Capacity Market—five-year review

Original news

The Capacity Market has operated efficiently in its first five years, review concludes, LNB News 31/07/2019 98.

The Department for Business, Energy & Industrial Strategy (BEIS) has published a review of the CM’s first five years of operation, 2014–19. The review assesses the scheme to be working well and no major changes have been proposed. However, BEIS intends to continue to make incremental changes to the CM, on the basis of its operation and the responses to BEIS’ call for evidence.

What is the background to this report?

The government issued a call for evidence on the Great Britain Capacity Market and Emissions Performance Standards in August 2018 and published the responses in March 2019. The report also comes at the end of the first year of capacity being delivered under the full CM mechanism. There have been a number of recent changes to the CM framework, both to refine and develop the CM and to manage the ongoing standstill of the market following the annulment of its state aid clearance in November 2018.

Given the complexity of the CM framework, it is not surprising that the background and context of the report isn’t straightforward. At its core, the report on the five-year review has been published by the government with four aims in mind. These include:

• satisfying the government’s obligations under the Capacity Market Rules and SI 2014/2043
• forming the basis of a wider report that the government is obliged to lay before Parliament under the Energy Act 2013 (EA 2013), and
• satisfying the terms of the original state aid clearance of the CM, even though that clearance has now been annulled

EA 2013, SI 2014/2043, and the Capacity Market Rules are broadly aligned in requiring the government to assess whether the objectives of the relevant aspects of the CM are being achieved, whether those objectives are still appropriate and, if so, whether they could be achieved with less regulation or in a less burdensome way. It is therefore understandable that the government has sought to achieve this via a single review.

The government has also dealt with the questions of whether the CM is still required—it quickly concluded yes – and the next steps needed to develop and assess the CM over the coming years.

What are the key findings to come out of the report?

The report concludes that the CM is meeting its central objectives and says the mechanism in its current form is necessary for maintaining security of electricity supply in a cost-effective way. The government continues to believe that the security of the country’s electricity supply would be unacceptably uncertain in the coming years without the financial support provided via the CM.

This is particularly so, given the closure of old coal and nuclear generation during the 2020s. The report also re-emphasises that the government remains wedded to the CM as the appropriate mechanism for providing the market with this ‘missing money’. It discounts a move away from a CM to, for example, the strategic reserve approach seen elsewhere. The report also resists adding other core objectives to the CM, noting that issues such as decarbonisation of electricity generation should be achieved and protected through external regulations or policy.

The report does, however, conclude that the government will evaluate a number of potential changes to the CM, so it can meet its objectives more effectively. These act as a useful pathfinder for the likely future direction of the CM.

What do you expect to see coming up for consultation in the future?

The report notes that a level playing field between technologies, so that their contribution to security of supply is fairly taken into account, is important. In light of this, the report suggests that the government will review a number of changes across the themes of security of supply, cost-effectiveness, and the avoidance of unintended consequences.

These include consulting on the general simplification of de-rating—the level of reliability the mechanism attributes to each technology type—in late 2019. To date, the approach has evolved in a piecemeal fashion across different technologies. There is also the potential removal of the 2 megawatt (MW) minimum capacity threshold to reflect the trend for smaller generation and demand side response (DSR) and the move towards electricity trading in smaller MW increments.

The government will also consider whether to build on the work already done to allow more renewable technologies to participate in the CM. This could be done by providing a de-rating factor and a more sophisticated approach to connection capacity that allows for renewable ‘hybrid’ projects—where renewable generation is coupled with other technologies, most notably storage—to participate in the CM as one project.

There will also be a further examination of the potential for ‘battery augmentation’—enhancements made to battery storage projects during the course of their lifetime—to be acknowledged or provided for within the CM mechanism.

Perhaps most significantly in this levelling of the playing field section of the report, the government notes areas of specific interest around DSR, such as the one-year limit for capacity agreements. While it is minded to maintain the limit, it acknowledges some in the industry have argued for change and it promises to engage with them over the agreement lengths.

On interconnection, the report notes the upcoming and important move to allow foreign plants to participate directly in the CM as required by virtue of Regulation (EU) 2019/943, the Recast Electricity Regulation. At present, foreign capacity can only be caught via the participation of electricity interconnectors.

