Considered in Grand Committee
My Lords, these regulations were laid before the House on 12 June 2023. Before I outline the provisions made by this draft instrument, I will provide some context. The capacity market is at the heart of the Government’s strategy for maintaining the security of electricity supply in Great Britain. Through capacity auctions, we secure the capacity needed to meet future peak demand under a range of scenarios, based on advice from the capacity market delivery body, the National Grid Electricity System Operator.
Existing and new-build capacity compete in technology- neutral auctions, held one year and four years ahead of delivery, to obtain agreements. Those which win capacity agreements, known as capacity providers, commit to making their capacity available when needed in return for guaranteed payments. This supports the necessary investment in new and existing capacity to ensure security of electricity supply. The most recent capacity auctions, held in February 2023, secured the electricity capacity that Britain needs to cope with peaks in winter demand for 2023-24. Capacity providers that fail to deliver against their obligations are subject to financial penalties. Capacity payments are funded by electricity suppliers, which recover this cost from electricity consumers.
Since its introduction in 2014, the capacity market has contributed to investment in just under 17.5 gigawatts of new, flexible capacity to replace older, less efficient plant as we transition to a net-zero economy. To ensure that the capacity market continues to function effectively, we regularly make adjustments to the implementing legislation based on our day-to-day experiences of operating the scheme. Although the future geopolitical context is, of course, still uncertain, we recognise that the world is likely to face continued challenges next winter around the security of energy supply, considering Russia’s illegal invasion of Ukraine. The Government continue to work closely with Ofgem, the gas and electricity system operators, and all relevant stakeholders to build on the measures we put in place for winter 2022-23 and ensure we have the appropriate tools available to secure our energy supply for winter 2023-24.
The changes we are making to the capacity market this year, through both this draft instrument and changes to the capacity market rules, focus on longer-term changes that will impact capacity auctions held from February 2024 onwards, for delivery from winter 2024-25. In this context, this draft instrument makes changes to three electricity capacity regulations to deliver technical improvements that support the functioning of the capacity market, which have been identified and explored over the past year through consultation.
The capacity market is now well-established, with capacity auctions held every year since their inception in 2014. The Secretary of State has published their intent to hold these capacity auctions every year. This draft instrument aims to reduce the administrative burden associated with the process, as we believe it is more appropriate to instead notify the market when the intention is for an auction not to be held.
We have also been made aware that the existing transfer route that enables capacity agreements to be terminated in order to participate in the contracts for difference scheme cannot be used in practice, due to interactions between the definitions used in the regulations and delivery timeframes. This draft instrument therefore seeks to amend the definition of the contracts for difference transfer notice to better enable transfer routes to be utilised in practice.
Finally, the draft instrument seeks to improve administrative arrangements by extending the timescales associated with the settlement body’s calculation of penalties and issuing of associated invoices for non-delivery. This extension is required to ensure that the settlement body has sufficient time to receive relevant data, so that it can accurately calculate the appropriate penalties for capacity providers.
The amendments included in this instrument were consulted on between 9 January and 3 March this year and were broadly supported by respondents. We also consulted on a wider range of changes, including to the capacity market rules. As signalled in the Government’s response to the consultation, we intend to follow a two-phased approach to capacity market reforms. First, we intend to proceed with technical changes to strengthen security of supply and ensure better value for money for consumers. In the second phase, we intend to undertake further analysis and development before taking a final decision on implementation. This is to ensure we can have confidence that the changes we make remain aligned with the core objective of ensuring security of electricity supplies at the least cost to consumers, while minimising unintended consequences.
In line with the broad support for greater alignment of the capacity market with net zero, the Government remain committed to introducing an emissions limit reduction into the capacity market to help drive the transition to a net-zero power system by 2035—subject, as always, to security of supply. Further analysis is required to understand the impact these proposals will have on energy security. This is key to ensuring that the Government can progress their ambitions for a clean energy system in a way which takes account of increased geopolitical uncertainty and the resultant impact on energy security.
