secretary of State every September.  These reports are, it is to be assumed, to be a key part of the capacity mechanism under EMR and will be used to decide what capacity must be secured under any new approach.

"The argument can be made that, by introducing an external view of what capacity is needed into the market, the price for power will be distorted by the assumptions made in developing that view rather than the market price indicating what capacity is needed through imbalances between supply and demand. The manner in which such report is developed which is the subject of this consultation by Ofgem is therefore of crucial importance for future energy prices" Hobday said.

Ofgem proposes to use a de-rated capacity margin as its model. This measures the expected excess of available power generation capacity, taking into account any forced outages or intermittency, over demand.

Its report will also measure the risk of shortfalls in supply occurring over the measured period.

"Any decision on the required capacity level will have significant consequences for consumers and other market participants. If the level is set too high, it may result in unnecessarily high prices to pay for the excess capacity. Conversely, if set too low, it could result in supply issues if the capacity level is not sufficient to cope with demand," the report said.

The consultation is open until 7 December 2011, and the Regulator intends to publish its final plans in early 2012. It will submit its first report to the Secretary of State by 1 September 2012.

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