Motion to Approve
My Lords, this draft instrument seeks to amend regulations concerning the contracts for difference, or CfD, scheme and the capacity market. CfDs provide long-term price stabilisation to low-carbon generators, incentivising investment by lowering the costs of capital and thus reducing the costs to consumers. The capacity market is the Government’s main policy to ensure a healthy margin of electricity capacity. Regular payments are made to different forms of generation or demand-side response in return for such capacity being available when needed.
In both schemes, support to participants is assigned through competitive auctions, minimising costs to consumers. The 2017 CfD auction secured 3.3 gigawatts of renewable capacity, enough to power an estimated 3.6 million homes. It also saw the clearing price of offshore wind halve compared to the first auction back in 2015. The next competitive auction for less established renewable technologies is planned for spring 2019.
Following four successful four-year-ahead auctions, the capacity market is already securing the capacity we need through to 2021-22. The latest auction secured 50.4 gigawatts of capacity at a price of £8.40 per kilowatt per year. The main auctions have all cleared at between £8.40 and £22.50 per kilowatt per year, below most industry estimates and indicating that the process is highly competitive and delivers value for money for consumers.
The Low Carbon Contracts Company and the Electricity Settlements Company, two operationally independent government-owned companies, work with government to operate the capacity market and CfDs, playing a crucial role in their successful delivery. The Low Carbon Contracts Company was set up to be the counterparty to the contracts for difference. It manages the contracts for their duration, as well as collecting and making CfD payments. The Electricity Settlements Company was established as the capacity market settlement body to oversee all financial transactions relating to the capacity market. Both companies recover their operational costs through levies on electricity suppliers. This is the subject of the regulations that we are considering today.
The regulations will set revised operational cost levies for each of the companies for financial years 2018, 2019 and 2020. Previously, the levies have been set annually. These regulations, however, will set levies for each of the next three financial years, allowing the companies to recover their expected operational costs over this period. Additionally, the regulations make a minor grammatical amendment to the Electricity Capacity (Supplier Payment etc.) Regulations 2014, removing the words “is responsible”, which are not required.
Both companies are essential to the Government’s decarbonisation and security-of-supply objectives and must be sufficiently funded to perform effectively while keeping costs to consumers minimised. The budget-setting process aims to strike the right balance. The budgets are scrutinised by government to ensure they reflect operational requirements and deliver value for money. The budgets have also been exposed to external scrutiny through consultation. The three consultation responses were broadly supportive of the proposed budgets. We also asked stakeholders for their views on setting levies for the next three years instead of one year ahead. They agreed that this was a sensible approach, as it provides them with greater visibility of the estimated costs. Furthermore, parliamentary time is saved over what is likely to be a very busy period.
The operational cost budgets over the three-year period have been set to cover the expected activity required to manage the CfD scheme and the capacity market. The Low Carbon Contracts Company’s budget will be £16.5 million in 2018-19, increasing by about £0.5 million for each of the next two years. The Electricity Settlements Company’s budget will be £7.6 million in 2018-19 and decrease slightly to £7.5 million in 2020-21. The Low Carbon Contracts Company’s net core operating cost for 2018-19 is slightly down on last year. The increase in total cost reflects the inclusion of a contingency provision for managing potential contract disputes. The increase in the final two years takes account of potential additional contracts awarded through future allocation rounds. Importantly, however, management costs per contract are projected to fall by 30% over the budget period.
The Electricity Settlements Company is managing a significant increase in the amount of capacity and the number and type of capacity providers. Moreover, there will be an ongoing need to refine the operation of the capacity market. To manage this activity effectively and ensure that it continues to successfully deliver all the financial transactions for the capacity market, the Electricity Settlements Company requires investment. The budget increase reflects the investment needed.
The regulations revise the levies currently in place to reflect the expected operational cost requirements in financial years 2018, 2019 and 2020. Subject to the will of Parliament, the levy to fund the Electricity Settlements Company’s operational costs is due to come into force on the day after the regulations are made; the operational costs levy for the Low Carbon Contracts Company on 1 April. I commend these regulations to the House.
I thank the Minister for his introduction to the order before your Lordships’ House today. He has set out the details very well, in that the order amends the rates for the operational costs levy for the next three financial years in the contract for difference regime and the rates for the settlement costs levy also for the next three financial years in the capacity market. These costs are borne by electricity suppliers who pass them on to their customers through their bills. These costs are levied to cover the operational and administrative charges borne by the CfD counterparty, the Low Carbon Contracts Company that operates the ESO regulations, and the Electricity Settlements Company that is responsible for the operation of the capacity market.
