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My Lords, the draft instrument seeks to amend two secondary legislation packages for the capacity market. The powers to make this implementing secondary legislation are found in the Energy Act 2013, which, following scrutiny in the House and the other place, received Royal Assent in December 2013, with cross-party support. The five changes contained in the draft instrument are essentially technical to improve fairness, ensure the competitiveness of auctions and provide important clarifications to scheme operations. They were supported by the majority of respondents in consultation.
Before I explain the changes in detail, it may be helpful as a reminder to noble Lords if I say a few words of background about the capacity market itself. Ensuring that families and businesses across the country have secure, affordable energy supplies that they can rely on is a top priority. We are facing challenges to electricity security of supply resulting from the closure of older plant and the move towards less polluting, but more intermittent and inflexible technologies, such as solar, wind and nuclear. That is why we have the capacity market; this scheme ensures that there will be sufficient electricity capacity in Great Britain for this winter and beyond. It gives generators confidence that they will receive the revenue they need to maintain, upgrade and refurbish their existing plant, and to finance and build new plant to come on stream as and when existing assets retire. It also ensures that those who are able to shift demand for electricity away from periods of greatest scarcity, without detriment to themselves and to the wider economy, are incentivised to do so.
It does this by offering capacity providers, who are successful in competitive auctions held four years and one year ahead of delivery, a steady, predictable revenue stream on which they can base their future investments. In return for these capacity payments, providers must meet their obligations to deliver electricity or reduce demand at times of system stress or face penalties.
The capacity market is working. Fierce competition between providers in the auctions held to date meant that we obtained the required capacity at prices below the levels many had expected. That is good for consumers as it translates to lower costs on bills. The capacity market is driving investment in new, flexible capacity. The most recent four-year-ahead auction secured over 3.4 gigawatts of new-build generating capacity, including combined-cycle gas turbines, open-cycle gas turbines, small flexible engines and battery storage, as well as 1.4 gigawatts of demand-side response.
The clear message from industry and investors is that the mechanism retains their confidence and is the best available approach for ensuring our long-term security of supply. Industry and investors also stress that regulatory stability is crucial but that the scheme, operating in a rapidly changing environment, must be regularly reviewed to ensure it remains fit for purpose. The changes set out in the instrument are the latest in a series of amendments that ensure the scheme is kept relevant and workable. I will briefly expand on the amendments.
First, the instrument amends the method by which the costs of the capacity market are recouped from suppliers. It was felt the current supplier charge arrangements potentially gave an unfair advantage to embedded generators—smaller generators connected to the lower voltage distribution network—and could distort the outcome of the capacity auctions. That arises because, under current arrangements, suppliers are charged according to their share of total demand at peak times, measured by the demand they place on the transmission grid. That is their net demand. By contracting with embedded generators to run over winter peaks, some suppliers are able to reduce their net demand and therefore their share of capacity market costs, with others having to pay more. With some of the savings inevitably being passed on to the embedded generators, such arrangements unintentionally risk giving them a double payment for what is essentially only one contribution to security of supply. The instrument addresses the issue by amending the basis of the capacity market supplier charge and settlement costs levy from net to gross demand. That is a fairer way of sharing costs between suppliers: it ensures suppliers’ costs reflect their overall demand and helps ensure a level playing field between different generators in the auctions.
Secondly, the instrument seeks to prevent new and refurbishing plants being overcompensated in the capacity market where they are also in receipt of aid through risk finance schemes such as the enterprise investment scheme, seed enterprise investment schemes and venture capital trusts. Currently, there is a risk of double subsidy, which would likely distort the outcome of the capacity auctions. To ensure fair competition and value for money for consumers, the instrument asserts that where a capacity provider has accessed investment through one of these risk finance schemes to fund capital expenditure, their capacity payments must be reduced until such a time as this has been off-set. These off-setting arrangements ensure that the total amount of aid is capped at the amount awarded in the capacity market auction.
Thirdly, the instrument seeks to remove an inconsistency in the way demand-side response capacity is de-rated relative to other capacity types. De-rating is the process by which the volume of a provider’s capacity is adjusted to reflect the reliability of the technologies being used. Unlike other participants, demand-side response providers can nominate a lower amount of capacity to bid into an auction than the capacity they estimated at pre-qualification stage, but that nominated amount is not currently subject to de-rating. The instrument addresses that by ensuring that the nominated value is de-rated, thereby improving the overall reliability of the capacity that is procured. I hope noble Lords have got that.
Fourthly, the instrument clarifies the requirement that capacity market participants maintain credit cover until they have fully discharged all the requirements against which the credit cover has been lodged. In addition, the instrument puts beyond doubt that a party’s credit cover will not be drawn down where a termination fee is due unless the termination fee is unpaid.
Finally, the instrument amends the name, but not the substance, of the capacity market warning—a notification that must be issued in specific circumstances under the scheme. Revision to the capacity market notice better reflects the nature of the notification and will be clearer for participants.
My department published two consultations on these changes during September and October last year. In total, 38 responses were received across the two consultations. There was significant support for the majority of the proposals raised. I look forward to hearing what noble Lords have to say about the proposed changes.
My Lords, I am grateful to the Minister for reminding us of the long hours we spent on the primary legislation with the noble Lord, Lord Grantchester, who is in his place on the Labour Front Bench. We are sadly missing a previous Member of this House, Lord Jenkin of Roding, who understood absolutely all this very complicated legislation. Because it is so complicated it is not surprising that after a period of time we need to make some adjustments to it. It would appear that most people involved in this complicated market are in favour of the adjustments the Government wish to make to the previous legislation.