We also intend to make a number of technical amendments to the capacity market rules, which are due to be laid before the House shortly. These include technical changes to the way capacity is registered during pre-qualification to better reflect what a capacity provider can deliver when needed. The amendments also extend temporary measures introduced last year to increase opportunities for competition in capacity auctions, by removing identified barriers to participation for mothballed plant and allowing enough time for participants to have the necessary verifications in place. Finally, rule changes will be introduced to reduce administrative burdens for prospective capacity providers and to clarify how auctions are operated for the benefit of participants.
In conclusion, this draft instrument introduces a number of technical provisions which are necessary to enable the continued efficient operation of the capacity market, so that it can continue to deliver on its objectives. I commend these regulations to the Committee.
My Lords, I will concentrate on the Explanatory Memorandum in relation to the capacity market. As I understand it, last winter something did not go quite right in the sense that, at a certain point we had to use coal, which had not been planned for. Perhaps the Minister will correct me if it had been planned for, but my understanding is that it was not planned for. As we look at the coming winter, we have just experienced one of the hottest Junes ever and it is not inconceivable that we could have the coldest winter ever. As I understand it, there is definitely no coal available for this coming winter. Is that right? If the coal is not there, where is the extra capacity to come from?
I also notice that, for some reason, His Majesty’s Government have postponed bringing on small-scale nuclear. A number of us have kept a close watch on Rolls-Royce in particular, which I understand has been ready to get moving on small-scale nuclear, which would be part of a capacity situation. I am deeply concerned—and I am looking for a confident answer from my noble friend—that if we hit a really cold winter this year, we have the capacity for something to come on stream. There would be nothing worse for the United Kingdom as a whole if we found that we needed black- outs and fuel cuts.
My Lords, I inform the Committee that I have a close family member who works for Ofgem. He is responsible for energy security and has been making plans for next winter, but I have not discussed this SI with him.
The capacity market, brought in by a Liberal Democrat Secretary of State, has been a great success. This statutory instrument aims to continue that success by improving the processes and reducing the administrative burden. We are all in favour of that, especially the flexibility that makes it easier to transfer from capacity market schemes to contracts for difference, where appropriate. However, I have a few questions for the Minister about the scheme in general.
First, how well are the Government succeeding in minimising the use of fossil fuels in the capacity market? What percentage is expected to be clean energy, and within what timescale? I was glad to hear the Minister say in his introduction that there will be an emissions limit on those applying.
Secondly, what is the Government’s aim for enabling demand reduction, and what percentage of bids do they want to see for the demand-side reductions? This is just as important as generation if we are to decarbonise and reduce the potentially enormous grid capacity increase needed to reach net zero. How many of the successful companies in offshore wind round 4 auctions have reached financial close for their projects—that is, they have agreed their financing requirements to deliver the scheme with financial institutions? As I understand it, only one successful bidder has yet managed to reach financial close on their project, so the whole programme of offshore wind coming on stream is coming to a halt.
Moray West offshore wind farm, owned by Ocean Winds and minority shareholder Ignitis Group, has secured £2 billion of non-recourse project finance. Initially, bids were famously low, but with inflation now across the supply chain, perhaps the numbers do not add up for most of the schemes. How are the Government going to solve this? Given the financial situation, can the Minister say whether it is still wise to have most capacity market schemes for only 12-month projects?
I look forward to the Minister’s reply—particularly to the questions about coal.
My Lords, I thank the Minister for setting out the instrument and giving us advance warning that more is to come shortly. The capacity market is at the heart of maintaining a secure and reliable electricity system. It provides all forms of electricity capacity on a system during periods of electricity shortage and stress, such as when it is extremely cold or when the wind is low while demand is high. As the Minister said, the capacity market works by allowing eligible bidders to compete in T-1 or T-4 auctions on a one-year or four-year basis ahead of when they must deliver capacity. A successful bidder is awarded a capacity agreement which requires delivery during times of stress.