While the report does not highlight this, it is worth noting that the relevant provision of the Recast Electricity Regulation applies from 1 January 2020. Therefore, in the event of a no-deal Brexit before this date, the European Union (Withdrawal) Act 2018 means this requirement would not become retained EU law in the UK and so the obligation to implement it may not arise. However, clearly this is both subject to the timing of Brexit and to any agreements reached between the UK and the EU in respect of the EU internal energy market more generally.

In addition, the report discusses the need to ensure the CM supports the necessary investment in reliable capacity. One of the striking features of the CM to date has been the relatively small volumes of new build/refurbishing generation that has won support, as a result of the low clearing prices.

While the report commits to reviewing the potential for ‘split auctions’—whereby new build capacity participates in a different auction to existing capacity—it appears to suggest the government is at present comfortable with a single auction and with maintaining capacity agreements at the same length. Though not directly linked to the CM—which is a mechanism for the procurement of capacity rather than system services—the recent power cut may, among a number of questions, heighten focus on the types of technology on our system and, in particular, their ability to respond quickly to stabilise the frequency on the system. It will be interesting to see whether this has any impact on the relatively technology agnostic approach of the CM.

However, with a view to ensuring reliable delivery of capacity, the report suggests termination fees will be simplified, with the potential for partial termination introduced, while penalties for non-delivery of capacity during times of system stress will be strengthened.

When it comes to cost-effectiveness, the report suggests the government will be mindful of avoiding over-procurement, given the impact this can have on costs to the consumer and will reassess the way in which the volume of capacity to be procured is calculated.

In the section on avoiding unintended consequences, the report reiterates that, while the primary role of the CM is not to drive decarbonisation, it should be consistent with decarbonisation policies and not prejudice them. Examples are given of moves already made to avoid such inconsistences/unintended consequences, such as the recent introduction of a carbon emissions limit for new plant pursuant to the Recast Electricity Regulation, with a consultation on carbon emissions limits for existing and refurbishing plant launched in tandem with the report. Going forward, the report notes that at present government is particularly mindful that:

• small capacity is not exposed to EU-ETS carbon costs
• the Carbon Capture and Readiness (CCR) requirement (under the Carbon Capture Readiness (Electricity Generating Stations) Regulations 2013, SI 2013/2696) only applies to large plant, and
• behind the meter generation acting as DSR may not be subject to emissions controls. Therefore, the industry can expect to see action on this, if distortions to the CM are precipitated

Is five years the right time scale to judge how the market is developing?

Clearly, five years is a relatively lengthy period, particularly given the speed of evolution of the electricity market. However, given the need to build investor confidence in any mechanism like the CM, as a general rule stability rather than constant wholesale review is to be encouraged. There is also the need for a balance between ongoing reassessment on the one hand and having a sufficient body of data for such reassessment to be meaningful on the other hand. In terms of capacity delivery, the CM has only just got going—and indeed this has been put on hold as a result of the State aid standstill—therefore a review any earlier may well have been premature. It is also worth noting that the five yearly review process does not prevent, and markedly has not prevented, earlier changes being made to the CM mechanism by government and Ofgem when deemed appropriate.

Were there any surprises arising out of the report?

As noted above, the report is primarily a review of the CM to date and a pathfinder for possible future changes, rather than purporting to decide or implement changes. In this context, the report provides a reasonably comprehensive review of the key issues and features noted in respect of the CM to date.

The role and success of different technology classes in the CM has prompted debate for some time—among others the low clearing prices leading to little new build/refurbished capacity being supported, the place of DSR, and the position of interconnection. All of these areas are considered in some detail, but, for the relevant parts of industry there may be disappointment that more fundamental changes have not been signalled.

Relatively few pages are explicitly dedicated to the ongoing standstill of the CM following its state aid clearance being annulled. However, for the industry, this standstill remains a primary issue, with progress on new state aid clearance being achieved a key area of concern and interest.

What, if any, changes to the CM are to be made following the report?

While the report does not implement changes, it does signal possible changes across a wide range of areas. These include a consultation on emissions limits for existing and refurbishing capacity and a consultation before the end of the year on issues such as strengthening the penalty regime.

Interviewed by Grania Langdon-Down.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.