Considered in Grand Committee
My Lords, before outlining the provisions made by this draft instrument, I will provide the Committee with a brief reminder of what the capacity market is and does. The market is at the heart of the Government’s strategy for maintaining security of electricity supplies in Great Britain. It secures the capacity needed to meet future peak electricity demand under a range of scenarios through competitive, technology-neutral auctions, normally held four years and one year ahead of the relevant delivery year. Those who win capacity agreements, known as capacity providers, commit to providing capacity during periods of system stress in exchange for receiving capacity payments. Capacity payments are funded by electricity suppliers, which recover this cost from electricity consumers.
Since its introduction in 2014, the capacity market has succeeded in ensuring secure electricity supplies at a low cost to consumers. Furthermore, it has a proven track record of facilitating investment in new-build capacity. To date, the capacity market has supported investment in over 13 gigawatts of new capacity, including smart technologies such as battery storage and demand-side response.
The most recent auctions, which took place in March this year, were successful in securing all the capacity needed to meet peak demand through to 2024-25. This year, for the first time, as a result of the carbon emissions limit introduced to the capacity market in 2019, coal-fired plant did not participate in the four-year-ahead capacity market auction, nor will it be able to participate in any future four-year-ahead auctions. This is just one of the steps that we are taking to help to align the capacity market with our broader decarbonisation objectives on the road to net zero emissions by 2050.
In 2019 we published our five-year review of the capacity market. In it, we found that the capacity market was fundamentally meeting its objectives. However, we identified a number of areas that could be improved through incremental change, many of which have since been implemented through subsequent amendments. That has ensured that the capacity market remains the best way to ensure security of supply at the lowest cost to the consumer. Most years, we also make adjustments to the legislation based on our day-to-day experiences of operating the capacity market in order to ensure that it continues to function effectively.
In that context, the draft instrument before us today makes three technical improvements that will address issues in the functioning of the capacity market that we have encountered over the past year. Specifically, a number of capacity providers had agreements terminated last year but were unable to transfer their obligations to other providers through the capacity market’s secondary trading market. To reduce risks to security of supply, the draft instrument aims to remove the barriers restricting the trade of obligations following termination. This will improve the flexibility of the secondary trading regime and make it easier to replace capacity that closes prematurely and at short notice.
The past year also saw a large number of appeals by prospective capacity providers whose applications to participate in the capacity market had been rejected, often for minor administrative errors. The draft instrument aims to make clearer that the capacity market delivery body—the organisation that delivers the capacity market—can accept information that corrects such errors when determining these appeals. That will help to reduce the risk of applicants being rejected due to minor or administrative errors that could otherwise have a detrimental impact on the level of competition in the auction.
Finally, the draft instrument aims to allow capacity providers who have had the duration of their agreements reduced as a sanction for non-compliance with certain requirements the option to appeal a decision to the Secretary of State. We acknowledge that a reduction in agreement length could have significant impacts on the viability of projects, and we therefore believe that it is right that capacity providers in such a situation should be given the right to appeal.
To complement this draft instrument, we have put forward an amendment to the capacity market rules, which was laid before the House on 5 July 2021. The amendment rules make a number of additional technical improvements. Notably, they update the carbon emissions limits to introduce new formulae that allow for a better reflection of the actual carbon emissions of certain generators, such as those equipped with post-combustion carbon-capture technology.
The rules amendments also extend some of the coronavirus easements which were introduced and debated in this House last year, in recognition that coronavirus has impacted the ability of capacity providers to meet some of their obligations under the capacity market. The extension of some of these arrangements will help providers in coping with the continuing impacts of the pandemic.
In conclusion, this draft instrument introduces a number of technical provisions which are intended to address issues that we have identified over the past year through our experience of managing the annual delivery cycle of the capacity market. Therefore, these technical provisions are necessary to enable the continued efficient operation of the capacity market in delivering on its objectives. I therefore commend this draft instrument to the House.
I call the noble Lord, Lord Bradshaw. Lord Bradshaw? We seem to have lost the noble Lord. We will therefore move to the next speaker and then return to the noble Lord, Lord Bradshaw. I call the noble Lord, Lord Bhatia.
My Lords, I thank the noble Lord, Lord Callanan, for explaining this instrument, and I fully agree with what he has said. In view of this very important matter, can the Minister explain whether this capacity system will create more emissions?
I think that we can now try to return to the noble Lord, Lord Bradshaw. Lord Bradshaw? We will move on to the noble Baroness, Lady Bowles of Berkhamsted.
My Lords, this is a set of changes to the capacity market system following a consultation. As a serial responder to consultations—although not in fact to the one relating to this—I must say that I am surprised by how few responses some get. In this instance, there were 38, although some were from trade associations, so, collectively, it covers more than 38 entities. But it still seems a low number, although, if I remember correctly, there have been fewer on some other electricity generation SIs.
