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Guess who’s back? The Capacity Market and what happens next

Lee Drummee Lee Drummee Analyst
30th October 2019

On 24 October, the European Commission (EC) announced its decision to approve the GB Capacity Market (CM) after an investigation which lasted several months.

While this is a positive outcome for holders of capacity agreements, the ~£1bn ‘back-payment’ bill comes at a difficult time for suppliers, who are facing up to a challenging competitive environment as well as other large industry charges with the Renewables Obligation (RO) annual payment due tomorrow (31 October).

The investigation into the CM was opened in February 2019, following a decision by the European General Court in November 2018 to annul the EC’s original decision to grant State Aid approval. This was due to an appeal by Tempus Energy, with the annulment granted on procedural grounds that the EC had not properly considered the case for granting State Aid. Tempus argued that the scheme unfairly favoured traditional generation over demand-side response. Following this, the CM was suspended pending the outcome of the investigation.

In its decision for approval the EC stated that it “did not find any evidence that the scheme would put demand response operators or any other capacity providers at a disadvantage with respect to their participation in the scheme”. The EC also found that the UK government is committed to improving the scheme for the future, as identified in its five-year review of the CM in July, with improvements including:

  • The lowering of the minimum capacity threshold for participating in the auctions from 2MW to 1MW
  • The direct participation of cross-border capacity (instead of interconnector’s participating as a ‘proxy’ for cross-border capacity)
  • The participation rules for new types of capacity, such as renewables
  • The compliance with the EU’s Clean Energy Package

A major focus of the reinstated scheme will be the participation of cross-border capacity in the CM. Not only has BEIS stated that it is the government’s ambition to allow cross-border capacity to participate, it is also a legal requirement under the EU’s Clean Energy Package which the UK must adopt by 4 July 2023, four years after the Clean Energy Package came into force. In the five-year review of the CM BEIS stated it would review a number of overseas capacity mechanisms to support improvements to the scheme. One such review will look at the Pennsylvania-New Jersey and Maryland CM in terms of participation of cross-border capacity.

The participation rules for new technology types has already seen changes with wind and solar now eligible to participate in the CM. A decision on a reduction to the minimum threshold for participating capacity in the CM from 2MW to 1MW has not been made by BEIS, although it did commit to consult on such a change in the five-year review. A lower threshold was tested in the 2015 and 2016 transitional auctions, but the participation of assets below the ordinary 2MW threshold was found to be low.

The EC’s decision also provides confirmation that the upcoming CM auctions can take place without the uncertainty surrounding the legality of the scheme or the agreements that they will award (unlike June’s conditional CM auction). The T-4 (2022-23 delivery) replacement auction, now more realistically described as a ‘T-3’ auction, is scheduled to start on 30 January 2020 with a current target capacity of 44.2GW. The T-1 (2020-21) auction will target just 300MW of capacity with the auction set to commence on 6 February 2020, with the T-4 (2023-24) following on 5 March looking to procure 43.5GW of capacity.

While the CM has been deemed legal by the EC there is still an ongoing judicial review, also filed by Tempus Energy, against the UK government which alleges that it failed to comply with the general court’s decision to annul the CM in November 2018. The JR seeks to reverse the UK government’s decisions to hold a conditional T-1 auction for delivery in 2019-20, continue existing agreements with deferred payments, continue to collect the CM supplier charge and not recover the payments already made to CM agreement holders. The English High Court is set to hear the case in the week starting 11 November.

On 25 October, the Secretary of State notified the Electricity Settlements Company (ESC) of the EC’s decision and officially triggered the restart of the CM. This includes the collection of deferred capacity payments (i.e. payments withheld since November 2018), the confirmation of agreements from the latest T-1 auction and the restart of capacity payments going forward. On the same day, the ESC published a timeline for supplier payments following the restart of the scheme, shown in Figure 1 below.

Supplier charge invoices for the c.£1bn of standstill payments are scheduled to be issued on 14 November with a payment deadline of 21 November. 14 November also marks the Business-As-Usual (BAU) first credit cover deadline with BAU supplier charge invoices to be issued 12 working days later on 2 December. Back-payments are expected to reach capacity providers towards the end of January 2020.

The process of collecting and distributing deferred capacity payments could prove tricky with some suppliers not actively billing large business customers, particularly those on “pass-through” contracts during the suspension of the scheme. The collection of these costs may also prove more challenging if customers have since switched to other suppliers in the interim. Although domestic suppliers have likely continued to collect these costs from customers (especially following Ofgem’s decision to include CM costs in the price cap), additional costs will come through the mutualisation process with 17 suppliers having exited the market during the scheme’s suspension. 12 of these exits have come through the Supplier of Last Resort (SoLR) process.

There is the potential for initial payments to be reduced in order to avoid a delay in deferred payments to capacity providers and following the first mutualisation exercise payments will be proportionately adjusted if there is a shortfall. Capacity providers will then be entitled to a supplementary payment if initial payments are reduced, following a supplementary mutualisation process. So, whilst structures are in place to ensure providers receive payments, stresses in the supply market ultimately feed through the scheme through deferred payments.

This structure of CM payment recovery, akin to other policy schemes such as the RO, highlights the interlinkages in the market between suppliers under the supplier hub model and capacity providers in the CM. Collection of deferred payments will ultimately be a test of the effectiveness of the ESC debt recovery process, Ofgem’s ability to recover unpaid capacity payments through financial penalties and for these funds to be included in a capacity payment reconciliation.

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