Security of Supply, the Role of Interconnectors and Option Values : insights from the GB Capacity Auction

The UK Government has carefully designed a Capacity Mechanism to deliver reliable electricity. This paper criticises the determination of the amount to procure, and argues that the amount set for the first auction was excessive, particularly (but not exclusively) in ignoring the contribution from interconnectors. Too little attention was given to either the political economy or the option value aspects. Procuring too little raises fears of ‘the lights going out’, but over-procurement increases consumer costs; undermines renewables by transferring capped finance to fossil generators; and impedes the Single Market including by weakening the business case for interconnectors. Making more use of the demand-side and potentially available ‘latent’ capacity lowers risk and increases options allowing more capacity procurement to be deferred. Capacity markets are intended to address problems of ‘missing money’ in terms of energy-only market incentives to invest; but over-procurement risks exacerbating the underlying problem, whereas addressing market failures and missing markets, and properly accounting for interconnectors, reduces the underlying problem.