I do not expect that the Minister can easily do anything about that, and there are so many consultations that I can understand if there is consultation fatigue—I have suffered from that myself—but it worries me if responses are obtained only from directly interested parties, important though they are. They are public consultations and the clue is in that name. The consultation informing this instrument seems to have received only one potentially non-industry submission from an individual respondent. Yet, as the Minister has explained, the capacity market is an important part of maintaining a secure and reliable electricity system and even this instrument is not devoid of public interest, as against producer interest, points.
Our capacity auction system is neutral in that all types of generation are included and, as the Explanatory Memorandum says at paragraph 7.2, and as the Minister has alluded to, the purpose of the payments is to,
“incentivise the necessary investment to maintain and refurbish existing capacity,”
and in some instances to support new-build projects. However, there is also a secondary market in capacity agreements and this instrument now breaks the link between the continuing existence of the original capacity agreement owner and the ongoing validity of capacity agreements that they have sold on.
I have some reservations about that change in that it might have perverse incentives to encourage overbidding for the purpose of secondary trading. It could be counterproductive to encouraging investment and, more to the point, knowing where that investment is to be made, and makes trading for cash more likely, which is not really what it was all meant to be about. For example, what pressures might there be from shareholders for certificates to be sold rather than for investment to be made?
Therefore, I am not entirely convinced that the public interest, which is substantial in terms of security of supply, is served by this. I can see that there may be arguments on the other side about maintaining the capacity that has been auctioned, and I should be interested if the Minister elaborated on those more fully and on what other mechanisms compensate for the fact that what was originally a kind of safeguarding mechanism has been removed.
Not surprisingly, the consultation responses agreed with the proposition. However, as I have pointed out, given that all those responses, bar one, have been entirely from industry and therefore from those who would benefit by it, either by way of enhanced secondary-market value of an agreement or from ongoing value irrespective of the status of the original owner, that is hardly a response that can be said to have the public interest uppermost.
I turn now to the reductions in the length of capacity agreements when a provider has breached obligations. I have no objection to the basic fairness of allowing appeals. I cannot help wondering how that might interact with a potentially lively secondary market and keep up with the obligations that attach to the traded certificates. I would welcome more explanation as to how that works. For example, can the Minister assure me that purchasing an agreement and obligation on the secondary market does not give, of itself, an excuse for non-performance or leniency?
The third change relates to allowing the delivery body to take into account changes in non-material errors in pre-qualification applications during appeals. This seems to be eminently sensible and I wonder whether that is, or can be, part of a wider approach within BEIS to a whole range of matters where non-material points or presentation prevent access to grants and other assistance, in particular for smaller entities. I note the value of the change to smaller entities, as explained in the memorandum. I would welcome that becoming a more general approach in BEIS.
I am interested to hear what the Minister has to say about the issues that I have raised and especially whether the effects on the trading changes will be monitored for any detriment and whether that may have been necessitated because of Covid, rather than the previously-existing steady state?
I will now call the noble Lord, Lord Grantchester, and after that I will call the noble Lord, Lord Bradshaw, again. It would be helpful if he could remain muted until he is called after the noble Lord, Lord Grantchester.
I am grateful to the Minister for his introduction to the regulations before the Committee today. He looks a little isolated in the Committee Room today, but I hope our words will buoy him up. We are conducting very successful deliberations today. As he remarked, these regulations are non-contentious and provide sensible revisions to strict interpretations to the letter of the previous regulations by the capacity market delivery body. I agree that the three amendments will enable a better dialogue between capacity providers and the body to enable corrections of non-material errors in pre-qualification applications to enable secondary trades to be better maintained and to enable appeals to be heard to extend compliance periods or withdraw reduction decisions. All these should enable a more competitive capacity market to operate, so I am content to approve the regulations today.
Although they are uncontentious, I must comment that I found the Explanatory Memorandum rather scant. While I note from paragraph 15.3 that the Explanatory Memorandum meets the required standards, which I am sure will have been set and agreed with your Lordships’ Secondary Legislation Scrutiny Committee, nevertheless it would have been helpful to me if the memorandum had offered an overview of the main pertinent elements of the consultation respondents’ comments. I realise that the Minister will reply that further information can be gathered through the link to the consultation document and the Government’s response, but some indication of which minor amendments were put forward that have been taken into account where sensible would have given better assurance that respondents were broadly supportive of the proposals. Indeed, the noble Baroness, Lady Bowles, spoke about consultation and its importance with interpretation.
Furthermore, at paragraph 6.2 the Capacity Market (Amendment) Rules 2021 are specifically mentioned as additional to these regulations, but without explanation. The Minister said a little about the background details to that in his opening remarks, and I am grateful to him for that.
