The Capacity Market and Contracts for Difference regimes respond to COVID-19

United Kingdom

The lockdown and related restrictions imposed by Government as a result of the COVID-19 pandemic have impacted on the Capacity Market (“CM”) and Contracts for Difference (“CfD”) schemes. As a result, the Government has now relaxed some of the rules for these schemes, focussed in particular on:

  • minimising the likelihood of capacity agreement terminations arising from COVID-19; and
  • the Government owned CfD Counterparty issuing guidance in respect of CfD force majeure and supplier funding of the CfD scheme.

Here is what you need to know.

Capacity Market

The Department for Business, Energy & Industrial Strategy (“BEIS”) published a consultation, “Capacity Markets: Proposed Easements in response to COVID-19 Pandemic” (the “Consultation”) on 24 April 2020 outlining ways the Government proposes to reduce burdens on capacity agreement holders during the ongoing COVID-19 crisis. The Consultation was only open for responses until 30 April 2020 and at the time of writing BEIS’ consultation response is awaited.

The stated objective of the proposals is to minimise, as far as possible, the risk of termination of capacity market agreements where capacity providers fail to meet capacity agreement obligations as a result of the COVID-19 pandemic. BEIS emphasises that the security of electricity supply is its top priority and therefore the relaxed position will only be temporary so as to ensure this objective is not undermined.

In summary, the areas the Government are proposing to temporarily modify are as follows:

Change

Details

Termination Position

Substantial Completion/Minimum Completion Requirement Long-Stop

For New Build and Refurbishing Capacity Market Units (“CMUs”) facing capacity agreement termination (or capacity agreement length reduction to one year) for a failure to meet these deadlines by 1 October 2020, the Consultation proposes an extension to this Long-Stop Date by one year to 30 September 2021. However, this extension requires the relevant CMUs to provide, to the Delivery Body by 1 October 2020, an Independent Technical Export (“ITE”) report confirming that the project would have demonstrated fulfilment of the requirement by 1 October 2020 “had it not been for the impacts of the COVID-19 pandemic and an explanation of how the effects of the COVID-19 pandemic led to delays”.

 

Extension to discretionary time period for remedying a default giving rise to a termination notice

The existing Electricity Capacity Regulations 2014 (as amended) (the “Capacity Regulations”) provide the Secretary of State with a discretionary right to give capacity providers given a termination notice for failing to meet a specified requirement a grace period of up to 6 months from the termination notice to meet the relevant requirement. The Consultation proposes to increase this discretionary grace period to up to 12 months in respect of capacity agreements in existence on 1 April 2020.

 

COVID-19 specific termination right

A “no fault” capacity agreement termination avenue, to apply at the Secretary of State’s discretion is proposed. This would apply where a capacity provider can demonstrate that a failure to meet a relevant obligation/requirement has come as the direct and unavoidable result of the COVID-19 pandemic. Termination in this scenario would not trigger a termination fee but would trigger the obligation to repay any capacity payments previously received under the capacity agreement. This new termination avenue would apply only in respect of capacity agreements in existence on 1 April 2020 and would be subject to certain deadlines.

 

General

Satisfactory Performance Days (“SPDs”)

Applicable to capacity agreements awarded in auctions after 21 December 2017, the Consultation proposes no suspension of capacity payments between 30 April 2020 and the termination deadline (in most cases 31 July 2020) in instances where a CMU fails to demonstrate three separate SPDs by 30 April 2020 provided the SPD requirement is fulfilled by the longstop of 31 July 2020.

 

Metering Tests

Extension to the metering test deadline, from 17 September to 30 September 2020, for Existing CMUs and Proven and Unproven DSR CMUs holding T-1 capacity agreements for capacity obligations which begin to have effect in the 2020/21 delivery year.

 

ITE Reports generally

Removing the requirement for an ITE report in relation to any Six-Monthly Progress Reports falling due during the 2020/21 financial year for New Build CMUs and Refurbishing CMUs (i.e. from 1 April 2020).

 

Demand Side Response (“DSR”)

Metering Test and DSR Test

Giving DSR providers with Unproven DSR CMUs holding capacity agreements for capacity obligations which begin to have effect in the 2020/21 Delivery Year an additional 12 months to comply with these test requirements is suggested.

 

DSR Baseline Demand

 

Reducing the amount of data required to be provided by capacity providers to establish baseline demand for Unproven DSR CMUs with capacity agreements for capacity obligations which begin to have effect in the 2020/21 delivery year. It is proposed capacity providers will be required to provide data from two working days rather than six working days from the six-week period preceding the settlement period.

 

Appeals Process

Deadline extensions

The CM regime includes various appeals processes involving, in different scenarios, the Secretary of State, the Delivery Body, and Ofgem. In respect of this, the consultation proposes to change the position to:

  • Allow a longer period for a person to appeal to these bodies in relevant scenarios.
  • Slightly lengthen the deadlines within the relevant process for the Delivery Body to reconsider “delivery body reviewable decisions” (such as the issue of termination notices and prequalification decisions).

 

Next Steps

Subject to the outcome of the Consultation, these changes would be introduced via amendments to the Capacity Market Rules and the Capacity Regulations.

Contracts for Difference for Renewables

CfD Generators

On 7 April 2020 the Low Carbon Contracts Company (“LCCC”) as the CfD Counterparty issued a bulletin in relation to the COVID-19 impacts on generators. The LCCC clarified that the COVID-19 outbreak is, in LCCC’s view, capable of constituting a Force Majeure (“FM”) event for the purposes of the CfD contract. The bulletin clarifies that generators must still demonstrate that all the other relevant elements of an FM claim are satisfied. The LCCC asks any prospective claimants to provide a brief explanation, relating to their particular case, demonstrating the relevant elements. Claims will be assessed on a case by case basis, and the LCCC states it will be taking a reasonable and pragmatic approach to this.

