The Capacity Market: What next?

Introduction

Since it was introduced in 2014, the GB Capacity Market regime (the “CM Regime”) has served as a key tool for the UK government to ensure that there is a reliable electricity supply in order to meet peak demands while also safeguarding against shortfalls faced by intermittent energy sources. Security and consistency of energy supply has become an increasingly pertinent political issue in light of on-going threats to long-term gas supplies across Europe following Russia's invasion of Ukraine. With this in mind, the Department for Business, Energy & Industrial Strategy (“BEIS”) is consulting on potential reforms to the CM Regime (the “Consultation”). The Consultation builds upon an initial call for evidence issued in July 2021 which sought views on improving delivery assurance.

The Consultation covers, amongst other things, proposed reforms to the CM Regime that are primarily aimed at incentivising greater investment in low carbon technologies through closer alignment with the UK’s 2035 net-zero commitments. Given how few amendments have been made since the CM Regime was implemented in 2014, it is important for BEIS to address industry concerns and lessons learned over the last 9 years while simultaneously incentivising cleaner technologies. Whilst the Consultation introduces a range of proposals, this article focuses specifically on three of the proposals in more detail: strengthening security of supply through a reorganisation of the Satisfactory Performance Day Requirements, strengthening the non-delivery penalty regime during a System Stress Event, and the exit regime for projects looking to participate in a Contract for Difference (“CfD”) allocation round.

Satisfactory Performance Days

The Consultation proposes strengthening the security of supply provisions to ensure Capacity Market Units (“CMUs”) are capable of delivering during periods of peak demand. In this regard, the Satisfactory Performance Days (“SPDs”) are an important indicator as to whether a facility is both available and capable of meeting its Capacity Obligation, particularly during winter months when demand is higher. Currently CMUs must demonstrate their ability to meet their Capacity Obligation for at least one settlement period on three separate days over the winter period of a Delivery Year. However, the timelines for submission of the SPDs is dependent on the rules in place at the time when the CMU was issued a Capacity Agreement and has, at times, resulted in the Delivery Body only being informed of a CMU’s pass/failing of an SPD test in April, after the relevant winter. This is too late for the Delivery Body to address any concerns and does not provide the necessary assurance that a CMU is capable of satisfying its Capacity Obligation through months of peak demand.

The proposal is to revise the SPD regime so as to require facilities to demonstrate SPDs between three pre-defined periods (1 October-31 October for SPD 1, 1 January-31 January for SPD 2 and 1 March-31 March for SPD 3). The proposal seeks to ensure that a CMU is capable of delivering its Capacity Obligation at the start of the relevant winter with the subsequent two SPD windows then targeting continued assurance of this fact. The Consultation sets out where an SPD is not demonstrated in the required window, Capacity Payments would be suspended and the CMU would have an additional month to meet its SPD requirement. If the SPD is still not demonstrated during the extended pass window, Capacity Payments would continue to be suspended and the Delivery Body may terminate the Capacity Agreement. It has also been proposed to clarify that CMUs that have a traded part of their Capacity Obligation will be required to demonstrate an SPD commensurate with its net capacity obligation following such secondary trade.

This proposal would optimise the Delivery Body’s ability to monitor Capacity Providers’ compliance with SPDs while also providing certainty to CMUs as to when SPDs must be submitted and the consequences for failing to do so. The suggestion that part-secondary traded capacity commitments need only demonstrate net capacity SPDs following such a trade also seeks to remedy an unintended loophole whereby a Capacity Provider who proactively seeks to secondary trade its Capacity Obligation, so as to avoid falling below its original Capacity Commitment, could still be penalised for doing so.

Penalty Regime in the event of a System Stress Event

BEIS proposes to significantly increase the penalty for non-delivery in a System Stress Event. The proposal is to increase the penalty sixfold so that the full calculation for the penalty regime would then be: Penalty rate (expressed in £/MWh) = clearing price (£/MW) x 1/4 instead of 1/24 ). However, there are no plans to change the penalty caps at present, which are 200% of the CMU’s Capacity Payments for the relevant month or if there are multiple months during a Delivery Year where a System Stress Event occurs 100% of annual payments received by the CMU, meaning that the overall limit of liability is unchanged. The existing penalty rate will be retained for any Capacity Agreements that are currently in, or will come into, force prior to any proposed amendments taking effect.

There is a balance to be struck between ensuring that non-compliance penalties are sufficiently robust so as to deter non-performance, while also not making applicants factor increased risk into their auction bids and thereby increasing auction costs or, worse still, not bidding at all. However, while the proposal sends a clear signal to discourage non-delivery in a System Stress Event, it lacks any true ‘bite’ by not exposing providers to additional financial risk, given that the penalty caps are not being raised in parallel. In our view, further thought is required as to the appropriate corresponding penalty cap in order to have a meaningful impact on the behaviour of owners of capacity committed facilities during System Stress Events.

Changes to the Capacity Market/CfD Transfer Process

In order to comply with subsidy rules, CMUs cannot receive subsidies from both the CM Regime and the CfD scheme in tandem. However, Regulation 34(1) of the Electricity Capacity Regulations 2014 allows Capacity Providers to voluntarily withdraw from a Capacity Agreement where it intends to participate in a CfD allocation round. This withdrawal is facilitated by the Delivery Body terminating a Capacity Agreement following receipt of a “CfD Transfer Notice” from a Capacity Provider. However, Regulation 34(3) provides that the CfD Transfer Notice must be issued at least 16 months before the commencement of the CMU’s first Delivery Year under its capacity agreement and also needs to state that the CfD Counterparty intends to grant a CfD to the Capacity Provider in question. This raises a practical issue as the CfD Counterparty cannot know in advance who will be successful in a CfD Allocation Round and as a result cannot provide the statement required in the CfD Transfer Notice.

The proposal is therefore to amend the definition of a CfD Transfer Notice so that only a statement confirming that a Capacity Provider is withdrawing from the CM Regime is required in order to become eligible to bid in a CfD Allocation Round. The 16-month notice period would be retained in order for replacement capacity to be sourced to make up the shortfall in that Delivery Year.

The amendment to the definition of “CfD Transfer Notice” would give Capacity Providers more certainty on the transfer process. Of course, withdrawing from the CM does not equate with success in the CfD auction, so will need to be a commercial decision for the Capacity Provider to make, taking into account the applicable de-rating factors applied to technologies such as wind and solar in the Capacity Market. However, there may be a risk that allowing this switching can also undermine the overarching objective of ensuring security of supply or at least reduces the amounts that would be secured through the longer term (T-4 auctions) leaving more participation in the T-1 auctions. It remains to be seen what the feedback from stakeholders will be regarding this proposal.

Conclusion

It is clear from the consultation that BEIS is mindful of the need to update the CM Regime so as to ensure it is a meaningful tool for guaranteeing certainty of supply and facilitating a progressive net-zero transition in the current GB market. The proposals set out in the Consultation are a step in the right direction but leave some questions open about their wider impacts on the overall aims of the capacity market. Clearly we are going to keep seeing further revisions to the CM Regime, especially as a consequence of the REMA changes when these are introduced. Consideration will also need to be given in relation to the CM Regime’s compliance with the UK’s new domestic subsidy control regime that came in to force on 4 January. BEIS will review responses in the Spring of this year. We therefore expect that the earliest any amendments could be implemented by is 1 October 2024 in the case of T-1 auctions and 1 October 2027 for T-4 auctions.

Consultation closes on 3 March 2023 with findings to be published in Spring 2023.