September 14, 2018

Review of Capacity Market and Emissions Performance Standard

How well have the Capacity Market (CM) and Emissions Performance Standard been working and are there any opportunities for improvement? Clare Hatcher, a partner in Clyde & Co LLP's projects and energy team, says the questions raised by the government’s report reflect many of the concerns raised by the energy industry.

Original news

The Department for Business, Energy & Industrial Strategy is seeking views and evidence on how well the CM and Emissions Performance Standard has been working and any opportunities for improvement. The consultation is a review, as it has been five years since the Energy Act 2013 (EA 2013), which introduced the policies, was passed. This consultation closes on 1 October 2018.

What is the background to this review?

Under EA 2013, which implemented the policy objectives of the government's Electricity Market Reform (EMR), there is a statutory requirement to review the measures that EA 2013 introduced after five years. This five-year review is due to commence in 2019. It also provides an opportunity to fulfil the UK's commitment to the European Commission to review how the CM is working in practice, which was a condition of it being granted a ten-year State aid approval. Ahead of this review, on 8 August 2018 the government published a call for evidence: Capacity Market and Emissions  Performance Standard review: call for evidence (referred to in this News Analysis as the ‘report’.

The CM was set up to encourage the investment in generation capacity necessary to maintain security of supply at a time when significant plant closures were anticipated. It does this by providing payments to capacity providers who guarantee to provide capacity when the grid is under stress. Some existing power generators, as well as new generators, interconnectors and demand side response (DSR) providers, are eligible to bid in auctions for capacity contracts. Where a successful bidder holds a capacity contract and fails to deliver electricity - or reduce demand in the case of DSR - when required to do so, they incur financial penalties.

The government states in its report that it believes the existing design has been broadly successful in meeting its objectives. It has secured the required capacity at an affordable price with a high degree of market liquidity. At the same time, the government recognises that the energy market is undergoing a rapid transformation with new technologies beginning to compete effectively with traditional generation assets and so the government wants to consider how the CM can better support these new technologies. The report specifically identifies the need to provide better support for DSR and enhance participation of aggregators and other smart system services.

The Emissions Performance Standard (EPS) was also introduced by EA 2013. Its objective is to ensure that new fossil fuel fired electricity generation contributes to the security of supply in a way that is consistent with the UK's decarbonisation objectives. The EPS places a limit on the carbon dioxide emissions that can be produced by a new fossil fuel generation plant.

The report states that the government believes that the EPS is achieving its objective as all generation plants that have been constructed since its introduction have complied with the EPS.

What questions are raised by the report?

The report has identified two priority issues that need to be addressed. The first is whether it is possible to enable subsidy-free renewables to participate in the CM. The design of the CM was intended to be technology neutral so that existing and new build capacity DSR and interconnectors could all compete. However, most renewables (including wind and solar) are not eligible to participate. Currently only biomass and hydro can participate. This is because historically, renewable technologies benefited from low carbon support schemes but, as the cost of wind and solar have fallen quickly, some onshore wind and solar projects are becoming viable without subsidy. Hybrid sites (sites with multiple technologies) and aggregated sites (asset portfolios which are not geographically located together) have also not been eligible although they can offer real advantages in terms of a security of supply. The review recognises that to enable participation in the CM by subsidy free renewables, it is necessary to look at how to derate these technologies and whether the existing penalty regime sufficiently addresses the risks of non-dispatchable technology.

The second priority issue is the role of interconnectors in the CM and cross-border participation. Although the amount of interconnection capacity with CM contracts has increased and injected competition in CM auctions, their contribution to security of supply in the future may diminish as they are reliant on the same limited pool of spare capacity in interconnected countries and a number of these countries are introducing their own capacity schemes. As a result, the government wants to consider whether there should be changes to the derating methodology used for interconnectors to ensure that they are not over compensated relative to their real contribution to security of supply.

The report also notes that there are issues around protecting against delivery risks and tightening the incentives on those with CM contracts to ensure they honour them. The penalties for non­delivery are capped at a relatively low level of 100% of the capacity providers’ annual capacity payment. It has been suggested that the penalty regime should be strengthened and reflect the value of the lost load during periods of scarcity.

What are the next stages?

The government's call for evidence is the first stage of the government's CM review and responses must be submitted by 1 October 2018. The conclusions of the CM review must be included in a report to be laid before Parliament by summer 2019. The government wishes to introduce any necessary amendments to the CM Regulations and CM Rules so that they are ready for the auctions in winter 2019/20.

Do you have any comments on omissions or surprises for the market in what the report has raised?

The questions raised by the report reflect many of the concerns raised by the energy industry which shares the government's view that the CM is fundamentally the right mechanism to deliver security of supply but believes that it is important to look at the interaction between the CM and ancillary services to ensure that the design is fit for purpose and delivers a competitive outcome based on a level playing field.

Clare Hatcher is a recognised expert in energy and renewables and received a client choice award in the energy and natural resources sector in 2016.

Interviewed by Kate Beaumont.