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Draft Electricity Capacity (No. 2) Regulations 2019

Debated on Monday 1 July 2019

The Committee consisted of the following Members:

Chair: David Hanson

Beckett, Margaret (Derby South) (Lab)

† Bradley, Ben (Mansfield) (Con)

Champion, Sarah (Rotherham) (Lab)

† Creasy, Stella (Walthamstow) (Lab/Co-op)

† Day, Martyn (Linlithgow and East Falkirk) (SNP)

† Djanogly, Mr Jonathan (Huntingdon) (Con)

† Efford, Clive (Eltham) (Lab)

† Grant, Bill (Ayr, Carrick and Cumnock) (Con)

† Jarvis, Dan (Barnsley Central) (Lab)

† O'Brien, Neil (Harborough) (Con)

† Skidmore, Chris (Minister for Energy and Clean Growth)

† Tomlinson, Michael (Mid Dorset and North Poole) (Con)

† Twist, Liz (Blaydon) (Lab)

† Vickers, Martin (Cleethorpes) (Con)

† Whately, Helen (Faversham and Mid Kent) (Con)

† Whitehead, Dr Alan (Southampton, Test) (Lab)

† Whittaker, Craig (Lord Commissioner of Her Majesty's Treasury)

Dominic Stockbridge, Committee Clerk

† attended the Committee

First Delegated Legislation Committee

Monday 1 July 2019

[Mr David Hanson in the Chair]

Draft Electricity Capacity (No. 2) Regulations 2019

I beg to move,

That the Committee has considered the draft Electricity Capacity (No. 2) Regulations 2019.

It is a pleasure to serve under your chairmanship, Mr Hanson. The draft regulations were laid before the House on 12 June 2019.

The capacity market is a key element of the Government’s strategy to maintain security of electricity supplies in Great Britain. This statutory instrument will help to maintain a strong security-of-supply position into the future. The capacity market ensures that there will be sufficient electricity capacity in Great Britain during periods of peak electricity demand, securing the capacity required through competitive technology-neutral auctions, normally held four years and one year ahead of delivery, ingeniously known as T-4 and T-1 auctions. Those who win capacity agreements, known as “capacity providers”, commit to providing capacity during periods of system stress in exchange for receiving capacity payments.

The draft regulations will help to maintain the effectiveness of the capacity market by allowing a one-off, three-years-ahead or—no prizes for guessing—a T-3 auction to be held in early 2020, to replace the T-4 auction that was postponed from early 2019 following the European Court of Justice judgment that annulled state aid approval for the capacity market. The regulations will also support the participation of certain unsubsidised renewable technologies in future auctions, and make minor changes to the existing credit cover requirements for upcoming capacity auctions likely to be scheduled for early 2020.

Before I explain those changes, I will first set out the context in which they are being introduced. On 15 November 2018, the general court of the Court of Justice of the European Union annulled the European Commission’s state aid approval for Great Britain’s capacity market, and introduced a standstill period until the scheme can be reapproved. The judgment means that the UK Government are not able to award capacity agreements, or to make capacity payments, unless and until state aid approval is obtained following the European Commission’s current investigation. We are working with it to ensure that it has everything necessary to reapprove the scheme as quickly as possible.

We discussed those issues and took steps, through the first instrument in this series—the Electricity Capacity (No. 1) Regulations 2019—and associated changes to the capacity market rules to maintain the operation of the capacity market, to the extent possible, while state aid approval is obtained. The steps we have taken to put in place those interim arrangements are subject to judicial review proceedings, which we are robustly defending.

The House of Lords Secondary Legislation Scrutiny Committee has highlighted the continuing uncertainty resulting from those judicial review proceedings and the Commission’s state aid investigation. This draft instrument therefore focuses on future auctions that are needed and will not proceed unless and until the capacity market has the state aid approval. The instrument is therefore unlikely to be impacted by the judicial review.

