Motion to Consider
My Lords, this draft instrument—the supplier payment regulations—forms part of the implementing secondary legislation for the Government’s capacity market scheme, which is part of the electricity market reform programme. The powers to make this implementing secondary legislation are found in the Energy Act 2013, which, following scrutiny in this House and the other place, received Royal Assent in December last year, with cross-party support.
The capacity market will address our medium-term electricity needs and ensure that there is sufficient electricity supply towards the end of the decade and beyond. It is one of the two key schemes brought in by electricity market reform to incentivise much needed investment into our energy infrastructure. The other, the contract for difference scheme, is not the subject of today’s debate.
The capacity market will help keep the lights on by driving new investment in gas and demand-side capacity, as well as getting the best out of our existing generation fleet as we transition to a low-carbon electricity future. In brief, the capacity market will achieve this by making a regular capacity payment to providers who are successful in capacity auctions. In return for this payment, providers must meet their obligations to provide capacity or reduce demand when the system is tight, ensuring that enough capacity is in place to maintain security of electricity supply.
The supplier payment regulations will sit alongside the Electricity Capacity Regulations 2014, called the principal regulations, and the Capacity Market Rules 2014. The principal regulations and rules, which received parliamentary approval in July this year, brought the capacity market into force on 1 August and, as a result, the first capacity auction will be held later this month for delivery in 2018-19. Those successful in this and subsequent auctions will be awarded capacity agreements entitling them to capacity payments. This will be paid for by a charge on all electricity suppliers. It should also be noted that while the first capacity delivery year will be in 2018-19, the Government are committed to supporting the growth of the demand-side response sector. As part of this, two transitional auctions, just for this sector, will be held in 2015 and 2016 for delivery in 2016-17 and 2017-18. This tailored support will help grow the demand-side and storage industries and ensure effective competition between traditional power plants and new forms of capacity, thereby driving down future costs for consumers. As with payments made during the capacity delivery year, payments made under the transitional auctions will be funded by a charge on all electricity suppliers.
When we debated the principal regulations, I highlighted that the Government would be bringing forward a second set of regulations on the supplier payment arrangements for the capacity market to align the legislative framework for the capacity market and contracts for difference. The supplier payment regulations were not brought in at the same time as the principal regulations, as they are technical provisions which we wanted to get absolutely right. It was not necessary for them to be in force prior to the first capacity auction.
The supplier payment regulations, which suppliers, industry and consumer groups have been consulted on throughout their development, include an obligation on all electricity suppliers to pay a “capacity market supplier charge” from 1 April 2015. As I have mentioned, this charge will fund the capacity payments to those successful in capacity auctions. The first capacity payments will be made in 2016 and 2017 to those successful in the transitional auctions, and to those with a capacity agreement for the first capacity delivery year in 2018-19. In addition, the regulations include a small additional levy—known as the settlement costs levy—to cover the operating costs of the government-owned Electricity Settlements Company, whose role it is to calculate, determine and administer the payments from suppliers to those who are successful in the capacity auctions.
The regulations determine how much each licensed supplier will be required to pay for the capacity market. The amount payable by a supplier will be calculated on a supplier’s share of the market, based on how much electricity they were supplying between 4 pm and 7 pm on working days between November and February in the relevant delivery year. This approach seeks to achieve a balance between the objective of incentivising reductions in electricity use, at times when demand is high, and that of remaining predictable and manageable for electricity suppliers who have to pass these costs on to their customers transparently. The regulations will facilitate the flow of payment from all electricity suppliers to those successful in capacity auctions. On receipt of capacity payments, capacity providers are then obliged to provide capacity or reduce demand when required. This therefore ensures security of electricity supplies.
While further amendments will be made in early 2015 to the principal regulations, mainly to enable the Government to meet their commitment to allow interconnected capacity to participate in the capacity market from 2015 onwards, these regulations complete the secondary legislation framework for the capacity market. I beg to move.
I thank the Minister for her explanation to the Committee of the electricity capacity regulations. She referred to the Energy Act 2013, of which these and other provisions are the consequence. Many days were spent in this very Room debating the issues pertinent to the regulations before us today and we remain supportive of the role of the capacity market mechanisms, as part of electricity market reform. However, one or two curiosities remain from these regulations and I would be grateful if the Minister could clarify them today.
The Minister has made it clear that each supplier will pay the capacity market on a forecast of their share of net demand between 4 pm and 7 pm on working days in winter, and that this will be reconciled using actual demand data once they become known. What degree of accuracy in that forecast is specified in the regulations or is there an element of incentivisation included, such that suppliers do not overbudget the market for cash-flow purposes, resulting in higher consumer costs? How will this element be monitored and any sanction calculated or even applied for, should there be excessive demand forecasting, and what happens if there is then a dispute concerning the calculation of actual demand? What dispute-resolution mechanisms have been proposed?
The regulations also make it clear that should a supplier default on payment, this contribution to the capacity market must be made up through further contributions from the remaining non-defaulting suppliers. What degree of allowance for this can a supplier rely on in undertaking his or her forecasting? Have the Government calculated a fair cost element to each supplier of carrying this additional risk and how significant this may become?
