The Capacity Market: Focus on Phase 2 Proposals

1. Background  

The GB Capacity Market regime (the “CM Regime”) continues to act as a fundamental pillar of the UK government’s approach to preserving reliable electricity supply in such a way that meets demand and avoids the potential risks associated with shortfalls in generating capacity.

In June 2023, the Department for Energy Security & Net Zero (“DESNZ”) published a summary of the responses (“Phase 1 Consultation Response”) to a consultation (the “Consultation”) on CM Regime reforms (for which CMS previously published a LawNow summarising the findings here).

The Phase 1 Consultation Response focussed on various government proposals, the key themes involved: (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 seeking to participate in a Contract for Difference (“CfD”) allocation round.

In line with the government’s desire to continue improving security of supply within the context of its wider push to achieve net zero, responses to ‘Phase 2’ of the Consultation were published in July 2024 (“Phase 2 Consultation Response”). 

This article focusses specifically on four key themes emerging from the government’s proposals to improve supply security and addressing investment in low carbon technologies, in particular: (i) proposals to align Regulation 50 with policy intent; (ii) the proposal to change Regulation 16(2) clarifying non-permitted CM and CfD participation; (iii) addressing challenges faced by batteries in the CM; and (iv) proposals related to projects with long build times.

2. Improving security of supply

1. Extended Performance Tests (“EPTs”) and aligning Regulation 50 with policy intent
   
   Proposal:  
   
   The Consultation proposed that Regulation 50 be amended to further align with CM rules, providing that failure to meet EPTs would be treated in the same way as a failure to meet SPDs in respect of suspension of payments. Currently, EPTs are undertaken to ensure that storage CMUs can provide capacity for the required duration – requiring performance demonstration “at a level to or greater than its Adjusted Connection Capacity for the number of consecutive Settlement Periods that is equivalent in duration to the specified minimum duration for that Storage Generating Technology Class.”^[1]
   
   Responses:
   
   A large majority of stakeholder responses to the proposal were positive. In particular, it was noted that it made practical sense from a security of supply perspective to align the treatment of EPTs and SPDs given the similar nature of both concepts as demonstrations of performance.
   
   Notes of caution were expressed by some respondents who argued against a blank application of EPTs, suggesting that they should not apply to demand side response CMUs but rather only to storage resources on the basis that application to the former would be too costly. Other respondents noted that sight of the specific drafting of any proposed amendment to Regulation 50 would be required prior to any substantive response being provided.
   
   Ultimately, the government confirmed that the proposal will not be introduced before pre-qualification in 2024 due to parliamentary time restrictions.
    
2. Clarifying non-permitted CM and CfD participation
   
   Proposal:
   
   The Consultation has furthered its focus on streamlining the regulations related to non-permitted CM and CfD participation. As addressed in a previous LawNow here, the government sought responses to a proposal to both simplify and increase certainty in the transfer process.
   
   The proposed amendment would be to clarify that “a CMU can only be prequalified where no CfD has been awarded in respect of it, even if the CfD is for a later delivery period, unless the CfD in question has expired or been terminated”.
   
   Responses:
   
   There was a mixed response amongst stakeholders to the proposal – with 14 out of 30 expressing support. Those supportive of the proposal were encouraging of the need to ensure further clarification in the drafting of the regulation and to firm up the initial policy intent to prohibit CFD generators from gaining access to CM prior to the start of a CfD agreement – specifically in terms of when a CfD is deemed to apply (being the point at which it is awarded).
   
   Four respondents opposed the proposal on the basis that the additional suggested language remains ambiguous, and that further clarificatory wording is needed to capture situations where CfD and CM auctions overlapped. Specifically, one respondent suggested it would be desirable to note that a CMU can only prequalify in circumstances where a CfD has been “entered into” rather than “awarded”. 
   
   The government confirmed that the proposal will not be introduced before pre-qualification in 2024 due to parliamentary time restrictions.

3. Addressing investment in low carbon technologies

1. Addressing challenges faced by batteries in the Capacity Market
   
   Proposal:
   
   With increased participation in the Capacity Market from CMUs with a generating technology class, capacity providers had raised concerns about the ability of battery storage CMUs to meet the EPT over the course of multiple years. In order to address these concerns, the government proposed to do the following:

• amend Rule 4.4.4 of the CM Rules, to enable Permitted Augmentation of battery storage sites; and
• enable the level of EPT requirement to be appropriately adjusted when secondary trading occurs.
  