My Department carried out a public consultation from 7 March 2019 to 4 April on the changes that will be implemented under the draft regulations. That consultation received 42 responses from a range of stakeholders. The majority broadly supported holding that T-3 auction in early 2020. Respondents also supported allowing additional types of renewable technology to participate in the capacity market. The instrument also addresses concerns that running the T-3 auction in parallel with the usual T-4 auction in early 2020 could result in unduly burdensome credit cover requirements for some participants.

I will now expand briefly on the main provisions of the draft instrument, first on that T-3 auction. The instrument makes changes to enable the T-4 auction for the 2022-23 delivery year, which was postponed following the state aid judgment, to be replaced by the one-off T-3 auction. If held, that auction will be scheduled for early 2020. It will only be held if state aid approval has been received.

In the event of a no-deal Brexit, there will be many issues of state aid requirements to which we are no longer subject. While we continue to be a member of the European Union, as we are, we must continue to legislate according to the principles of our membership. The state aid judgment issue is one that, having worked with the Commission closely, we believe will be resolved. We will ensure that we will be a law-abiding country.

The Commission is in the process of investigating and we anticipate that it will have concluded that investigation, and decided whether to approve the capacity market, by 31 October. On the effect of a no-deal Brexit, if the UK leaves the EU without state aid approval from the Commission or an implementation period, approval under the UK’s domestic state aid regime would still be required, and responsibility for investigating state aid cases would transfer to the Competition and Markets Authority. Therefore, the issue of state aid will not go away; it is a question of whether it will be under EU state aid requirements or UK requirements in the future.

Secondly, the regulations make changes to remove or reduce what might otherwise be unnecessary burdens on business in relation to credit cover. Applicants currently seeking to enter certain types of capacity market units—such as new technologies that are unproven or those not yet constructed—into capacity auctions, must provide and maintain credit cover. The regulations adjust the requirements for CMUs entered into both of the upcoming T-3 and T-4 auctions, to enable the credit cover obligations for both auctions to be satisfied jointly rather than separately. That will help to reduce bureaucracy.

The regulations extend the existing suspension of credit cover obligations provided for by the Electricity Capacity (No. 1) Regulations 2019 to the three capacity auctions likely to take place in 2020. They make changes to ensure that when the suspension of credit cover is lifted, following state aid re-approval, existing exceptions to credit cover requirements will still operate as intended.

Finally, the regulations make changes to support the participation of certain unsubsidised renewable technologies in future auctions. Some types of renewable technology, such as biomass, have always been able to participate in the capacity market provided they are not receiving other specified low carbon subsidies. Although the capacity market was always intended to include all unsubsidised technologies, when it was conceived wind and solar required subsidy and so were not included in the technical rules. With such unsubsidised renewables now a prospect, the capacity market rules were recently amended to allow wind and solar to participate for the first time.

The regulations support that change by requiring state support for new build renewable CMUs declared under the rules to be deducted or repaid from capacity payments, which enables renewable technologies in receipt of subsidies, other than those which exclude them from the scheme entirely, to participate without cumulation of state aid received through the capacity market and other schemes. Alongside the regulations, we have laid complementary amendments to the capacity market rules, which govern the technical and administrative procedures relating to capacity market operation.

The regulations are necessary to ensure the smooth running of the capacity market in the period after state aid approval is received, and to broaden the participation of renewable technologies. That is important the week after we committed to net zero emissions by 2050. I commend them to the Committee.

It is a pleasure to serve under your chairmanship, Mr Hanson. The regulations are, as their title might suggest and as the Minister mentioned, closely associated with the Electricity Capacity (No. 1) Regulations 2019, which we discussed recently. As I am sure the Minister recalls, even if no one else does—I do not remember who else was on that Committee—we had some debate about the circumstances under which the regulations were drawn up.