In her remarks, the Minister referred to the inclusion of interconnectors. I remember our debates and the encouragement for the inclusion of this innovation, to contribute to the UK’s security of supply. In anticipation of such future inclusion of interconnected capacity, Regulation 3 of the principal regulations is amended in the definition of “providing electricity”. It is obviously disappointing that interconnectors could not take part in the capacity mechanism from the very beginning. With the first round of auctions taking place on 16 December, as she said, the potential for some of these interconnector projects, which could well be in place by 2020, is significant. The impact assessment also notes that a greater degree of interconnection could help to reduce the role of the capacity market in future, yet the capacity market is needed to enable access from interconnectors. How does the Minister see this conundrum playing out as we move to the more contractual counterparty model used for contracts for difference?
The position of existing nuclear power is also somewhat curious. It is included in the list of qualifying plant for the capacity market yet these nuclear plants have already been built, are already generating and are receiving revenues for electricity that will not be hit by carbon pricing. Has the Minister reflected that nuclear plants can now enter the capacity market, even though industry is intended to finance the cost of upgrade and life extension work? As the Minister knows, subsidy will find its way back in the end to bills that the consumer pays.
The Explanatory Memorandum also mentions that as the capacity market is intended to be a transitional measure, regular reviews of the capacity market will take place. Has the Minister any view on how often these regular reviews and audits should be taking place? As each year’s auction will clarify progress on a number of eventualities and be subject to demand-side and storage transitional arrangements, as mentioned in the Minister’s remarks, does she envisage that they would best be undertaken yearly?
The Minister will also be aware that carbon impact policies do not apply to plants producing less than 20 megawatts. This will give a cost advantage to plants conveniently bidding on providing 19 megawatts. Will the Minister outline the rationale for that defining level as oil plants, being perhaps among the most polluting forms of generation, will tend to be at a sub-20 megawatt level? In the expectation of her fulsome replies and clarifications, I am in support of these regulations today. In the spirit of Christmas, I look forward to congratulating the Minister on a successful auction next week. We will have the joy of experiencing it in the announcement of the results by National Grid early in the new year.
I start by thanking the noble Lord, Lord Grantchester, for what was, I think, his general support for the draft regulations. Of course, he reminded me of the hard work that the Committee undertook during debate on what became the Energy Act 2013. I was extremely grateful for the noble Lord’s participation in ensuring that the level of scrutiny that took place really did enhance the Bill as it moved through to become an Act.
As always, the noble Lord, Lord Grantchester, asked a large range of questions and before I continue, if I fail to answer any of the questions that he posed, I will of course read Hansard carefully, and I undertake to write to him and place a copy in the Library.
The noble Lord asked about the period of reviews. Reviews will be undertaken yearly by Ofgem and every five years by the Government. It is important that we ultimately deliver the right formula to ensure a value-for-money cost to the consumer. I know that ultimately the noble Lord and I share the primary object of ensuring that not only do we have enough supply but that it provides value to the consumer.
The noble Lord also asked what suppliers thought of mutualisation of the costs in the event that one supplier fails to pay. We have consulted with suppliers on charging arrangements and they accept that mutualisation is necessary in order to provide the necessary certainty that capacity payments will be made to providers. This reflects cost recovery mechanisms in similar organisations elsewhere. It is not unique to the proposal we are putting forward here.
The noble Lord asked what dispute mechanisms were in place in relation to the data used or the calculations carried out. The majority of data used for settling the capacity market comes from existing industry processes established by the balancing and settlement code. So, again, we have evidence available from resources already in place.
The noble Lord also asked about electricity suppliers’ charges being based initially on their own estimates. The payment methodology ensures that, in all instances, 100% of the necessary costs can be collected. This is an important objective. We opted not to create a penalty on suppliers for inaccurate estimates because of the additional complexity that that would create. The challenge, of course, as the noble Lord is aware, is to achieve this in a fair manner. We do not want to have unintended consequences on suppliers just because a new mechanism is being put into place.
Sitting suspended for a Division in the House.
My Lords, I will continue with my responses to the noble Lord, Lord Granchester. He asked about interconnectors. As he mentioned, we announced the interconnected capacity, which will participate in the market from 2015. We will bring forward amending legislation and an impact assessment in the new year that will address the points the noble Lord raised about interconnectivity.
The noble Lord also asked about existing plant such as nuclear and asked why it was being allowed to partake in the auction. The purpose of the capacity market is to ensure that we have secure energy—that the lights do not go off. That means that we need to ensure that all forms of capacity are able to take part in the system. However, it is open to best value: of course the capacity market is there to generate competition, but also to ensure that we have enough supply to keep the lights on. I think the noble Lord will of course agree that those established technologies have a lot of upfront costs when they build, so a lot of other costs are associated with the traditional sector and we should not exit them out just because they have already built and are partaking. However, nuclear offers a low-carbon energy supply, and I think the noble Lord will agree that that is also a necessary need to fulfil, as well as ensuring that the lights stay on.
The noble Lord asked about carbon impact policies and the advantage for plants that are bidding at the 19-megawatt ratio. I would like to reassure the noble Lord that we will be reviewing the outcome of the first auction to ensure that it is a fair process and that we do not unintentionally benefit one form of supply over another.
This debate has been important and I do thank the noble Lord for his questions, which have allowed me to illustrate the fairness of the system—but again, as with all things, we will make sure that we are reviewing the process as we go along. I would also like to put on record that I hope that the noble Lord gets an opportunity over the Christmas period to take some time off and rest, because I know that he works extremely hard, as do his colleagues, in challenging the Government—which is only right and enables us to produce better legislation. I commend the draft regulations.