As the Minister said, this instrument makes changes to three areas of regulation. First, Regulation 10 of the 2014 regulations obliges the Secretary of State to set out whether capacity auctions are to be held. The change will require the Secretary of State to publish a decision only if the Government determine that an auction will not be held, helping to improve administrative efficiency. Does this effectively enrol a current capacity provider into the scheme automatically?
Secondly, Regulation 34 of the 2014 regulations allows capacity providers to seek termination of their capacity agreement with a view to becoming eligible to participate in the contracts for difference scheme. I think the Minister said that they are mutually exclusive as things stand. Currently, the LCCC, as the counterparty, has to give notice of such an intention. However, it cannot know in advance if the CMU will be successful in its bid for a contract for difference.
This instrument means that notice comes from a capacity provider seeking termination of their capacity agreement in order to become eligible to apply in a contract for difference allocation round. How many capacity providers have thus far been unable to use the process set out in Regulation 34? The Minister may say all of them, but how many would have wanted to use the termination process? Have the Government made any assessment of the impact of this, and will this change be kept under review?
Thirdly, I turn to Regulation 41 of the 2014 regulations. Capacity providers can be financially penalised, as the Minister said, if they fail to provide capacity in times of stress. Currently, the settlement body has 21 days to calculate the relevant penalty and to invoice capacity providers which must pay such penalties. This instrument increases the timeframe to 35 days. Does that mean that penalties that should have been paid were previously missed because they were not calculated in time? If so, could the Minister indicate the value of those? By contrast, is this change expected to increase the number and value of penalties that are enforced? I look forward to the Minister’s response.
First, I thank the noble Lords, Lord Naseby and Lord Lennie, and the noble Baroness, Lady Walmsley, for their valuable contributions on an important subject for the nation’s electricity supplies.
As I mentioned in my introduction, the capacity market is our main mechanism for ensuring the security of electricity supply. To address the point made by the noble Lord, Lord Naseby, I say that it has already secured the majority of Great Britain’s capacity needs right out to 2026-27, because the Government take no chances with the security of supply. We continue to believe that the capacity market is an effective insurance mechanism, providing secure and affordable electricity that families and businesses can rely on.
The capacity market is, indeed, tried and tested. The fact that it has supported investment in just under 17.5 gigawatts of new-build, flexible capacity since its introduction demonstrates that it can bring forward the capacity needed to meet future peak demand and replace older capacity as it retires and as we transition to a net-zero economy.
Furthermore, we continue to take steps to ensure its ongoing, efficient and effective operation. 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. That includes regularly assessing the performance of the capacity market and, as we are debating today, exploring improvements to the scheme.
As we noted in our 2023 government response to the capacity market consultation, we have set out a two-phased approach for reforms in the capacity market. This instrument seeks to implement purely technical amendments under the first phase to improve the administrative arrangements. In the next phase of reforms to the capacity market, the Government intend to undertake further analysis and development on the remaining proposals prior to taking a final decision on implementation. This includes proposals to align the capacity market with net zero, such as reducing the emission intensity limits for new-build plants and enabling low-carbon capacity with low capital expenditure to access multi-year agreements.
We will also look ahead to the future as part of the review of electricity market arrangements programme. REMA is exploring options to create an electricity market design that will enable us to transition efficiently from fossil fuels to renewables and other forms of low-carbon generation, which I hope will make us more resilient to overseas energy shocks and ensure energy security.
