On 6 May 2016, the Department for Energy and Climate Change (DECC) published its response(Response) to the March 2016 consultation on capacity market reform (“March Consultation”). As commented previously, the March Consultation proposed reforms to the Capacity Market including changes to the Electricity Capacity Regulations 2014 (Regulations), and the Capacity Market Rules 2014 (Rules). DECC envisages that the changes to the Rules required to implement its decisions will be made later this year and in time for prequalification for the next Capacity Market auction. 

As proposed, DECC confirmed that it will hold an additional auction in 2017/2018 for procuring additional capacity and plans to increase the penalties on non-delivery of capacity. Considering this auction would need to be notified for state aid purposes, the decision and the proposed changes must also be set into the context of the broader European Commission inquiry into capacity mechanisms in the light of EU state aid rules. 

The Rules are also in the process of being reviewed by Ofgem (as per its consultation published on 29 April 2016). Ofgem also intends to publish a final decision and the final amendments to the Rules in summer 2016 before the next prequalification round opens. 

Those participants seeking to pre-qualify and take part in the 2017/2018 auction will need quickly to grasp the implication of the proposed Rule changes as well as of the impact of any changes to the Regulations over the course of the coming months. 

Yet, despite the various moving pieces, DECC considers that the responses show that industry and investors remain confident in the Capacity Market and that it is the “best available approach” to secure long-term supply. DECC also recognises the concerns raised about distortions and interventions, such as the Contingency Balancing Reserve, and the role of diesel generation (as outlined below) and proposes to hold further consultations on these areas. 

Response: what has changed? 

Most of DECC’s proposals set out in the March Consultation are to be implemented, namely:

  • “Holding an ‘early’ auction to bring forward the first CM delivery year to 2017/18;
  • Tightening delivery incentives on those who have agreements to deliver against them and to penalise those who renege more severely; and
  • Buying more capacity, and buying it earlier.”

New auction and more capacity 

As expected, National Grid as the EMR Delivery Body will hold an early auction in January 2017 for delivery of capacity in 2017/2018. All participants will be offered one year contracts only so this auction will be less suited to the participation of new plant. 

Additionally, DECC considers that the December 2016 T-4 auction could procure up to an additional 3GW of capacity. This increase could come from the “introduction of new sensitivities to cover a more extreme cold winter scenario and/or increased non-delivery risks”, and by encouraging the participation in the T-4 auction of “a significant proportion of the 2.5GW that might otherwise be set aside for the one-year ahead of auction”. The precise target for this auction will not, however, be set until summer 2016. 

Tightening incentives 

The increased termination fees for new build units that fail to demonstrate that they achieved their financial commitment milestones have also been confirmed, including for those participating in the early auction for 2017/2018. 

However, DECC will not be seeking to increase the termination fees for those CMUs that were the subject of a termination event for a previous capacity agreement, nor implement a multiplier for termination fee liability based on previous termination events or repeated failures to meet financial or project completion milestones. Still, DECC plans to implement its proposed provisions for disqualifying new build CMUs which have had their agreements terminated as a result of failing to meet their financial milestone commitments or their minimum completion requirements. 

Finally, DECC has confirmed its proposed changes to prequalification timings. In particular, it will amend the Regulations regarding the requirement for the EMR Delivery Body to advise it whether the demand curve for the capacity auction should be adjusted following the prequalification period until after the results of Tier 1 appeals are known. 

Future changes on the horizon 

Avoiding cumulation of state aid: This remains an unresolved issue with DECC intending to hold a further consultation in autumn 2016 on limiting CMUs from benefitting also from other forms of state aid such as under the Enterprise Investment Scheme or the Venture Capital Trust Scheme.

Diesel generation: DECC announced that it will publish a consultation on proposed options to tackle emissions from diesel generators later in 2016 but has made clear that it remains in favour of the Capacity Market remaining technology neutral. Instead, the controls, including by way of measures to control emissions limits as set out in the Medium Combustion Plant Directive, are likely to be through parallel mechanisms. 

Embedded benefits: DECC has welcomed Ofgem’s review of embedded benefits but considers this a complex issue needing further scrutiny. Accordingly, the Response states that Ofgem will publish a proposed way forward on embedded benefits, potentially including on any transitional arrangements that are required in summer 2016. 

Comment 

While DECC’s adherence to the principle of technology neutrality is in line with the European Commission’s initial findings in its sector inquiry, the Capacity Market’s flaws in encouraging the bringing forward of new large generation (including new gas plant) remains to be resolved. Some respondents even suggested that a separate auction should be held for CCGTs or high efficiency plant. On the other hand, these changes may be seen as beneficial for DSR and have given a platform for encouraging a review of the scope of the Capacity Market to allow renewables coupled with battery storage, or baseload renewables, to participate in the Capacity Market. 

On a practical note, participants rightly need to understand the landscape prior to participation in any auctions. In this, a consolidated version of the Rules well ahead of pre-qualification and further clarity of the exact changes to the Regulations and Rules is needed.