Ofgem has launched a consultation into proposed changes to the Capacity Market (“CM”) rules, which aim to simplify the market and reduce complexity which Ofgem feels may be acting as a barrier to entry and inhibiting competition. There are also proposals to improve the liquidity of the secondary trading market, including allowing secondary from the T-4 auction.

“We believe that the Rules are meeting their first objective to deliver security of supply, but that in part they hinder their own ability to meet their second objective to ensure the efficient operation of the CM. The complexity of the Rules and the regulatory burden they place on participants may be a barrier to participation and certainly makes participation complicated, which may in turn lead to inefficient bidding in the Auction,”
– Ofgem

Ofgem’s review is in parallel with and complementary to BEIS’ Five Year Review which will take into account the conclusions of Ofgem’s review, however, as the BEIS review is now delayed due to the CM suspension (see box), Ofgem has decided to delay the implementation of some of its proposed changes to future delivery years. As the BEIS Five Year Review may result in significant changes to the CM framework Ofgem does not propose to make substantial changes to the Rules in its own review.

The proposed changes include:

  • Reducing the complexity and burden of the pre-qualification process, including enabling providers to delay submission of certain data which should reduce the risk of rejection at the pre-qualification stage;
  • Reducing the burden of a new-build plant having to supply reports by an independent technical expert ahead of the delivery year;
  • Facilitating a more open and liquid secondary trading market, including by opening the secondary trading market from the T-4 Auction and by reducing barriers to participation in secondary trading;
  • Reducing the complexity of participation, by making the rules clearer and enabling changes to aspects of CM unit configuration between the auction and the delivery year; and
  • Amendments which were delayed from previous years to enable effective IT system delivery.

Ofgem believes that as the CM has become a fundamental part of wholesale electricity markets it is necessary to try to align it as much as possible with the other markets. The CM currently operates independently of these other markets and there is a risk that changes to the CM rules could lead to unintended, inefficient outcomes in other markets. Ofgem is seeking views on the alignment of the CM with other markets.

The consultation will close on 28 May 2019, with Ofgem’s review of the CM rules expected to be published in the summer. At that time, Ofgem intends to implement some of the proposed changes and will subsequently consult on more detailed proposals to implement some of the other proposals discussed in this current consultation.

Simplifying the Capacity Market pre-qualification process

The CM was designed for a market that looked very different from that which has since emerged, and in particular did the original design did not foresee the significant increase in small and distributed generation, the growth trajectory of demand-side response (“DSR”), or the emergence of subsidy-free renewables.

The pre-qualification process was designed to provide delivery assurance for large generation projects, instead, a large proportion of applications have come from small projects for which some of these delivery assurance requirements are less appropriate. This change in market structure has also resulted in operational inefficiencies – the original operating assumptions were made on the basis of around 300 applications for pre-qualification being made by around 45 companies annually, while in reality, 1,660 applications were made in the 2018 window, a fourfold increase on the first year of the CM.

A number of amendments to the pre-qualification rules is being proposed:

Data submission: having only one opportunity to ensure all submitted data is correct creates a significant risk of failure in the pre-qualification process. Ofgem is proposing to either remove or delay certain data items submitted at the pre-qualification stage to reduce the burden on both applicants and National Grid in assessing applications, and in the longer term, Ofgem sees merit in lengthening the submission period.

Data submission – repeat applications: the need to complete entirely new submissions for units that had successfully pre-qualified in previous years, where there has been no change to the unit, creates an un-necessary failure risk due to potential data entry errors. To mitigate these risks, Ofgem is proposing a “roll-over” process for previously successful units.

Planning consents: long lead times for planning consents can cause issues for new-build projects, particularly where a Development Consent Order (“DCO”) is needed for larger new-builds. Ofgem is seeking views on three options for addressing this risk:

  1. Replacing the requirement to provide planning consents at the pre-qualification stage with submission of a declaration that states the project will have the relevant planning consents by the time of the Financial Commitment Milestone (“FCM”), with proof of these consents being submitted before the FCM;
  2. Enabling applicants who have applied for a DCO and completed the examination stage to defer the provision of its relevant planning consent until after the pre-qualification window;
  3. Going ahead with a previously announced rule change which removes the option to defer provision of relevant planning consents until after pre-qualification, which is due to take effect from 2020 onwards.

Reducing the burden of progress reporting for new-builds

Currently, new build CM units are required to provide a series of reports related to key project milestones and any changes to construction timelines. These reports must be validated by an Independent Technical Expert (“ITE”). These reports are resource intensive as they place an unnecessary administrative burden on participants, and can be very expensive – in many cases the ITE cost is fixed regardless of project size. It has been suggested that these costs could also be driving inefficient bidding in the auctions.