I will deal with the specific questions raised, starting with my noble friend Lord Naseby. I emphasise that spells of cold weather in winter 2022-23 actually helped to show the resilience of the UK’s energy supply. Our gas system was well supplied at all times, and the market responded effectively to increased demand where necessary. Electricity margins were, on occasions, fairly tight. This was resolved through the national grid’s standard tools. Our back-up coal plants, to which my noble friend referred, were warmed up, but only called into action once, where two coal-fired units were fired up in West Burton to help to maintain a healthy buffer of supply. For winter 2022-23, National Grid ESO agreed temporary extensions of the operation of certain coal-fired power stations to provide additional back-up generation, which retained about 2.4 gigawatts of non gas-fired electricity capacity.
Of course, while the future geopolitical context is still very uncertain, we recognise that the world is likely to face continued challenges next winter around security of energy supply, given the context of Russia’s illegal invasion of Ukraine. Having said that, the Government will continue to work closely with Ofgem, the gas and electricity system operators and all relevant stakeholders to build on and expand the measures that we put in place for winter 2022-23 and ensure that we have the maximum tools available to secure our energy supply for the winter coming up, 2023-24. To take an example, the T-1 capacity market auction has secured 5.8 gigawatts of electricity capacity for the delivery year 2023-24, bringing our total to 53.8 gigawatts.
My noble friend also mentioned small and advanced modular reactors. As I have said to him before in answer to Questions, we have announced £385 million of funding in an advanced nuclear fund to invest further in the next generation of nuclear technology—of course, as always, subject to value for money and future spending rounds. The Government intend to take two projects to final investment decision in the next Parliament, including SMRs and AMRs, subject to scrutiny approvals, value for money, and technology readiness and maturity.
On the points made by the noble Baroness, Lady Walmsley, I emphasise that agreements for up to 15 years are available to new-build projects. I am happy to write to her on the specific developments she mentioned. The capacity market helps to maintain public support for net zero by ensuring a secure electricity supply as we decarbonise the power sector. The Government also remain committed to achieving a fully decarbonised power sector by 2035—again, subject to security of supply—and the actions that will set us on course for this have been set out in our many publications: the energy White Paper, the Net Zero Strategy, the British Energy Security Strategy and the Powering Up Britain energy security plan.
The share of low-carbon technologies, including storage, DSR and renewables, awarded agreements in the capacity market auctions has, in fact, grown significantly in recent years. A second consultation on the review of electricity market arrangements in autumn 2023 will set out further details on a direction of travel and next steps on measures that will facilitate the net-zero transition of the power sector. Across the electricity system, there is a need to significantly increase the deployment of low-carbon flexibility to maintain security of supply, to integrate renewables and to meet our decarbonisation goals—all at the lowest possible cost. The 2021 smart systems and flexibility plan therefore set out a range of actions to remove barriers and reform markets for flexibility. This included considering how the capacity market needs to adapt to better align with our net-zero ambitions.
In response to the noble Lord, Lord Lennie, I emphasise that transfers between the capacity market and contracts for difference will not be automatic. The delivery body must make an assessment of the applications and will issue a termination only if these requirements, as set out in the regulations, are met. We are aware of a handful of capacity providers that have mentioned interest in the transfer route. We expect uptake in the route to be relatively small, but we are committed to monitoring the ongoing impact of the change.
Regarding the respondents who asked for broader consideration of the interactions with other government support schemes, as always, the Government intend to keep this under review to ensure continued alignment with the subsidy control principles and wider energy market developments.
On the requirement for penalties timelines, these changes are required to maintain the efficient delivery of the scheme. We have not had a system stress event since the inception of the scheme, which demonstrates the success of the capacity market in achieving its core objective of maintaining security of supply. We expect that the practical changes made through this instrument will simply improve the accuracy of the penalties that may be issued following a system stress event, but we do not expect impacts on the number of penalties issued.
Returning to the draft instrument before the Committee, the changes respond to three targeted and technical improvements to address issues that we have encountered through the operation of the capacity market. The amendments will ensure that the capacity market continues to deliver on its objective of ensuring secure electricity supplies—as always, at least cost to consumers. I therefore commend these draft regulations to the Committee.
Committee adjourned at 6.06 pm.