The LCCC reminds generators that the conditions for granting FM relief include the requirements for a CfD generator to use reasonable endeavours to mitigate the effects of the FM (including any delay to the project) and to continue to comply with its obligations under the CfD as far as reasonably practicable, and that notice of any FM event should be given to the LCCC as soon as reasonably practicable.

The LCCC states it understands the nature of the impacts of COVID-19 might not yet be clear, and so it may be some time before projects are able to fully assess and evidence if and how they have been impacted. The LCCC notes it will continue to work with projects to assess and process any impacts, both those are that immediate and those that develop over time.

The funding of the LCCC to make CfD payments to generators

On 24 April 2020 BEIS issued a related statement: “Loan arrangement for Low Carbon Contracts Company in respect of the Supplier Obligation Levy”. In this statement BEIS indicated that it understands the difficulty of the current situation for suppliers and as such asked the LCCC not to implement an in-period adjustment. BEIS also confirmed it will, on a one-off basis, extend a temporary loan to the LCCC to ensure that the LCCC can continue to pay CfD generators in Quarter 2 (as set out below to be repaid to BEIS by the LCCC (funded by suppliers) in due course).

On the same day LCCC also issued an Electricity Supplier Bulletin confirming that it will not be applying an upward in-period adjustment to the funding requirements on licensed electricity suppliers pursuant to the Supplier Obligation Interim Levy Rate or Total Reserve Amount for Quarter 2 of 2020. BEIS have stated the intention to consult on proposed changes to the underlying regulations to implement this through reduction in suppliers’ liabilities for CfD payments this quarter by the amount of the loan provided to LCCC, and to increase suppliers’ liabilities by the same amount in Quarter 1 2021. The LCCC would be required to repay the working capital amount to BEIS in 2021.

As indicated in their statement, BEIS has now published a consultation on the details of these proposals on 12 May 2020, “Contracts for Difference: proposed changes to the Electricity Supplier Obligations Regulations in response to COVID-19”. As anticipated the consultation will only run for a short time until 19 May 2020 due to the urgency of the proposals. In the consultation BEIS set out proposals for how they intend to change the Electricity Supplier Obligations Regulations (“ESO Regulations”) to amend the way that suppliers’ obligations are calculated and the Interim Levy Rate (“ILR”) is set, to reflect and recover the amount of government loan deemed to have been used to make the CfD payments in the quarter. The proposals are as follows:

Proposal

Details

Reducing suppliers’ obligations for CfD payments

 

Proposing that the level of each supplier’s obligation relating to the quarter should be reduced in proportion to its market share (of eligible demand) over the quarter. BEIS recognise that there are alternative approaches that could be taken, however these would require more complex changes to the settlement system that could not be delivered in time, and may carry significant delivery risk and cost.

 

How and when will suppliers’ future obligations be increased?

 

Proposing that suppliers’ obligations would be increased for the third quarter after the quarter in which the obligations had been reduced, by the amount of the government loan used in the earlier quarter. It should be noted that the increased obligation would apply to all suppliers operating in the future quarter not just those operating during the quarter in which the obligation was reduced. BEIS said this approach would give suppliers a high level of confidence over the additional cost that they will incur for each MWh supplied in Q1 2021, as this amount will be determined and announced in July 2020, enabling them to price this into tariffs in advance with minimal cost risk.

 

Changes to the formula for setting the ILR

 

Proposing changes to the ESO Regulations to enable the LCCC to take into account anticipated receipt or repayment of a government loan when setting the ILR for a quarter or making in-period adjustments.

 

Changes to enable LCCC to repay the government loan

 

Proposing to amend the ESO Regulations to enable the LCCC to repay government funding using monies collected from suppliers after the reconciliation process following the relevant period.

 

Next Steps

Following the consultation BEIS plan to publish the Government Response and lay amendments to the ESO Regulations in Parliament in early June to enable them to come into force, subject to the will of Parliament, before 9 July (the date on which it is currently expected the LCCC will carry out the Q2 reconciliation process). If BEIS is unable to or decides not to proceed with the proposal, the loan facility would still be provided to LCCC, but suppliers’ obligations for CfD payments in Q2 would be unchanged. As such, suppliers would then have to pay a higher lump sum to the LCCC following the reconciliation process in July. BEIS would still amend the ESO Regulations to enable the LCCC to repay the loan.

Concluding Comments

Subject to the outcome of the Consultation, the changes to the Capacity Market outlined in the table above would be introduced via amendments to the Capacity Market Rules and the Capacity Regulations. These changes will be temporary measures that will only remain in place as long as necessary, according to BEIS.

With regard to CfD generators, while any FM relief claim will need consideration in the specific circumstances, the stated starting position from the LCCC will be welcome news to CfD holders given the potential for delays to construction and commissioning to be precipitated by the COVID-19 position.

BEIS has said it will continue to work towards the “important objective of delivering CfD4 [CfD round 4] in 2021” in a bulletin sent out to stakeholders on 20 April 2020 . BEIS was already running a consultation round ahead of CfD round 4 which will now close on 29 May 2020, “Contracts for Different for Low Carbon Electricity Generation: Consultation on proposed amendments to this scheme”. For more information and insight into this consultation, see CMS publication “Winds of change: onshore, floating and other low carbon technologies CfDs”.