However, one of the areas in which I was involved in my early days in this House was the committee that looks at secondary legislation. In those days we looked quite carefully at the way government departments deal with these matters. There are rules laid down. Given that the way we deal with secondary legislation means we cannot really change it very much, it is important that government departments stick to the rules. I know that committee has highlighted this over the years. I draw the Minister’s attention to the fact that although they held consultations at the end of 2016, one of which closed in December, they did not respond to them until
I am happy to support what the Government are doing. It seems uncontroversial, but I charge the Minister, now he is in the department, with looking at the way they follow the rules on how we consult on and deal with secondary legislation.
My Lords, I also thank the Minister for his introduction to the regulations before your Lordships’ House. I agree with him that they are by and large technical in nature. I second the remark by my noble friend on the Liberal Democrat Front Bench that we miss Lord Jenkin for all the understanding he brought to the House on these quite technical matters.
We are in favour of the amendment regulations tonight because they introduce refinements, clarifications and new wording to manage the system around the operation of the capacity market. From my reading of the Explanatory Memorandum, which is excellent— I thank the Minister’s department for its clarity—I commend the Minister and his team for introducing these regulations to correct the imperfections in the original instrument, which could have led to double payments and loopholes that could have been exploited to the detriment of the consumer. However, that is not to say that there is universal approval for the capacity market. There is a debate to be had regarding whether it has achieved its objectives and whether it is good value for money. While strictly speaking the capacity market is not the subject of the regulations, I nevertheless have one or two questions to put to the Minister on how it is operating.
I liken the capacity market to a quasi-insurance policy. I agree that the lights going out would be a catastrophic event with severe consequences for the Minister, his Government and the nation. The capacity market is designed to ensure that this will never happen. This winter, 2017-18, is the start of the first delivery year and the date from which payments will start, even though there have been five capacity market auctions to date. The contracts for these auctions are for either one year or four years. What is the grossed-up value of these contracts, which I understand is somewhere near the total cost of the capacity market for availability of energy sources until 2021, excepting that there are also the one-year contracts to be awarded for the next three years? Is it useful to consider this figure in assessing the value-for-money aspects of the policy against achieving its objectives? The Minister in the other place suggested that the increase in customer bills amounted to £2 per customer per year. My question to the Minister is to understand the grossed-up figure that has been paid to generators and, from that, the size of the bill to the public.
The answer to the question regarding the success of this quasi-insurance is mixed. First, there will be no blackouts—I am sure that the Minister will be able to sleep well at night—but perhaps he could give some assurances regarding the “black start” that would be needed to re-energise the network following any blackout.
Secondly, has the certainty of return from the capacity market brought forward investments, especially in new gas build? Here, the policy does not seem entirely to be working. Do the plans to which the Minister drew attention in his opening remarks finally translate into certainty of new build being on the horizon?
Thirdly, is the cost to the consumer worth while, and has it been effective? I think that I can reply on the Minister’s behalf and say that to a certain extent it has already brought benefits in that the spikes in cost in marginal supplies to the grid have been reduced. Volatility has been lessened, which has already reduced net costs through bills to the consumer. Nevertheless, how likely would blackouts have been without the existence of the capacity market? That is the ultimate insurance question.
Lastly, has the capacity market brought flexibility and a diverse mix of energy sources to security of supply? On the demand-side response, the auctions are only for one-year contracts, which could hardly be described as bringing certainty. Can the Minister confirm whether there are plans to bring forward four-year auctions for DSR? Have the Government considered bringing forward the statutory review date of this policy from being four years into its operation? There could be other points along the way that are sooner than that at which some of these questions could bring forward further amendments.
My Lords, I think that I can thank both the noble Baroness and the noble Lord for supporting the regulations. They are pretty technical and complicated, but they correct perhaps inevitable imperfections in the original legislation passed in 2013.
The noble Lord, Lord Grantchester, raised a number of other more profound issues which I hope he will agree do not pertain directly to the matter in hand, but perhaps I may try to answer some of the questions that he raised. I think that his fundamental question was whether the capacity market is value for money. Using his analogy of the insurance market, the total gross premium that we have paid over the period to 2020-21 is £3.35 billion. That is the premium that we have paid to obviate the possibility of the lights going off over that period. Whether or not that is value for money, the noble Lord will have to draw his own conclusions. I think it is quite hard to assess that, except for the fact that if the lights did go off it would be a catastrophe. In the context of the British economy, that may be a premium worth paying. That is a subjective view, and he will have his own thoughts on that.
The noble Lord raised a number of other issues, to which I do not have a reply—at least, I cannot reply in the way that I would like to be able to. He asked four other questions. He answered one of them himself, fortunately, so that leaves me three other questions to address. One was: has this brought forward new investment in generation? The answer is that it has. I mentioned some in my speech. Whether it has brought forward enough is probably the question that he was asking, and he related that to the nuclear investment. I would like to think about that, if I may, and write to him afterwards. Related to that, he asked: has this brought forward new alternative capacity? I guess by that he meant wind, solar and the like. The answer has to be: yes, it has.
I agree with a lot of what the Minister has said but nevertheless draw his attention to the fact that, as yet, onshore wind is not allowed to compete.
The noble Lord is absolutely right: because it is an intermittent source, it is not eligible for the capacity market. I will have to write to him about whether or not the capacity market itself has brought forward alternative capacity beyond that which I mentioned earlier.
Finally, he asked about the statutory review date in the primary legislation. Again, I will have to look and see when that date is and write to him.
I should also respond to the noble Baroness, Lady Maddock, who asked about how we responded to the consultation. I apologise if we did not follow the rules correctly. We will do better next time.
On the basis of that response and the letters I intend to write to the noble Lord, I commend these regulations to the House.