* SSE not to invest in new plants until 2016
* Govt needs to speed up capacity mechanism - SSE
* Tighter capacity margins will increase volatility
LONDON, March 21 (Reuters) - British utility SSE Plc is to shut a quarter of its polluting and unprofitable power capacity over the coming year, warning that the government is seriously underestimating a looming electricity shortage.
Adding to supply concerns after closures announced by other operators, SSE also warned that a lack of clarity on proposed changes to the electricity market meant it would not decide to build any new power stations over the coming three years.
"The government is significantly underestimating the scale of the capacity crunch facing the UK in the next three years and there is a very real risk of the lights going out as a result," said Ian Marchant, chief executive of SSE, in a statement on Thursday.
SSE's review will lead to the closure of its power station at Slough, west of London, the mothballing of Keadby in eastern England and the shutdown of some units at three other sites - Ferrybridge in northern England, Uskmouth in Wales and Peterhead in Scotland.
Around a fifth of Britain's power plants are set to close by 2020 as old, polluting plants shut and the supply gap is worsened by operators' decisions to mothball unprofitable gas plants that have been hit by high input prices.
The head of Britain's energy regulator warned last month that Britons faced rising energy prices in a supply roller-coaster, as spare capacity margins tighten to as low of 4 percent, compared with around 14 percent now.
RWE npower will this week close its huge Didcot A coal-fired power station, while Scottish Power (part of Spain's Iberdrola ) produced the last electricity at its Cockenzie power plant last week.
SSE said the government needs to speed up its electricity market reforms and offer a so-called capacity mechanism, where power plants are rewarded for being on standy-by, from 2014 instead of the planned 2018 start date.
"We are not complacent about this, which is why we have an insurance policy - the capacity market," said Energy Minister John Hayes in a statement. "We're considering how and when this can best be used to bring about any necessary increase in supply or reduction in demand."
Analysts said it was unlikely Britain's lights would dim but a squeeze on capacity would increase price volatility.
"I don't think you'll see the lights go out, I think you'll see volatility in the prices, that's how it will manifest itself," said Iain Turner, analyst at Exane BNP Paribas.
Power traders said the plant closures had been largely expected and priced into forward power contracts, but agreed that tighter margins had added to price volatility, especially when there was high wind power production.