As the Minister said, these costs have previously been calculated on an annual basis. As both these operations have been successfully running for a few years and have become predictably regular, it makes sense to convert these from annual to three-year periods. The Minister is also correct to point out that both the capacity market and the CfDs have been a success in bringing forward reduced bids at the various auctions, resulting in lower costs to consumers. Against this, it must be acknowledged that both companies are now managing increased market complexity with a greatly increased number of participants that is reflected in the increased rates in the order today.
Discussions on the order in the other place focused on these costs, the not insignificant amount that is translated on to consumer bills and the enormous cost inflation—an increase of some 700% in the operational budgets of the ESC since 2014. Mercifully, we need not rehearse those discussions today. The Minister in the other place was able to clarify that, in the case of the ESC, the number of participants increased from 46 to 447, providing initially from 0.6 gigawatts of capacity to 55 gigawatts. It was interesting that, while operational costs as part of the whole scheme should reduce from 1.6% last year to 0.6% in 2020, this is against a forecast of a fall in gross electricity demand of some 2% over the same period, meaning levy rates increase. I hope that all that makes sense to the uninitiated.
What was not discussed in the other place was that, in relation to the LCCC in the CfD market, the budgetary increase was principally due to the inclusion of a provision set aside for disputes. Paragraph 8.4 of the Explanatory Memorandum explains that the Government will keep this contingency under review but that the LCCC must have sufficient funds to defend a dispute.
My questions to the Minister revolve around disputes. What do these disputes tend to be about; what have been the past costs in the operation of the CfDs; and has any dispute resulted in a court case and, where appropriate, involved the recovery of losses, with costs being borne by the loser? These points have not been explained—perhaps the Minister could explain them now. I phoned the department this morning and I am very grateful to Fiona Reynolds for discussing the issue with me; I trust she has been able to advise the Minister. Finally, are these disputes to be categorised more as queries, challenges or appeals against decisions, and what has been the experience from past years, such that a regularity can now be transposed into a budgetary contingency? While the order can be approved today, this would be interesting to understand.
My Lords, capacity markets and contracts for difference have been a roaring success and came in during the coalition years when Ed Davey was Secretary of State—we would expect no less. The regulations will pass today, but it is absolutely right to question any rise in cost, particularly when a small proportion of it is passed on to the consumer. It is always important to keep an eye on costs and particularly when renewing a contract with an entity that is effectively the sole supplier in the field, thus making competition on pricing an impossibility—there is no one competing, so they get more.
Having read the debate in the other place, the rationale given for the steep rise in costs to the Low Carbon Contracts Company and the Electricity Settlements Company since commencement, is basically the expansion of the number of providers, as the noble Lord, Lord Grantchester, mentioned, from 46 to 447—which, of course, is a good thing—as well as the need to cover disputes. I too am very interested in the information on exactly what those disputes are and look forward to reading that in due course. We need to remain vigilant that all costs are properly scrutinised.
I could not help but note that the Minister in another place, Claire Perry, in order to assuage any concerns over the creeping inflation of costs beyond what they should be, said:
“I am always keen to run the calculator over these companies’ calculations. As the Minister ultimately responsible, I will continue to do so”.—[Official Report, Commons, Delegated Legislation Committee, 19/3/18; col. 8.]
I am impressed with the Minister’s personal intervention in this mission and trust that her background in banking and finance mean that her use of a calculator is unimpeachable—but I hope there are some accountants keeping an eye on this too. I simply wish to reiterate that companies in receipt of large sums of public money need strict monitoring. On the basis that this will happen, I am content that the regulations should pass.
My Lords, I can certainly assure the noble Baroness, Lady Featherstone, that my right honourable friend Claire Perry will continue, as the noble Baroness quoted, to run a calculator over these issues—I am sure she will use a calculator, an abacus or any other instrument that is necessary but, just as important, she will also make use of accountants, and the department will keep a very close eye on these matters.
I think the only matter that I need to deal with for both the noble Baroness and the noble Lord, Lord Grantchester—who very helpfully let the department know what his concerns were—is how the budget, including the provision to deal with potential disputes in relations to managing CfDs, has been calculated. As the Low Carbon Contracts Company is the counterparty for CfDs, it is important that it has sufficient funds to defend a dispute if necessary. The provision included in the budget is largely based on previous experience and assumptions about potential disputes. Previous disputes have largely related to contract matters, though the nature of those will be confidential—that is the nature of such things. I emphasise that if the provision is not utilised for disputes and the surplus levy income is not required for other operational activity—we are only talking about matters relating to such activity—it will be repaid to suppliers in accordance with the regulations.
I hope that satisfies both the noble Baroness and the noble Lord and that, with their agreement, I can commend these draft regulations to the House.