Backup power installations funded by tax incentive schemes have distorted the UK’s capacity market and negatively affected costs for taxpayers, a new report has claimed.

Energy policy consultancy Ecuity’s analysis, undertaken for independent power producer UK Power Reserve, found that the nation’s capacity market auctions for the past two years have been distorted by low bids from players using investment with special tax relief, creating profit margin disparity, “an un-level playing field” and “a mini-investment bubble”.  

“The players in question are investing in power generation units with taxpayer-funded risk finance schemes like the Enterprise Investment Scheme (EIS), Venture Capital Trust (VCT) and Seed Enterprise Investment Scheme (SEIS) which the government set up to incentivize investment in high risk businesses,” UK Power Reserve said. “This kind of power generation is not high risk. Investors can earn up to six times their initial investment in just four years with tax relief.”

James Higgins, a Partner at Ecuity, said: “Being able to bid at a low level, while still getting high returns on their investment, means that the outturn price of the 2014 and 2015 capacity market auction has been lower than anticipated and the government has not been able to secure the right generation mix via the capacity mechanism.  

“In particular,” he added, “large gas-fired power stations (CCGTs) have been squeezed out of the mix because they would not make a profit at the outturn price.”

Ecuity estimated that 705 MW in backup power capacity has benefited from tax breaks in addition to capacity market payments.  

The Department of Business, Energy and Industrial Strategy (BEIS) has opened a consultation on the issue, and has proposed offsetting capacity payments against tax relief.

UK Power Reserve CEO Tim Emrich said: “It is important reforms happen and we welcome BEIS’s efforts to close the loophole because we estimate a further 1 GW+ of tax relief-funded capacity could emerge in the 2016 CMA.

“Ecuity’s analysis shows BEIS’s proposals must however be strengthened to sufficiently remove the subsidy, level the playing field, and ensure the government gets its desired energy mix.”