As the Minister mentioned, the European Court heard a challenge to the capacity market’s existence and decided that it should be annulled, pending a proper examination of the circumstances under which state aid was first considered by the European Union and whether a proper analysis was undertaken such that it was safe to conclude whether state aid arrangements, not just for now but for the whole period of the capacity market, which has been conducting auctions since 2017, should be considered for annulment. That is the effective judgment reached by the European Court and it is now, as the Minister said, for the Court to review the process that it undertook. The Minister indicated that he thinks—I am afraid that is as far as it goes—that the review by the EU may be out by October 2019, although, as we considered in the last SI, it is quite possible that it will not be. In that SI, we took some precautions by setting a fall-back date by which time payments that had been collected or given out would be disbursed back from whence they had come or to whence they should have gone, and would count as not having been set up at all.

The circumstances of the T-3 auction that is suggested as a replacement for the T-4 auction, which might not go ahead as a result of the judgment, do not differ from that position at all. It is a provisional auction in the sense that whatever is collected or potentially disbursed will be held until the EU study of its processes for defining adherence to state aid is published. We do not have an absolute fix on when that will be, although, as the Minister said, he hopes it will be October 2019. The circumstances have not changed at all since the discussion that we had on the Electricity Capacity (No. 1) Regulations 2019: we are still waiting on that review.

We still have not, as far as I can see, considered any further the fact that the Court judgment was not just about a matter of process on state aid; it was also about a number of other factors relating to the consideration of demand-side management in the whole capacity auction process, and a number of other issues that were in the judgment and go beyond the mere matter of procedure.

It is not entirely accurate to say that this is just a matter of procedure that could be resolved very shortly, and the capacity market as we know it could continue to operate. However, that is the basis on which this SI has been set out: there will be a provisional T-3 auction that will become a real auction when the report is received, and business as usual will continue. But it is by no means clear that business as usual will continue. It is a matter of some concern to me that the Government do not appear to have made any provision or contingency plans for the fact that there may not be a perfect outcome and it may not be business as usual in the capacity market in future.

My first question for the Minister is: have any plans been made on a contingency basis in case the outcome from the EU is not as felicitous as the Minister thinks it will be? Has he considered whether the process of annulment could spread to capacity payments that have been made already, rather than just those that are held up at the moment or will be held up when the T-3 auction is undertaken? That is an important consideration, because all the capacity market’s eggs are in the basket of business as usual, but there will shortly—possibly as early as the autumn—be a review of the capacity market to reflect on the past five years and suggest pointers for the future. It may be an ideal opportunity to consider whether the capacity market can or should continue in its previous form, in which it fell foul of the European Court judgment.

With respect to the operation of the capacity market, the Minister may also wish to consider the outcome of recent auctions. The T-1 auction that was held in December last year provisionally cleared at 0.4p per kW—a startling outcome, bearing in mind that as late as February 2018, T-4 auctions were clearing at £8.40 per kW, and in February 2017 they were clearing at £22.50 per kW. In our last meeting on the subject, the Minister said that he felt that having an 11% margin on supply as we went into the winter was an indication that the capacity market was working well. However, an alternative interpretation of the margin and the low price at T-1 auction is that the capacity market is not needed because there is ample capacity. People are getting virtually nil in capacity payments for standing by to supply in the future.

Has the Minister any view on what the T-3 auction will bring about? Does he think that the market will reinflate, or does he consider that one factor for review may be that the extremely low price for capacity coming into the market may indicate a more structural change in how the capacity market will work in future? As he will know, T-3 auctions are very important in that respect, because those are the auctions at which long-term capacity can be determined for the future—as opposed to T-1 auctions, which are all about short-term capacity for next year. Has his Department reflected on how the auction itself might turn out, notwithstanding that for the time being we cannot actually pay those who have been successful in it?

