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2004-05 Seminars

Generation Adequacy and Investment Incentives in the UK: from the Pool to NETA

Fabien Roques
PhD Student, Judge Institute of Management, Cambridge University

Abstract
There is no consensus among academics on which market design provides the least distorting long term investment incentives. Theoretical rationale and practical experience suggest that ‘energy-only’ markets such as NETA in the UK with spot prices that are allowed to reflect scarcity rents will generate sufficient income to allow capacity cost recovery by generators. However different market designs, with separate payments for capacity or reserve obligations have the advantage of not relying on infrequent price spikes to remunerate reserve capacity. Three years after the controversial change of the UK market design from the compulsory Pool with capacity payments to the decentralised energy-only NETA market framework, we contrast the two market designs in terms of investment incentives. We review the biases of the Pool capacity payments design, the draught of investment under NETA, and the reaction of the market during the first “stress-test” of NETA during the winter 2003. In an energy only market such as NETA, it is essential that price signals are right and the system operator has a crucial role in contracting ahead for reserve. We thus recommend that NETA comes back to a single marginal imbalance price as dual imbalance pricing conjugated with an average price calculation biases price signals in times of scarcity. We then turn to the current hedging and financing difficulties of power projects and show that vertical and horizontal reintegration compensate for the lack of long term contracting. Lastly we investigate the case for the re-introduction of a capacity payment in the UK, and argue that this is essentially a policy issue depending on the degree of volatility which is considered as being acceptable, but that it is not necessary as long as the flaws of NETA balancing mechanism are fixed.