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What is the Capacity Market?

The Capacity Market, often shortened to CM, is a UK government scheme that pays generators and demand-side response providers to be available to deliver or reduce electricity demand during periods of system stress. The scheme ensures that sufficient generation capacity is available to meet demand even when intermittent renewables are not generating. Costs are recovered from electricity consumers through suppliers, and appear on UK electricity bills as a recoverable charge.

The Capacity Market is part of the UK Electricity Market Reform package introduced in 2014. It is one of three major bill-recovered support schemes (alongside the Renewables Obligation and Contracts for Difference) that fund the transition to a low-carbon electricity system while maintaining security of supply. Capacity Market costs typically account for 2 to 4 per cent of a UK business electricity bill.

Why the Capacity Market exists

As the UK electricity system has transitioned to renewable generation, the share of intermittent wind and solar has grown substantially. Wind and solar generate when conditions allow, not necessarily when demand requires. To ensure the system can meet demand at all times, additional dispatchable capacity (generation that can be called on when needed) and demand-side flexibility (load that can be reduced when needed) must be available.

The Capacity Market provides a market-based mechanism to procure that capacity. Providers commit to being available during defined delivery periods (typically winter months when peak demand occurs) and are paid for the availability regardless of whether they are actually called on.

How the Capacity Market works

1. NESO assesses future demand and the capacity required to meet it.
2. The government and Ofgem set the target capacity for each delivery year.
3. Capacity auctions are held (T-4 four years ahead, T-1 one year ahead) at which providers bid to deliver capacity at the lowest cost.
4. Successful bidders receive Capacity Agreements obligating them to deliver capacity in the relevant delivery year.
5. Providers are paid a clearing price per MW of capacity per year for the term of the agreement (1 to 15 years depending on the technology).
6. The cost is recovered from suppliers based on each supplier share of peak demand, and passed through to consumers via bills.

Capacity auctions

Two main auctions are held each year:

• T-4 auction. Held four years before the delivery year. Procures the bulk of capacity for the delivery year. Long agreements (up to 15 years for new build) are typically awarded here.
• T-1 auction. Held one year before the delivery year. Procures the remaining capacity needed to top up the T-4 result. Shorter one-year agreements are typically awarded.

The clearing price in each auction is the highest bid required to procure the target capacity. All successful providers are paid the same clearing price (a “pay-as-clear” auction structure). Recent clearing prices have ranged from £6 to £75 per kW-year depending on the auction and market conditions.

Capacity providers

Successful Capacity Market providers include:

• Existing generators. Gas-fired power stations, coal (now exiting), biomass, hydro, nuclear, and other dispatchable plant.
• New-build generators. Reciprocating gas engines, gas peaking plants, battery storage.
• Battery storage. Increasingly significant. Storage is derated based on duration, with longer-duration batteries earning higher capacity payments.
• Demand-side response (DSR). Industrial and commercial sites that commit to reducing demand on instruction during stress periods.
• Interconnectors. Cross-border links to France, Netherlands, Belgium, Ireland, and Norway can bid for capacity payments.

Cost on UK bills

Capacity Market costs are recovered from suppliers, who recover from consumers. Typical figures:

• Around 0.5 to 1.5 p/kWh on UK business electricity bills.
• 2 to 4 per cent of a typical business unit rate.
• Annual cost for a 100,000 kWh per year business: approximately £500 to £1,500.

The cost varies year to year with the clearing prices in recent auctions. Higher capacity prices (reflecting tight supply-demand conditions) feed through to higher consumer costs.

Demand-side response in the Capacity Market

Demand-side response (DSR) is a growing share of Capacity Market provision. Sites that can reduce demand on instruction (industrial loads, refrigeration, EV charging, electric heating) can bid for capacity payments alongside generators.

To participate:

• The site demonstrates ability to reduce demand by a defined minimum capacity for a defined duration.
• Bids into a relevant Capacity Market auction directly or via an aggregator.
• If successful, receives a Capacity Agreement and the clearing price per kW of derated capacity per year.
• During delivery year, responds to NESO instructions to reduce demand during stress events. Each event is typically 30 minutes to 4 hours.

For larger sites with flexible load, Capacity Market participation can produce material revenue (typically £5,000 to £50,000 per year per MW of DSR depending on clearing prices). Most DSR participation is via aggregators that bundle multiple sites and handle the operational requirements.

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