Ofgem does not believe that the high cost of these ITE assessments is justified by the delivery assurance they provide, and is minded to remove the requirements for submission of progress reports and associated ITE assessments for all providers, replacing it with a requirement to submit a company directors’ declaration to inform National Grid of any material changes to the project timeline or to the construction milestones as described at pre-qualification. ITE assessments would still be required for any remedial plan associated with the Substantial Commitment Milestone (“SCM”) and with the FCM, along with any report associated with Total Project Spend and the Long Stop Date.

Ofgem also aims to increase clarity on what constitutes a material change.

Improvements to the secondary market

Stakeholder feedback suggests that the existing secondary trading framework does not adequately promote a liquid secondary trading market because it contains various barriers to entry. The processes required to complete trades take too long to allow effective obligation management, and trades do not currently adequately transfer obligations and risks between the transferor and transferee. Ofgem is seeking views on changes to:

Eligibility: simplification and reduction of the requirements for becoming eligible to receive a trade with the potential creation of a register of eligible and willing secondary trading participants;

Barriers to trading: potentially reducing the minimum trading threshold from 2 MW to 0.5 MW; a reduction in the time for National Grid to assess whether an applicant is eligible to engage in secondary trading (from three months to six weeks); and reducing the time National Grid has to accept or refuse a trade (from five working days to two);

Framework: allowing secondary trading from the T-4 auction rather than just the T-1 auction; and potentially removing the requirement for a transferee to have met its SCM prior to trading; and

Transfer of risk and Satisfactory Performance Days (“SPD”):  changes to ensure that termination risk and obligation to demonstrate SPD are transferred appropriately between the transferor and transferee following a secondary market trade.

The proposed changes should improve the operation of the market, and in particular make it more accessible to smaller providers by reducing the administrative burden and reducing the risk of errors leading to failed pre-qualification applications, and by pressing ahead with their reviews, the Government and Ofgem are signalling a determination to ensure the continuation of the capacity market.

However, the uncertainty surrounding the outcome of the various judicial and state aid processes, and the risk that previous capacity payments may be clawed back, could deter participation in the upcoming T-1 auction, which would likely lead to higher clearing prices.

Added to this is the impact of the Medium Combustion Plant Directive, which is deterring some demand-side plant from participating (which is ironic, since the action by Tempus Energy was motivated by a desire to expand demand-side participation in the capacity market), and has already seen a significant drop-off in diesel participation in the CM. The technology mix could therefore look quite different in any future auctions.

Capacity Market suspension

On 15 November 2018 the General Court of the Court of Justice of the European Union found in favour of Tempus Energy in Tempus Energy Ltd and Tempus Energy Technology Ltd v European Commission, which had the effect of annulling the European Commission’s state aid approval for the GB Capacity Market scheme. The Government responded by suspending payments to capacity providers, however, the capacity market itself has continued to operate and providers have been encouraged to continue to meet their obligations. In addition, the T-4 and T-1 Capacity Market auctions for delivery years 2022/23 and 2019/20 were also suspended. On 10 April, the energy secretary, Greg Clark instructed National Grid to hold the postponed T-1 Capacity Market auction “as soon as reasonably practicable”, albeit with payments held back until the resolution of the state aid issue. The T-1 auction for top-up capacity for the 2019/20 winter period was originally scheduled to take place in January but was postponed indefinitely after the European Court’s ruling. National Grid has also been instructed to allow prequalified CM units to withdraw from the auction without penalty. The Government is seeking reinstatement of state aid approval from the European Commission, and the European Commission has appealed the judgement, however, on 5 March Tempus Energy issued a claim in the English High Court for judicial review against the Government for continuing to operate other aspects of the CM during the standstill period. Tempus Energy contends that the continuing operation of the capacity market, even with payments suspended, is not sufficient and that demand-side response operators continue to be disadvantaged by the aid granted to capacity providers under the scheme. It is seeking a number of court orders which, among other things, would overturn the Government’s decisions:
  1. to hold a T-1 auction this summer;
  2. to continue the existing agreements with deferred payments;
  3. to continue collecting monies to fund the supplier charge; and
  4. not to recover payments that have already been made to Capacity Market agreement holders.
If this challenge is successful there could be a complete suspension of the capacity market. The European Commission has also initiated a state aid investigation which will either approve or reject the capacity market from a state aid perspective. Rejection could lead to permanent suspension, with the possibility that payments made to date under capacity contracts would be subject to clawback. Alternatively, the Commission may approve a modified version of the scheme, although in that case there may still be the possibility of some clawback. All of this will take time to resolve, and in the meantime, there is also the impact of Brexit, since leaving the EU would almost certainly place the UK outside the jurisdiction of the European courts.

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