It might be coincidence by this all happened when I moved to Catalina OS 10.15.6, but was ok in previous version of Catalina.
More likely you were just lucky to get away with it that long.. 10.15.5 is when lots of new people got added to the lists.
Catalina has determined it needs to create a whole new backup. The why is very obscure.. but now that it has happened you really need to figure out how to move forward which is not easy.
I was under the impression it automatically deleted backups, which it must as it Time machine reports oldest backup is 26th May 2018, yet does it delete enough space to generate the new required size ?
That works as long as you never upgrade or install large patches. In fact for ages now the issue is Time Machine cannot figure out what to delete to reduce the size of the backup because it does not have enough details on which files are essential and which are not.
Failed backups also create havoc. The fact that you attempted to backup by excluding the user files just leads to making the old backup less usable.
how do I release some of the older backups on the time capsule if OS is now unable to do this ?
Attempts to do this yourself are specularly unsuccessful. Don't bother.
You need to wipe the existing backup/s and start over.
If you wish to retain the history you can archive the existing backups. Airport Utility disk tab offers archive.. so plug a standard Mac formatted USB drive 3TB or larger, into the TC and archive.. it will take 1-2days.
Then you can start over.
Or just shrug.. consider that old backups for a working computer.. to which you are doing the right thing by creating a new backup will be unlikely to help in the future.. just do a quick erase of the drive and start over.
However Catalina is having issues backing up to network drives.. especially the Apple Time Capsule.. which is now out of date since Apple moved protocols for network to SMB3. TC only ever supported SMB1 which is now a security risk and deprecated across all OS.
We are strongly recommending people use Carbon Copy Cloner or equivalent 3rd party app for now.. big sur might finally invest in updates to Time Machine.
My Airport Time Capsule has been backing up daily since 2015
On a more general note.. 5 years on a TC is pretty well its economic lifespan. Hard disks do not last forever and the risk of total failure is increasing daily. You may like to consider moving to other ways of backing up.
Apple got out of the business. For now the best, cheapest and most reliable solution is a USB drive plugged directly to the computer as you are doing.
For networks a NAS.. synology for example is best.. but they are expensive.