The Department for Energy Security & Net Zero responds to the Capacity Market Consultation

Introduction

On 12 June 2023, the Department for Energy Security & Net Zero (“DESNZ”) published a summary of the responses (the “Consultation Response”) to its consultation on a range of potential reforms to the GB Capacity Market (“CM”) (the “Consultation”). The proposed reforms in the Consultation were stated to be aimed at incentivising greater investment in low carbon technologies through closer alignment with the UK’s 2035 net-zero commitments, and our commentary on the Consultation can be found here.

Whilst the Consultation Response covers a range of responses to the proposals introduced in the Consultation, this article focuses specifically on the government’s responses to three of the proposals in more depth: (i) strengthening security of supply through a reorganisation of the Satisfactory Performance Day Requirements; (ii) strengthening the non-delivery penalty regime during a System Stress Event; and (iii) the exit regime for projects looking to participate in a Contract for Difference (“CfD”) allocation round.

The government intends to take forward the proposals in two phases. Phase 1 consists of proposals to be implemented prior to the CM auctions, phase 2 includes proposals requiring further analysis and development, with a view to implementing these from 2024 at the earliest.

Satisfactory Performance Days

Proposal     

The proposal set out in the Consultation is to the revise the Satisfactory Performance Days (“SPDs”) 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). Where an SPD is not demonstrated in the required window, Capacity Payments would be suspended and the Capacity Market Units (“CMUs”) 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. The Consultation also put forward the proposal 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.

Responses

Although the proposal would optimise the Delivery Body’s ability to monitor Capacity Providers’ compliance with SPDs while also providing certainty to CMUs, the majority of responses disagree with the proposal. Many responses did not agree with the timings of the proposed SPD windows, with a strong consensus that the proposed SPD windows were too prescriptive and may not reflect the needs of the electricity system. The most popular suggestion proposed by respondents was to broaden windows across the winter period, for example by having two windows that each cover three months and require a certain number of SPDs to be demonstrated in each. Most stakeholders disagree with the proposed changes to termination feeling that it would have unintended consequences and support removing the risk of early termination, particularly for failing to demonstrate just one SPD.

The Consultation also considered if part-secondary traded capacity to demonstrate net capacity SPDs could remedy an unintended loophole whereby a Capacity Provider who proactively seeks to secondary trade its Capacity Obligation could still be penalised for falling below its original capacity commitment. Respondents largely agree providing an overall positive response to the proposal. Of the respondents who proposed alternatives to the SPD proposal, the majority felt that improvements to secondary trading should be made before introducing changes to SPD arrangements. Respondents believed this would enable Capacity Providers to better manage risks of failing to meet SPDs and address concerns over potential impacts on electricity security from termination.

The government will not be implementing the proposal as consulted on at this stage, instead the proposal will progress this policy as part of phase 2. The further review of the proposal will include a consideration of what further steps might be appropriate to strengthen delivery assurance and to explore interactions between changes to the testing and performance regime and secondary trading arrangements.

Penalty Regime in the event of a System Stress Event 

Proposal

In the Consultation, DESNZ proposed to strengthen the non-delivery penalty regime in a System Stress Event sixfold so that the full calculation for the penalty regime would be: Penalty rate (expressed in £/MWh) = clearing price (£/MW) x 1/4 instead of 1/24. While the proposal sends a clear signal to discourage non-delivery in a System Stress Event, no plans were proposed to change the penalty caps, leaving the overall limit of liability unchanged.

Responses

Half of the respondents did not support the proposal to strengthen the non-delivery penalty regime. Whilst there was some support for the principle behind a strengthened penalty regime, the respondents opposed to the proposal noted that the change would have a number of unintended consequences, such as the impact of high costs on CM participation and investment incentives.

In addition, some respondents considered that, given there have been no System Stress Events since the implementation of the CM in 2014, there is insufficient evidence that a change to the penalty framework is required to better incentivise delivery and that the impact of the proposed change to the penalty rate is therefore uncertain. Some stakeholders also felt that improvements to secondary trading were required before changing the penalty regime to enable Capacity Providers to better manage risks of non-delivery.

Respondents did generally agree with DESNZ’s view that the increase in penalty rate raised concerns around a potential imbalance between penalty rate and the monthly penalty caps that would remain unchanged. Respondents noted that the proposed increased rate would mean that CMUs that did not deliver during a System Stress Event would reach their monthly penalty cap within 40 minutes under the proposed rate. As such, these respondents felt that this risked removing incentives to deliver once the penalty cap is reached, which could worsen security of supply impacts.

In light of concerns raised in relation to the interaction between the penalty rate and penalty cap, and the potential unintended consequences for security of supply, the government has decided not to make changes ahead of the 2023 CM prequalification window and will progress the policy proposal as part of phase 2.

Changes to the Capacity Market/CFD Transfer Process

Proposal

Although CMUs cannot receive subsidies from both the CM and the CfD scheme in tandem, Capacity Providers can 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. 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. In the Consultation, DESNZ put forward the proposal to amend the definition of a CfD Transfer Notice so that only a statement confirming that a Capacity Provider is withdrawing from the CM is required in order to become eligible to bid in a CfD Allocation Round.

Response

The amendment to the definition would give Capacity Providers more certainty on the transfer process. The majority of respondents support this view and the proposal, asserting that the route should be made to available future agreements and that the option for voluntary termination of capacity agreements should be extended to other government energy support schemes that are currently not directly referenced in CM legislation, including those that may be available in the future. The government intends to keep this under review to ensure continued alignment with Subsidy Control principles and wider energy market developments.

In our previous Law-Now, we noted that withdrawing from the CM does not equate with success in the CfD auction and some supportive respondents also noted uncertainty over future support for low carbon projects and indicated support for allowing greater certainty of CfD support before terminating capacity agreements to provide revenue certainty and avoid knock-on impacts for security of supply. The government considers it is fair and appropriate that CMUs intending to utilise this route would be required to withdraw from the CM without certainty of being successful in the relevant CfD allocation round.

We also mentioned the risks that may arise from allowing switching, which could undermine the overarching objective of ensuring security of supply or at least reduce the amounts that would be secured through the longer term (T-4 auctions), leaving more participation in the T-1 auctions. The few respondents who did not support the proposal agree with this and raised this concern in their responses.

The government intends to implement the amendments to the definition of the CfD Transfer Notice as consulted as part of phase 1, with a view to implement the proposal prior to the 2024 CM auctions. The government also plans to continue exploring whether the CM to CfD transfer route remains appropriate for future agreements or if further amendments may be required in the future.

Conclusion

On 12 June 2023, DESNZ laid the Electricity Capacity (Amendment) Regulations 2023 before Parliament which included amendments made to the definition of the CfD Transfer Notice set out in Regulation 34 or the Electricity Capacity Regulations 2014. This definition is updated in alignment with the proposal put forward in the Consultation.

DESNZ will look to review the proposals on SPDs and strengthening the non-delivery penalty regime with the aim of implementing the updated proposals from 2024 at the earliest.

The CM regime and implementation of the proposals will also be subject to ongoing compliance with the UK’s new domestic subsidy control regime that, which was established under the Subsidy Control Act 2022. As part of this, the government will consider if a further consultation is needed to seek additional stakeholder views on these proposals.

It is clear from the Consultation and the Consultation Response that both DESNZ and industry are 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.