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Electricity Capacity (Amendment) Regulations 2016

Volume 773: debated on Tuesday 5 July 2016

Motion to Consider

That the Grand Committee do consider the Electricity Capacity (Amendment) Regulations 2016.

Relevant document: 2nd Report from the Secondary Legislation Scrutiny Committee

My Lords, this draft instrument seeks to amend the main secondary legislation package for the capacity market scheme, which was part of the electricity market reform programme in 2013. 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 2013 with cross-party support.

I remind noble Lords that the capacity market will address our electricity needs and ensure that there is a sufficient electricity supply towards the end of the decade and beyond. 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 supply, or reduce demand, when the system is tight, ensuring that enough capacity is in place to maintain security of supply.

Ensuring that hard-working families and businesses across the country have secure, affordable energy supplies they can rely on is our top priority as a Government. That is why we already have firm mechanisms in place, working closely with National Grid and Ofgem, to maintain comfortable margins on the system in the coming winter.

Beyond that, it is essential that generators have confidence that they will receive the revenues they need to maintain, upgrade and refurbish their existing plant, and can finance and build new plant to come on stream as and when existing assets retire. Equally, we want to make sure that those who are able to shift demand for electricity away from periods of greatest scarcity—without detriment to themselves and the wider economy—are incentivised to do so.

That is why we have the capacity market. The first two capacity market auctions took place in 2014 and 2015 and the first of two separate auctions, focusing on demand-side response, took place at the beginning of 2016. These resulted in a good outcome for consumers, as fierce competition between providers meant that we obtained the capacity we will need at prices below the levels many had expected. That translates to lower costs on consumer bills.

To ensure that the capacity market remains fit for purpose, my department has reviewed the capacity market mechanism in light of experience gained in these auctions. 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. They also stressed that regulatory stability is crucial.

At the same time, we heard concerns that we must do more to protect against delivery risks, that we need to tighten the incentives on those who have been awarded agreements to honour those agreements, and that we must avoid the risk of under-buying, or buying too late. United Kingdom electricity market conditions have also changed considerably since 2014, when the capacity market was established. The huge reduction in global commodities prices has lowered consumers’ energy costs but has pushed many generators into loss-making territory. As a result, several plant closures have been announced earlier than was anticipated, in 2014, and other generating plant may be at risk.

In order to address these points, this instrument will provide for: first, a new supplementary capacity auction for delivery of capacity in 2017-18—that is a one-off capacity option—with, secondly, minor reforms to help the capacity market deliver its objectives. I will set out the most significant amendments in turn.

First, these regulations make provision for a supplementary capacity auction to be held this coming winter for delivery in 2017-18. Running this auction mitigates the emerging increased risk to security of supply in 2017-18 by ensuring that enough capacity is available for that year. This acts as an insurance policy against a material risk of plant closures, which we believe is real. Our analysis shows that this approach is expected to be up to £8.4 billion cheaper than an alternative scenario in which further plant closures would have occurred.

These regulations also make provision for a number of amendments in light of my department’s review of the operation of the capacity market. Our public consultation exercise outlined the need for a robust system of checks—both on new-build projects to ensure that they are on track to deliver and on existing plant to ensure that they honour their agreements or that their operators do so. At the same time, it recognised the importance of ensuring that the system is not so punitive that legitimate projects are dissuaded from participating in the first place.

We have evidence that, despite the termination fee regime already in place, there have been instances where capacity providers have viewed their obligations as relatively low-cost options and have contemplated reneging on their commitments. I am therefore proposing measures to help ensure that new-build capacity that wins a capacity agreement has the appropriate incentives, and is exposed to a robust assurance regime, to deliver against their agreement. These measures include increases in credit cover for projects which cannot demonstrate sufficient progress against the required milestones, and limited but material increases to the termination fees which all those with an agreement must pay if they renege on their commitments. Through the supporting Capacity Market Rules, I am also proposing a prohibition on failed projects from participating in future auctions, and increased monitoring and reporting milestones.

