Stick around long enough in any industry and you will eventually find yourself thinking "haven't I  seen this before somewhere?"

And there have certainly been times during the evolution of the EMR process when anyone who has  been in electricity for a while will have got a touch of déjà vu.

So when proposals for a UK capacity market surfaced in 2011, so too did memories of the capacity  payments under the old Pool rules. But in a post-Pool world, with a bilateral market based on  energy balancing, the model of capacity payments for  availability is not an option – so what’s  been suggested instead?

On 31 July the electricity capacity regulations 2014, Statutory Instrument No. 2043 or capacity  order, was published and apart from the section on capacity market rules (which will come into  force the day after the results of the first capacity auction are published), came into force on 1  August.

Read in conjunction with the capacity rules – which are still only in draft at this stage – the  capacity order establishes how the capacity market will work in the UK.

The new capacity market is designed to ensure security of supply and avoid blackouts. It will  procure capacity through auctions which will be held on a four year ahead (T-4) and one year ahead  (T-1) basis. The starting point in the process is setting the amount of capacity that is needed.

National Grid is designated as the delivery body and must deliver an electricity capacity report by  June each year.

The capacity order establishes a reliability standard of three hours expected loss of load in a  year. The first date for capacity delivery is October 2018 and the secretary of state will have to  decide whether to hold a T-4 auction, based on the electricity capacity report and the reliability  standard, by the end of this year.

Subsequently, the decision as to whether a T-4 auction is needed in each year after 2018 will be  taken by 15 June each year. The capacity market is open to any generator that is not receiving  government support via any of the renewable generation support schemes (ROCs, CfD FiTs, RHI, NER  300, CCS commercialisation) and does not have a long term STOR contract. It is also open to demand  side reduction (DSR) providers.

The capacity order refers to "capacity providers" to cover both, but the rest of this article will  concentrate on the rules relating to generators since DSR is subject to a separate transitional regime.

Generators as Capacity Providers

In order to take part in capacity auctions, all eligible capacity providers must prequalify in  accordance with the capacity rules.

Existing licensed generators are obliged to pre-qualify but they may opt out by giving a notice,  and reasons for their opting out, during the prequalification process. Following the  prequalification process, National Grid will determine the de-rated capacity of each capacity  provider as part of the prequalification process.

The auctions will be run on a descending clock, pay as clear basis, with different rules applying  to existing plants and new plants. Existing plants will be price takers, and, subject to certain  specific exceptions, may only bid for capacity agreements of a year at a time. New plants will be  price makers, and may bid for capacity agreements of up to fifteen years' duration.

If successful in the auction, capacity providers will be awarded a capacity agreement, which  imposes the capacity obligation on the capacity provider and gives it the right to receive monthly  capacity payments in return.

The capacity obligation is what sits at the heart of the entire scheme, and it is interesting to  note that it is not an obligation to be available, for despatch on command from the system  operator.

Obligations and penalties

Rather, the obligation is to "provide a determined amount of capacity when required to do so in  accordance with the capacity market rules". What this means is that a plant with a capacity  agreement must discharge its capacity obligation by delivering its committed capacity at times of  system stress.

System stress is a defined set of circumstances as set out in the capacity rules, in respect of  which National Grid will issue a capacity market warning at least four hours prior to the  anticipated event.

The capacity market is not an instruction to capacity providers. Rather it is a signal that  capacity providers are expected to meet their capacity obligation if the system stress event  occurs.

Payments under a capacity agreement are spread over the year and paid monthly. If a capacity  provider fails to meet its capacity obligation penalties are payable. These are capped and cannot  exceed an amount equal to the total annual revenue which the capacity provider could receive under  its capacity agreement.

From a legal perspective, the capacity agreements have some unusual features, the most notable  being contained in Rule 6.2.3 in the capacity rules, which states that a capacity agreement is "not  intended to create contractual relations between nor…give rise to contractual rights for the  benefit of a capacity provider or an administrative party [DECC, Ofgem, National Grid or Elexon]".

It is also expressly stated in the capacity order that a capacity agreement may not be disclaimed  and it may only be terminated in accordance with the capacity rules.

The capacity rules require the capacity provider to notify National Grid if any of a series of  defined events occur. Broadly, these events are insolvency of the capacity provider, loss of  transmission entry capacity, the capacity provider ceasing to meet eligibility criteria and, in the  case of new build plant, failing to meet various milestones.

Whether National Grid is notified of such an event by the capacity provider, or becomes aware by  other means it must issue a termination notice. Similarly, a capacity agreement must be terminated  where a capacity provider does not comply with auction rules or otherwise engages in "unreasonable  business methods".

It is also notable that there is no relief from the capacity obligation where the capacity  obligation cannot be discharged due to force majeure. System stress events cannot be declared where  there is a network failure, but there is still potential for a generator to be affected by an event  of force majeure and still be liable under its capacity agreement.

Finally, a familiar feature under EMR is the existence of a supplier obligation and the capacity  market has its own.

The obligation will be calculated by reference to a supplier's market share on winter evenings, and  will pay for the capacity payments to be made to capacity providers. It is not yet clear when the  first supplier payments will become due.

As with other aspects of EMR, it is not straightforward trying to predict what effect the capacity  market will have.

DECC calculates that it will increase household energy bills, but it should bring down wholesale  energy prices as result of reducing the costs that need to be recovered in the energy market. The  interaction of the capacity market with other policies will no doubt become apparent over time.

It is also expressly stated in the capacity order that a capacity agreement may not be disclaimed  and it may only be terminated in accordance with the capacity rules.

The capacity rules require the capacity provider to notify National Grid if any of a series of  defined events occur. Broadly, these events are insolvency of the capacity provider, loss of  transmission entry capacity, the capacity provider ceasing to meet eligibility criteria and, in the  case of new build plant, failing to meet various milestones.

Whether National Grid is notified of such an event by the capacity provider, or becomes aware by  other means it must issue a termination notice. Similarly, a capacity agreement must be terminated  where a capacity provider does not comply with auction rules or otherwise engages in "unreasonable  business methods".

It is also notable that there is no relief from the capacity obligation where the capacity  obligation cannot be discharged due to force majeure. System stress events cannot be declared where  there is a network failure, but there is still potential for a generator to be affected by an event  of force majeure and still be liable under its capacity agreement.

Finally, a familiar feature under EMR is the existence of a supplier obligation and the capacity  market has its own.

The obligation will be calculated by reference to a supplier's market share on winter evenings, and  will pay for the capacity payments to be made to capacity providers. It is not yet clear when the  first supplier payments will become due.

As with other aspects of EMR, it is not straightforward trying to predict what effect the capacity  market will have.

DECC calculates that it will increase household energy bills, but it should bring down wholesale  energy prices as result of reducing the costs that need to be recovered in the energy market. The  interaction of the capacity market with other policies will no doubt become apparent over time.

First published in Utility Week on 06/08/2014