From NOT A LOT OF PEOPLE KNOW THAT

By Paul Homewood

Timera analyse the latest capacity auction:

Implications of a surge in UK capacity prices

The UK capacity market auction process normally takes two days of bidding rounds before a result. This year’s auction for 2026-27 capacity was over almost before it started.

The auction cleared at a record 63 £/kW/yr, around 3 times the average clearing price of previous T-4 auctions.  Successful new build projects were dominated by batteries, engines, DSR, a CCGT & an interconnector. These will benefit from a substantial portion of required revenue being underwritten by multi-year fixed price capacity agreements (15 years in most cases).

Let’s take a look at what caused this surge in capacity prices and what its implications are for flexible asset investment, both in the UK and more broadly across Europe.

Auction deconstruction

It was clear before the event that this was going to be a tight auction. There was a structural deficit of existing capacity (38.48 GW) vs the government set auction demand target (43.00 GW at the clearing price). This was exacerbated by an older CCGT (0.75 GW) exiting the auction early (South Humber 1).

Chart 1: Deconstruction of 2026-27 T-4 capacity auction result

Successful new capacity was dominated by a new CCGT (EPH’s Eggborough 1.55 GW project), batteries (1.25 GW derated), the Viking Interconnector (1.04 GW), DSR (0.79 GW) and gas engines (0.51 GW).  The high auction price saw 352 MW of 4-hour duration batteries successful, which have less penal derating factors than shorter duration BESS.

Much tougher battery derating factors also contributed to the capacity deficit in this auction. For example 2-hour BESS projects were derated at 23.63% (vs 39.73% in last year’s auction). Tougher derating factors saw 5.0 GW of nominal BESS capacity contribute only 1.2GW of derated capacity. BESS derating factors are likely to decline further in future as the marginal capacity contribution of batteries erodes with scaling.

The big surprise in the auction was how high offer price levels were for new build capacity. Historically there has been a strong overhang of new build gas engine & CCGT projects above 30 £/kW/yr that have acted as strong price resistance. The increase in cost structure of this thermal capacity is playing an important role in pulling up capacity prices.

5 factors driving the capacity price surge

At the simplest level, the reasons for a high clearing price were:

• A relatively aggressive government demand target
• An increase in the cost structure of new build capacity to meet that target.

Digging a level deeper reveals a set of drivers that are relevant for capacity prices & flexible asset investment across all power markets in Europe.

For example the impact of the current energy crisis is likely to see governments providing more proactive capacity payment support to reduce the risk of extreme market tightness as experienced across 2022 (note this will likely weigh on wholesale power prices). A strong policy push towards decarbonisation is also acting to drive up the cost of the marginal sources of flexible thermal capacity.

Previous auctions have been running at a cost of about a billion a year, but this one, which comes into effect in 2026/27, will cost £2.7 billion, equivalent to £100 per household.

The main reason for the jump in cost is much simpler than Timera think; it is the gradual disappearance of existing capacity which previously won contracts, notably coal and nuclear. This has brought new build on to the scene, but this needs much higher capacity support to justify the capital costs involved. In contrast, for existing capacity capacity payments are just bunce.

It is also worth noting Timera’s comments about the high risks faced by new CCGTs, including the risk of being excluded from the market after 2035, and ESG mandates. Investors will be reluctant to put money into such risky projects. Also the comments on interconnectors are interesting – much of the business case so  far has been to take advantage of price spreads, buying cheap from Europe and selling high in the UK, and often the other way round. But more significant is the concern about the security of supply in a tight market; in short, the firm operating the interconnector may end up losing money to fulfil its Capacity Market obligations.

The graph below from the EMR shows how tight the market is becoming. Raising demand from 43 to 46 GW would push the price up from £60 to £75/KW/yr

https://www.emrdeliverybody.com/CM/Capacity%20Auction%20Information.aspx

More alarmingly though is the lack of new generation being brought forward. While gas and interconnectors still dominate the overall mix, there is only one new CCGT, Eggborough, rated at 1.5 GW. As existing gas plants age and shut down, this lack of new capacity will come back to haunt us.