These regulations also include measures to ensure that a secondary trading market can develop that supports investment in capacity market units. These changes would improve the current regulatory framework by dealing with the interaction between transfers of agreements and the penalty regime.

Finally, the transitional arrangements auctions—which is what these are—are aimed specifically at the demand-side response sector in recognition that it is a relatively small and immature sector. We are keen to ensure that funding provided through the next transitional arrangements auction is targeted to those types of resource that need it most, and these regulations therefore refine the eligibility criteria for the second transitional arrangements auction so that it focuses on genuine demand-shifting, turn-down DSR, rather than the small-scale generation, including diesel, that won many of the agreements in the first auction. So, that is a second type of auction: we have the supplementary capacity mechanism, and these transitional arrangements apply specifically to the demand-side response sector.

My department consulted on these changes across two consultations, in October 2015 and in March of this year. In total we received more than 200 responses to the two consultations. There was significant support for the majority of the Government’s proposals, particularly the supplementary capacity auction, refinements to the eligibility criteria for the second demand-side response transitional arrangements auction and the core proposals relating to delivery incentives. These regulations implement these proposals. I look forward to hearing what noble Lords have to say on these proposed changes. I beg to move.

My Lords, I am grateful to the Minister for setting out the intentions behind the amended regulations today. I have to say at the outset that the strategy for maintaining energy supply consistency does not seem to be working out quite as well as the Minister would have had us believe in his comments earlier and just now. We seem to be moving to a place where what was once a vibrant independent energy market is increasingly making investment decisions based on the government subsidy that is available. The more that the Government intervene, the more their interventions skew the overall energy capacity available.

Of course these latest proposals have to be seen against the backdrop of government policy shifts that have created huge uncertainty and risks for investors, deterred investment and put up costs. The Minister will have debated with my colleagues on numerous occasions the negative investment impact that has arisen from pulling the plug on schemes such as feed-in tariffs and the renewables obligation. I do not expect him to agree with me but we would contend that some of the problems with which he is now trying to grapple are essentially of the Government’s own making.

The original intention of the capacity market scheme was to attract new investment, encouraging gas-fired power stations in particular, but it seems to have completely failed in that objective. Instead, the subsidies seem increasingly to be used to reward existing profitable suppliers, including nuclear power stations. For example, nuclear power plants have so far received payments amounting to £153 million for 2018 and £136 million for 2019, despite the fact that they were almost certain to remain open during those years without receiving those subsidies.

Incidentally, I could use this opportunity to raise again with the Minister the question marks over Hinkley Point, given the outcome of the referendum, which has fuelled further concerns about the commitment of the French Government to that investment, but I realise that he will feel obliged to repeat the mantra that all is well in that investment until eventually there is overwhelming evidence that that is not the case and the deal finally falls through. So I understand that he is limited in what he can say on that.

There is also a question mark over whether the capacity market interventions will run counter to the Government’s other binding commitments to reduce pollution, given that some of the beneficiaries are coal and diesel generators. Indeed, my colleague in the other place, Lisa Nandy, made a telling point that there is a danger that consumers will be paying twice for policies pulling in opposite directions: they will pay once to drive coal out of the system via the carbon price floor, and once to keep it in the system via the capacity market. We are now reaping the effects of ill- thought-through market interventions, with consumers bearing the ultimate cost.

The Minister may be aware of the recent report from the IPPR think tank into the workings of the capacity market. It underlines the argument that these measures work against decarbonisation. They have provided a lifeline for several old coal-fired power stations, which received a total of £373 million from the first auctions. They have also heavily incentivised the proliferation of new diesel generators, which are even more polluting than coal. The report also makes the point that the capacity market is designed around the requirements of large power stations rather than smart energy technologies, such as demand response and electricity storage.

Has any consideration been given to introducing an emissions performance standard, which could be applied to all those in receipt of the capacity payments? Is the department giving any thought to how the capacity payments could be used to incentivise gas power plants using carbon capture and storage if they are to stay open in the longer term? Is the department prepared to consider variable subsidies so that the new technologies, which could provide a longer-term solution, do not have to compete with traditional power station generators for support?