  The government will now introduce a definition of ‘Permitted Battery Augmentation’ consistent with previous guidance. Such definition will not allow for a Capacity Provider to supplement a CMU’s capacity with capacity from another CMU or increase its auction acquired capacity obligation. In line with the proposal, the CM Rules will be amended to enable the MW requirement of the EPT to be appropriately reduced when secondary trading takes place. The requirement will also increase if the CMU is a CMU Transferee. Similarly, where a Capacity Provider’s Capacity Obligation is increased through secondary trade, the Rules will also be amended ensuring that adjusted connection capacity is increased.
  
  Response:
  
  With regards to amending the definition of ‘Permitted Augmentation’ 19 out of 30 responses agreed with the proposal and noted the current ambiguity associated with Rule 4.4.4. The government also sought responses on any unintended consequences that could arise from the amendment to the definition. A number of respondents could foresee an opportunity for market gaming and suggested that a potential method to address this is by including retesting requirements or requiring the secondary trade to cover the relevant three Delivery Years. Several respondents also felt there was a need for further certainty in respect of how the Technology Class Weighted Average (“TCWAA”) threshold figure is utilised in EPT calculations. In response, the government has stated no amendment to the Rules is necessary because the TCWAA of a battery Storage CMU that is the subject of a multi-year Capacity Agreement should not change during the course of that Capacity Agreement.
  
  Respondents were also asked to provide their input on any other changes they perceived to be required in order to accommodate the amendment of ‘Permitted Augmentation’, 21 out of 25 respondents put forward additional changes. A key suggestion that arose was a demand for wider changes to secondary trading given the current limited nature of the secondary market. Further, respondents felt that there was a need for the government to prioritise introducing wider measures to manage battery degradation and introduce policies that reduce the risk of agreement termination for CMUs.
  
  In respect of the EPT regime, the government sought comments regarding the retention of the framework for storage CMUs. Respondents questioned the continuing use of the EPT regime with a majority suggesting recommendations that go beyond the EPT framework such as the introduction of degradation profile and believe the current proposal does not manage degradation adequately. Despite the above, the government has confirmed that it considers the EPT framework as necessary to ensure confidence in Storage CMUs.
  
  b. Projects with long build times
  
  Proposal:
  
  The Phase 2 consultation highlighted challenges faced by projects with long build terms. To address this, the government proposed the following:
   
• Declared (12-month) long stop date - providing prospective generation CMUs with up to 12 months additional construction time and declare at prequalification its intent to deliver for the start of the second Delivery Year.
• Declared additional (24-month) long stop date – providing prospective generation CMUs with up to 24 months additional construction time and declare at prequalification its intent to deliver for the start of the third Delivery Year.
  
  Response:
  
  When asked if they agreed with the introduction of the declared longstops, 20 out of 30 respondents agreed with the proposal, 6 partially agreed and 4 disagreed. Those that agreed highlighted that the proposal achieved a balance between supporting projects and maintaining the current auction design and processes. Some respondents felt that the additional 24 months was not sufficient for large-scale projects, suggesting 36 months as an alternative.
  
  By contrast, when asked if the 12-month long stop date provide developers with any benefits in comparison with existing long stop process, the responses were much more mixed. Of the 15 responses received, 6 felt that there were benefits, 5 had mixed views and 4 felt that there were no benefits.
  
  Similarly, when asked whether a declared additional 24-month long stop date, together with Rule 6.7.7 (if applicable) and the existing 120 working days from a Notice of Intention to Terminate provide sufficient time for slippage, of the 14 responses received, 5 agreed, 5 provided mixed responses and 4 disagreed. Whilst several respondents felt the 24-month period was sufficient, some respondents felt that long build projects are likely to be complex and Capex intensive.
  
  With regards to the eligibility criteria, the majority of respondents agreed with the criteria and felt that it was proportionate and that only projects that genuinely required longer construction times would benefit from it.
  
  The government confirmed that the proposal will not be introduced before pre-qualification in 2024 due to parliamentary time restrictions.

4. Conclusion

The Phase 2 Consultation Response highlights the UK government's ongoing efforts to enhance the GB Capacity Market (CM) regime, particularly in improving system security and encouraging investment in low-carbon technologies.

While stakeholders generally support these measures, some have expressed concerns about potential ambiguities and the adequacy of certain provisions. The government has acknowledged these responses but confirmed that some of these proposals will not be implemented before the 2024 pre-qualification due to parliamentary time constraints. The ongoing dialogue underscores the complex balance required to secure a reliable and low-carbon electricity supply amidst evolving market and technological dynamics.

Article co-authored by Tom O'Mahony and Nevine Singer, Trainee Solicitors at CMS.
 

[1] Capacity Market 2023 consultation (publishing.service.gov.uk)