Having made these remarks, I merely add that the capacity market has worked well in bringing forward investments and innovations necessary to the electricity market reforms that are now appearing more and more to be merely providing free money to provide generation that either will not be called on or would be provided in any case, should there be a need. The most obvious example of this is nuclear power, where a plant is not subject to being switched on and off. Does the Minister consider this an issue, or does he believe that the price mechanisms adjust to this situation? Certainly, the initial operation of the capacity market has contended with and avoided the potentially huge volatility of price movements should various future energy needs predictions of marginal shortages have proved accurate. As we know, the cut-backs consequential to the Government’s austerity programme meant that there was no danger of the lights going out.
As the next review considerations begin to arise, can the Minister confirm that a full appreciation of the capacity market mechanisms to meet potential powers shortages will be part of that review and that it will not be limited to focusing merely on technical, operational measures? Will the review undertake more fundamental appraisals, such as considerations to replace the capacity market mechanisms with alternatives, such as strategic reserve capacity?
I now call the noble Lord, Lord Bradshaw. I will try one more time, before turning to the Minister, to call the noble Lord, Lord Bradshaw. As we are unable to reach the noble Lord, Lord Bradshaw, I now call the Minister to respond.
Perhaps I could say to the noble Lord, Lord Bradshaw, who has obviously had a problem coming in, that, if he has any specific questions about these regulations and wants to write to me directly, I will be happy to provide him with answers to any concerns he might have. I thank other noble Lords for their valuable contributions to this debate.
The Government continue to believe that the capacity market is the right mechanism for delivering security of supply at the lowest cost to consumers, and we continue to take steps to ensure its ongoing efficient and effective operation. The capacity market is tried and tested. The fact that it has supported investment in over 13 gigawatts of new-build generation and interconnectors since its introduction demonstrates that it can bring forward the capacity needed to meet future peak demand and replace older capacity as it retires.
Furthermore, the introduction of carbon emissions limits and the fact that coal-fired generation was unable to participate in the recent four-year-ahead auction shows that we are taking steps to ensure that the market is in alignment with our decarbonisation objectives. We acknowledge that further work will be required to ensure that the capacity market is aligned with our net-zero target and we intend to issue a call for evidence that will engage the industry on potential actions for delivering this objective. The Government are committed to ensuring that the right policy tools are in place for delivering a secure and affordable electricity system as we transition to net zero. This includes regularly assessing the performance of the capacity market.
In line with our statutory obligations under the electricity capacity regulations 2014, we have recently begun work on the next five-year review of the capacity market, which will be published in 2024. This in-depth review will scrutinise the objectives and design of the capacity market. It will take account of how the energy landscape has changed since the market was first introduced, in particular our net-zero ambition and changes to wider energy policy. We will also identify and implement changes to the design of the market to ensure that it remains able to deliver security of supply.
Returning to the draft instrument before the Committee today, the changes respond to three technical issues that we have encountered over the past year and will increase flexibility for both market participants and the capacity market delivery body. Ultimately, it will help ensure that the capacity market continues to deliver on its objective of guaranteeing secure electricity supplies at the lowest possible cost to consumers.
In response to the noble Lord, Lord Bhatia, and his brief intervention asking whether the market would create more CO2 emissions, I can tell the noble Lord that the capacity market helps to maintain public support for net zero by ensuring secure electricity supplies as we decarbonise the power sector. Furthermore, as I said earlier, we have introduced emissions limits to the capacity market to help align it with broader decarbonisation objectives.
The noble Baroness, Lady Bowles, was concerned about the low number of responses to the consultation. We held a series of stakeholder workshops during the consultation to gather additional views, including an open invite session which had around 100 different attendees. The noble Baroness also asked what the rationale was for secondary trading. This has been an important part of the capacity market since it was implemented in 2014. It supports the security of electricity supplies by enabling the transfer of agreements which cannot be fulfilled. In addition, the noble Baroness wanted assurances that secondary-trading agreements do not give the transferee a free pass on obligations and safeguards. They do not; capacity providers are subject to the same obligations whether or not they secured their agreements through secondary trading.
The noble Lord, Lord Grantchester, asked whether the market was simply providing payments for capacity which is already there. Existing plants can be the most cost-effective and efficient way of delivering reliable capacity. Including existing capacity in the capacity market auction drives competition and thus reduces the total cost of the scheme for consumers. The noble Lord went on to ask whether alternatives to the capacity market would be considered in the 10-year review. The answer is yes; the review will consider the case for government intervention in terms of security of supply, which scheme is best for this and what the objectives of such a scheme should be.
I think that deals with all the questions I was asked during the debate. So, with that, I commend these draft regulations to the Committee.
My Lords, that completes the business before the Grand Committee this afternoon. I remind Members to sanitise their desks and chairs before leaving the Room. The Committee is adjourned.
Committee adjourned at 5.04 pm.