The Opposition do not wish to oppose the draft regulations. We believe that it is important that the current chaos in the capacity market be resolved as much as is possible for the time being. The regulations will achieve that to some extent by securing a T-3 auction, albeit a provisional one, to stabilise the market and give some assurance to people who at present have very little idea whether they will get a capacity auction or where the money going in and out will end up. We do not want to oppose this, but, as I have outlined, we have a number of serious questions about the future direction of the capacity market and the research that the EU is doing in response to the Court’s judgement, which, as the Minister said, has been extended by way of judicial review and is still being contested, with some uncertainty as to its outcome.

Finally, I seek the Minister’s clarification on something else that I think is a welcome departure in this SI. Will he clarify how renewables and low-carbon energy in general can become eligible for obtaining some funding under capacity auctions? The Minister mentioned that renewable energy with some subsidies—but not subsidies sufficient to put them out of contention, by which I understand subsidies that have historically come under the terms of the renewables obligation, the feed-in tariffs and the contracts for difference—would continue not to be eligible, if those renewables were in receipt of those subsidies.

However, can the Minister tell me what subsidies would be eligible for those renewable and low-carbon sources of energy that are open for the capacity market? If there are none, does he consider it appropriate to pit completely unsubsidised renewable energy against other forms of energy in a capacity market auction, or should there be sub-auctions, even in unsubsidised circumstances, for renewable and low-carbon energy as against fossil fuel and high-carbon energy?

I thank the hon. Gentleman for his comments. He is absolutely right that we were here before when we took our seats for the Electricity Capacity (No.1) Regulations 2019. I like to think of these regulations as a bit like “The Godfather” and “The Godfather Part II”, in that the Electricity Capacity (No.2) Regulations 2019 is the only SI that betters the first one. When it comes to moving forward with the capacity market, the Government believe that the capacity market is the right mechanism for delivering security of supply at the lowest cost to consumers.

I understand the hon. Gentleman’s concerns. He is right to raise the issues of state aid and the progress of the judicial review. My Department has been in regular discussion with the Commission since the judgment, to ensure that we can support its investigation in the most effective and timely way possible. The Commission announced on 21 February that it would open an in-depth investigation and it intends to appeal the Court’s judgment; the UK Government are intervening in support of the Commission in that appeal.

While it is for the Commission to establish its own timetable, we expect it to make its final decision later in the year, before 31 October. It is important to reflect that that T-3 auction cannot take place in 2020 not only if we do not pass the SI today, but if the state aid judgment is not resolved. While we cannot pre-empt the outcomes of the Commission’s investigation, we remain confident that it will approve the scheme following investigation, not least as it has approved six other capacity markets since 2014.

It is possible that the Commission will require policy changes to the design of the capacity market scheme when granting state aid approval. In that case, the Government would seek to respond swiftly, to consider or bring forward the required changes. Obviously, the Government continue to monitor our security of supply position carefully, together with Ofgem and the delivery body. In the unlikely event that state aid approval is not granted or is excessively delayed, the Government will ensure that any necessary steps are taken. The Government remain of the view that the capacity market is the right mechanism to deliver secure electricity to suppliers, but we will step in, if needed, to make the appropriate decisions to resolve this issue, if the state aid judgment is not resolved.

The hon. Gentleman mentioned the judgment and the details around whether it was procedural or not. The General Court identified elements of the capacity market that should have given the Commission doubts about whether the scheme was compatible with state aid requirements. That meant that the Commission should have conducted an in-depth investigation before deciding whether to approve the scheme. However, importantly, the Court did not rule that the design of the capacity market was incompatible with state aid requirements or direct that changes be made to the specific mechanism. We carefully considered each of the issues raised through the Court judgment, and we remain confident as a Government that the design of the capacity market is compatible with state aid requirements.

As I have said, the General Court’s judgment prevents the UK Government from making or unconditionally promising to make capacity payments. The T-3 auction and other upcoming capacity auctions will not run unless and until state aid approval is obtained. The delivery body and the settlement body are continuing to operate other aspects of the capacity market scheme, to the extent possible, during the standstill period. If this SI is not approved, that will prevent the Government from making preparations for the period after state aid is reinstated or from running a T-3 auction to secure capacity for 2022-23, which may put electricity supplies at greater risk in 2022-23.

