Is the Capacity Market fit for purpose?: BEIS issues Capacity Market Review

United Kingdom

On 8 August 2018, the Department for Business, Energy and Industrial Strategy (“BEIS”) published a call for evidence for its review of the Capacity Market (“CM”) five years on since the legislation introducing the CM, the Energy Act 2013, was passed (“Call for Evidence”).

The Call for Evidence will assess whether:

  • the CM is still needed in the future;
  • the CM is meeting its objectives of ensuring (1) security of supply, (2) cost effectiveness, and (3) avoiding unintended consequences;
  • these objectives remain appropriate; and
  • these objectives can be achieved in the future in a way that imposes less regulation.

The Call for Evidence is the first step in the CM review process. It seeks views and evidence on the performance of the CM, any issues or opportunities to enhance the operation of the CM and considers whether the CM remains fit for purpose in the changing energy landscape.

In assessing the need for the CM and its objectives, the Government notes that the Industrial Strategy  and Independent Cost of Energy Review have found that the CM continues to be well aligned and central to delivering the Government’s energy priorities, including security of supply and the transition to a low carbon economy. Further, in assessing performance against the CM’s objectives, the Call for Evidence notes that to date the CM has secured the required capacity at an affordable price with a high degree of market liquidity.

Participation of Renewables

BEIS has identified two initial priority issues that it wants to tackle. The first is whether to enable the participation of subsidy-free renewables in the CM and, if so, how to do so. As part of this, BEIS intends to consider:

  • how to de-rate solar and wind technologies so as to ensure that they are rewarded appropriately under the CM;
  • whether the existing penalty regime is sufficient to address the risks of non-dispatchable technology and effectively encourage secondary trading; and
  • how to enable participation of hybrid or co-located capacity (e.g. renewables linked to storage).       

Inter-connector de-rating

The second issue of priority identified by BEIS is the de-rating of interconnectors. It has been suggested by some industry stakeholders that the contribution to security of supply made by interconnectors will diminish as the amount of interconnection on the system grows, and the changing energy system will result in more correlated stress events in interconnected markets, thus reducing the contribution that interconnectors make to security of supply. The Call for Evidence further notes that market conditions have changed since the interconnector participation was introduced in 2015. In particular, some other EU member states have introduced capacity mechanisms (with different penalty regimes), raising concerns about potential ‘double-commitment’ of interconnectors during correlated stress events.

BEIS will consider in the Call for Evidence whether changes to the de-rating methodology are required to ensure future interconnectors are not over-compensated relative to their real contribution to security of supply. In the longer term, BEIS suggests that a more optimal solution could be to facilitate the direct participation of cross-border capacity in the CM.

Supporting Investment in Capacities

To deliver security of supply, the CM aims to support timely investment in both existing and new generation and demand side response (“DSR”) capacity. Currently, CM has design features that help provide investors with confidence needed to commit to such investment, such as 15 – year agreements for new build capacity and a limited liability regime for non-delivery.

However, there are differing views on the need for longer-term agreements in the CM. Some believe that they are unnecessary and potentially distort competition in favour of new build capacity, whereas others would like to see longer-term agreements made available to other technologies such as DSR.

Stakeholders have also expressed concerns that the current penalty regime and four-hour notice period may inadvertently increase cost to consumers and increase security of supply risks.

Delivery of Capacity

Whilst securing capacity at the relevant CM auction is an important first step, it is equally important to have confidence that this capacity will be available in the relevant Delivery Year and deliver on its obligations during System Stress Events.

Previous stakeholder feedback has raised concerns that the penalties for non-delivery during the construction and development phase are set too low to provide an effective incentive and/or to facilitate liquid secondary trading at such capacity. There are also differing views on whether the credit cover and delivery milestones for Unproven DSR provide a sufficient level of assurance or whether these arrangements place Unproven DSR at an advantage over new build generation, which face more onerous requirements.

Some industry participants have criticised the complexity of the termination events and fees currently in place, and the Call for Evidence recognises that some reforms may be required to prevent inconsistencies in treatment between some types of technologies.

Increasing liquidity and competition

The Call for Evidence suggests that the appeals process relating to prequalification is sub-optimal as simple administrative errors by Applicants can potentially lead to the significant amounts of capacity not qualifying for an auction. This introduces a risk to auction liquidity. For instance, 3.73GW did not initially prequalify for the 2017 T-4 Auction.

The Call for Evidence suggests that there may be opportunities to increase competition within the CM by doing more to facilitate greater access to a wider variety of capacity. There have also been calls from some industry participants for the introduction of a framework that would allow overseas capacity to participate directly in the CM. 

Ensuring a level playing field

There remain concerns that the CM does not treat all potential participants equally, for example: 

  • there have been suggestions that despite the change in the methodology for calculating suppliers’ share of the CM costs from net demand to gross demand, this does not mean that grid connected and behind-the meter generation are treated equally may be unjustifiably high, creating market distortions and this does not mean that grid connected and behind-the-meter generation are  de-rated equally;  and
  • issues have also been raised concerning DSR including that the de-rating of DSR may be unjustifiably high, creating market distortions and DSR may be given a competitive advantage in the auctions due to the lighter touch arrangements in place in relation to credit cover, terminations and delivery assurance.

Emission Performance Standard

The Government also has a statutory obligation to review the Emissions Performance Standard (“EPS”). The objective of the EPS is to ensure that new fossil fuel-fired electricity generation contributes to electricity security of supply in a manner consistent with the UK’s decarbonisation objectives. The five-year review of the EPS will answer similar high-level questions to the CM review:

  • whether the measure is achieving its objective;
  • does the objective remain appropriate; and
  • can be achieved in a way that imposes less regulation.

What next

The Call for Evidence will be open for 8 weeks until 1 October 2018. Further instructions on how to respond can be found here. A summary of the responses received will be published later in 2018.

The Government intends to consult promptly on the priority issues so that they are in a position to introduce necessary amendments to the CM Regulations and Rules ahead of CM auctions to be held in winter 2019/20 (subject to the availability of Parliamentary time and approval). However, for other lower priority issues identified, the Government anticipate implementation to a longer timeframe, in line with stakeholder views about the importance of regulatory stability.