This month we found out that the government intends to amend the Energy Bill to provide financial payments for electricity saving. Whilst not perfect, this is a significant first step toward creating a market for ‘negawatts’ in the UK.

Including energy efficiency in capacity markets is a win for consumers as it should significantly reduce the cost of the mechanism. Capacity markets that have supported the growth of demand side response and energy efficiency have shown that they significantly lower the clearing price. One US study suggests that participation of demand side resources in the first New England auction potentially saved customers as much as $280 million by lowering the price paid to all capacity resources in the market¹.

However there are risks and Green Alliance and others have raised with government a number of concerns about this route to deliver efficiency. Primarily we fear that the capacity mechanism won’t provide enough funding and that the instrument may be too complex for many to participate.
What those international experiences with capacity markets also show is that even with careful design, energy efficiency projects at best get 5% of total capacity market revenues. Yes, it brings down the price of capacity, but it doesn’t do very much for energy saving. The money from capacity markets is only used to top up funding from other sources. In Massachusetts for example, the capacity market is only responsible for 7% of the state’s energy efficiency programmes, the rest comes from a regional carbon trading scheme and a supplier obligation.

Government therefore now needs to do three things to ensure we successfully prioritise electricity saving:

1. Get the pilot right –the government also announced that it would first run a pilot to see how efficiency could work in a capacity auction. There is however nothing in the proposed Energy Bill amendment to stop government from trialling a range of approaches, including something simpler like a feed-in tariff to see what works best. The pilot is far from certain to happen – as its funding is subject to the upcoming spending review negotiations. Given the significant potential to save consumers’ money, it is vital that the pilot is given the funding it needs. It’s also essential that the pilot is set up as soon as possible so that efficiency has a chance to establish itself before we introduce the capacity market. Different approaches and technologies should be trialled in different locations with a range of end users to see what works best.
2. Don’t buy too much capacity in the first main auction – alongside the main auction, the government intends to run a series of trial auctions for the smaller participants that would struggle to compete in the main capacity auction such as demand side response and storage providers. Ideally government should wait to see the result of these auctions before introducing a market wide capacity mechanism. There is a risk that buying too much in the first main auction could make the capacity market a one hit wonder, depressing the price in subsequent auctions and locking the government into expensive contracts for unnecessary new capacity. This would reduce the scope for the growth of alternatives like demand side response and energy efficiency.
3. Go beyond the capacity mechanism – The capacity market will provide for a fraction of the potential for increasing our energy efficiency. As a result this approach will need to be part of an effective wider policy framework – it won’t deliver on its own. Revenue from the capacity market needs to be combined with other revenue streams (eg from network companies and energy suppliers) to ensure efficiency gets the funding it deserves.

Without these steps we are unlikely to go any way towards delivering the vast potential for electricity saving across the economy. This would be bad news for consumers, the environment and our economy.

Rachel Cary, senior policy adviser, Green Alliance, May 2013.
Rachel leads Green Alliance’s low carbon energy theme of work.