Having said all that, the specific proposals in the amended regulations to increase the penalty for non-performance clearly make sense. It cannot be right for suppliers to accept subsidies and then walk away from the contract anyway. It is also right that there should be a robust system of checks on new-build and existing plant to ensure that agreements are honoured.

Finally, does the Minister feel that the financial assessment of the cost benefits of the new auctions, in what is clearly a volatile market, can be relied on, and is there a mechanism for revising such calculations in the light of changing market responses? Does he feel that enough stress-testing has been done to interrogate the market effects of introducing one-year auctions when we are trying to encourage longer-term planning and investment? I look forward to his response.

My Lords, I thank the noble Baroness, Lady Jones of Whitchurch, for her qualified support—I think she gave some support to the basic thrust of what we are seeking to do—and I will endeavour to respond to the points she has raised.

It is ironic that the Official Opposition have put forward a more market-based approach than the Government on this occasion. I feel that intervention is necessary, and the regulations have been brought forward on that basis. As I have said, the No. 1 priority for this Government, as I would think for any Government—I have yet to hear otherwise—is to ensure that we have security of supply and that the lights are kept on. In the broader sense, we need to ensure that our hospitals can carry out operations in a timely way; at the most basic level, we can see why that is so important.

Such interventions are necessary. As I have said, the changes that have occurred in the market since 2014, with the massive drop in commodity prices, have made many of the regulations necessary. Some power stations have closed. The noble Baroness will know that the Government are totally committed to the closure of coal-fired stations. That is something that only this Government have brought forward. We have said that unabated coal-fired power stations will end by 2025—that will be put out for consultation—subject to ensuring we have security of supply. We are the first developed country in the world to indicate that we will do so, ahead of all our European colleagues, the US and so on. As a country, we can be proud of that, and I hope that the Official Opposition support it.

The noble Baroness talked about the importance of underpinning renewables. That is certainly true, but we cannot rely totally on renewables. We need baseload to support renewables, which is what the regulations are about. She said she would refrain from mentioning Hinkley Point C, and then she did so. Having heard her dismal litany, I am obliged to say that the mantra she expected in response is indeed what we believe to be the case. Last week, I discussed this with a Chinese Minister, who is fully committed to the project, and we understand that the French Government are as well. It remains central to our energy policy, and I hope we can avoid talking down this area of activity, because the supply of nuclear is essential for us.

The noble Baroness mentioned diesel generators. I share some of her concerns, so I can understand where she is coming from on this point. As she will appreciate, this area cuts across government departments. Some of it rests with Defra, which we expect will announce consultation proposals in the autumn, ahead of both the next round of auctions and, indeed, the supplementary capacity auction that we are dealing with. We therefore expect bidders to be aware of likely future restrictions on their generation, and their bidding behaviour will adjust accordingly. We cannot anticipate precisely how that will go, but the consultation is being held with a view to ensuring that we can restrict diesel. I share the concerns she has expressed on that point, so I hope that that offers her some comfort.

In general, the noble Baroness will know that the auctions operate in relation not just to providing additional capacity but to the demand-side response of reducing capacity. That is central: we are looking not just to build in more generation but to restrict existing generation and to shift it. I hope that that will again provide some comfort to her. I should also say with regard to diesel that Ofgem will consult on proposals to tackle embedded benefits in due course, so action is going on elsewhere in government to deal with the diesel generation issue, which I recognise; I previously indicated in the House that we would look at it, as indeed we are.

Once again, I thank the noble Baroness for the qualified enthusiasm for the regulations she was clearly demonstrating, although she managed largely to restrain herself, and I commend the statutory instrument to the Committee.

Lest the Official Opposition, as he describes me, are totally misrepresented, I would say on intervention and regulation that our position is that when you do it, it should be smart intervention. There is always a danger in any regulation that you encourage perverse outcomes if you do not think through its consequences. I was just warning against some of those perverse outcomes which can occur, particularly when you deal with large sums of money, as we are here. However, I do not want to go back over the Minister’s clarification of other points but simply wished to say that on that basis we are happy to support the regulations.

Motion agreed.