The hon. Gentleman mentioned the five-year review; he is right that, in line with the requirement set out in the regulations, we intend to publish a report summarising our five-year review of the capacity market in the summer. The review is an important opportunity to look at making improvements. He also mentioned the low clearing price for the recent T-1 auction. We believe as a Government that that was due to a unique set of factors. The result tells us that we have a healthy capacity margin this winter, but does not tell us much about future T-3 or T-4 auctions, as the factors that led to the T-1 result are unlikely to arise in the same way.

That result was due partly to the fact that the auction was run close to the start of a delivery year, meaning that operational decisions for the delivery year had already been taken. It was also partly due to new-build capacity with future agreements and shorter lead construction timeframes commissioning ahead of their 15-year T-4 agreements, and existing capacity with agreements from previous T-4 auctions for future delivery years, looking to win interim T-1 agreements.

Regarding the T-3 auction in the regulations before us, when we look at the consultation that took place between March and April we see that most respondents agreed with the Government’s proposal to run this T-3 auction for the delivery year 2022-23. The approach will provide greater certainty to investors than a delayed T-4 auction, enabling that auction, unlike the T-1, to be run at a time when the Commission is expected to have made a decision about state aid approval.

That conditional T-1 auction was created to ensure that we had sufficient capacity for the next winter, 2019-20; as the auction was expected to be run during the standstill period, the agreements awarded were made conditional on the outcome of the Commission’s state aid investigation. This T-3 auction is different and we expect it to have received state aid approval ahead of running the auction in early 2020.

I turn to the matter of renewables, which the hon. Gentleman mentioned. Wind and solar make a measurable contribution to the security of supply, despite their intermittency. Remunerating that contribution is a key principle of the technology-neutral framework of the capacity market. It was always anticipated that the capacity markets framework would allow the participation of those technologies at some point. With the arrival of subsidy-free projects interested in bidding into the capacity market and the delivery body’s work to effectively de-rate intermittent renewables, the impetus for that change has become clear and is reinforced by the widespread support of stakeholders in the consultation.

Onshore wind, offshore wind and solar photovoltaic technologies will now be able to participate, and biomass and hydropower have always been allowed to participate, so this is equalling up on the renewables side. I state again that the capacity market is technology-neutral, and its role is to provide the security of supply at the least cost. Emissions performance standards and the carbon price floor work alongside the capacity market to ensure that our future energy supply is secure, low carbon and affordable. We are introducing other policy measures to support clean energy technologies, including the contracts for difference scheme.

Major schemes such as contracts for difference exclude renewables schemes from participation and we have not identified other forms of subsidy. We cannot rule out the possibility that some minor schemes may exist—at a local level, for example—but we are keen to do more and we will look, as part of the pathway to net zero, to set that out for the future. The Government believe that the capacity market is the right mechanism for achieving security of supply at the lowest cost to consumers—a view supported by the majority of stakeholders who responded to the call for evidence last September as part of our five-year review. The revenue from capacity payments incentivises the necessary investment to maintain or refurbish existing capacity and to finance new capacity. Without that capacity, we would be at greater risk of power shortages. It has had a direct and indirect impact on new-build capacity, and around 4 GW of new resources was cleared in the most recent 2018 T-4 auction.

To ensure that the state aid judgment is resolved in a timely manner, my Department will continue to work closely with the European Commission, ensuring that state aid approval for the capacity market can be reinstated swiftly, and robustly defends the recent judicial review of the arrangement that the Government have put in place during the standstill period. The regulations are necessary to ensure the smooth running of the capacity market in the period after state aid approval is received and to broaden the welcome wider participation of renewable technologies, and I commend them to the Committee.

Question put and agreed to.

Resolved.

That the Committee has considered the draft Electricity Capacity (No. 2) Regulations 2019.

Committee rose.