Draft Electricity Capacity (Supplier Payment etc.) Regulations 2014

The Committee consisted of the following Members:

Chair: Mr David Amess 

Bain, Mr William (Glasgow North East) (Lab) 

Coffey, Ann (Stockport) (Lab) 

Donaldson, Mr Jeffrey M. (Lagan Valley) (DUP) 

Greatrex, Tom (Rutherglen and Hamilton West) (Lab/Co-op) 

Hemming, John (Birmingham, Yardley) (LD) 

Hepburn, Mr Stephen (Jarrow) (Lab) 

Herbert, Nick (Arundel and South Downs) (Con) 

Jackson, Glenda (Hampstead and Kilburn) (Lab) 

Jenrick, Robert (Newark) (Con) 

Kwarteng, Kwasi (Spelthorne) (Con) 

Lammy, Mr David (Tottenham) (Lab) 

Liddell-Grainger, Mr Ian (Bridgwater and West Somerset) (Con) 

Phillipson, Bridget (Houghton and Sunderland South) (Lab) 

Prisk, Mr Mark (Hertford and Stortford) (Con) 

Pugh, John (Southport) (LD) 

Rudd, Amber (Parliamentary Under-Secretary of State for Energy and Climate Change)  

Uppal, Paul (Wolverhampton South West) (Con) 

Wallace, Mr Ben (Wyre and Preston North) (Con) 

Marek Kubala, Committee Clerk

† attended the Committee

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Fourth Delegated Legislation Committee 

Thursday 4 December 2014  

[Mr David Amess in the Chair] 

Draft Electricity Capacity (Supplier Payment etc.) Regulations 2014 

11.30 am 

The Parliamentary Under-Secretary of State for Energy and Climate Change (Amber Rudd):  I beg to move, 

That the Committee has considered the draft Electricity Capacity (Supplier Payment etc.) Regulations 2014. 

It is a pleasure to serve under your chairmanship, Mr Amess. The supplier payment regulations form 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 in the Energy Act 2013, which, following scrutiny in this House and the other place, received Royal Assent last December with cross-party support. 

I remind hon. Members that 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 through the electricity market reform to incentivise much-needed investment in our energy infrastructure. The other scheme, contracts for difference, is not the subject of today’s debate. 

The capacity market will help to 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 that by making a regular “capacity payment” to providers who are successful in capacity auctions. In return for that payment, providers must meet their obligations to provide capacity or to 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 the rules, which received parliamentary approval in July 2014, 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 that and subsequent auctions will be awarded capacity agreements entitling them to capacity payments. That will be paid for by a charge on all electricity suppliers. 

It should be noted that although 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 that, two transitional auctions, just for that sector, will be held in 2015 and 2016 for delivery in 2016-17 and 2017-18. That tailored support will help to grow the demand side and storage industries, and ensure effective competition between traditional

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power plants and new forms of capacity, driving down future costs for consumers. As with payments made during a 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, my predecessor highlighted the fact that the Government were to bring in a second set of regulations, on the supplier payment arrangements for the capacity market, to align the legislative frameworks for both the capacity market and contracts for difference. The supplier payment regulations were not brought in at the same time as the principal regulations because they are technical provisions that we wanted to get right and it was not necessary for them to be in force before 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 mentioned, that 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 with a capacity agreement for the first capacity delivery year in 2018-19. 

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 is to calculate, determine and administer the payments from suppliers to those who are successful in 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 year. This approach seeks to achieve a balance between the objective of incentivising reductions in electricity use at times when demand is high, while remaining predictable and manageable for electricity suppliers who have to pass the costs on to their customers transparently. 

The regulations will facilitate the flow of payment from all electricity suppliers to those who are successful in capacity auctions. On receipt of capacity payments, capacity providers are then obliged to provide capacity, or reduce demand, when required, thereby ensuring security of electricity supplies. Although 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. 

11.35 am 

Tom Greatrex (Rutherglen and Hamilton West) (Lab/Co-op):  It is a pleasure to serve under your chairmanship again, Mr Amess. 

I thank the Minister for setting out the issues raised by the statutory instrument we are considering today. At the start of her speech, she made it clear that the introduction of the capacity market, along with other mechanisms, was within the Energy Act 2013, which

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received support from all parties. We retain the view that the capacity market is an important part of the EMR process, and we support that mechanism. 

However, there are still issues that cause concern. The Minister might be aware that during a European Committee debate on energy security—her colleague, the Minister of State, Department of Energy and Climate Change, the right hon. Member for West Suffolk (Matthew Hancock), was involved in it—we touched on some of these issues. The first round of auctions for contracts for 2018-19 will take place on 16 December. Can the Minister tell us when the outcome of the first round will be announced? I have heard various dates from different parties in the past few days. Some say 24 December, some 30 December, and others 5 January. When will the announcement be made and who will be making it, the Government or the regulator? 

The Minister referred to the supplier’s share of capacity payments, which is at the core of the regulations. There is an obligation on suppliers to make the payments to cover the costs of administering the capacity market, based on their calculated share of the market. As the Minister said, that will be based on the share of net demand between 4 pm and 7 pm on working days between November and February. The regulations state that the share will be initially forecast, and the supplier will pay against that forecast on a monthly basis. At the end of the winter, the forecast will be compared to actual consumption, and a reconciliation will take place. 

Again, perhaps the Minister can enlighten us. What incentives are in place to ensure that suppliers accurately forecast their likely demand, as could happen, rather than underestimating the figure and enjoying the time value of the money, which does not have to be reconciled until the end of the winter? Also, what dispute resolution mechanisms have been prepared, should there be disagreement between the supplier and settlement body as to their actual demand? 

If a supplier defaults on payments, their contributions to the capacity market will be made up through further contributions from other non-defaulting participants. Has the Minister or her officials had discussions with electricity suppliers about that extra liability for the solvency of their competitors, which is a new feature in what is already a complicated market? Has anyone calculated a cost to each supplier of carrying that additional risk? It could be quite significant if any of the suppliers end up in such a position. 

The Minister also referred to the objectives of the capacity market in relation to new gas-fired power stations. I am sure she will be aware, as many are, of the concerns about the qualifying plants in the first round of auctions, which is structured in a way that might make it less likely that any new gas-fired capacity, other than that in the plant being built at Carrington, will be successful in that auction. Obviously, she cannot prejudge the auction, but she may be able to enlighten us on the Government’s view of that potential disincentive and how it might be addressed in the next round of the capacity market. 

Another issue is that of small-scale gas plants. The list of plants qualifying for the first round includes a large number of gas plants that conveniently provide 19 MW. The Minister will be aware that carbon impact policies do not apply to plants producing less than 20 MW. On the surface, it appears that there may be an

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increasing sense that more of those plants are bidding because they have a cost advantage over larger plants, but their impact on carbon emissions is being lost. That could encourage greater than optimal numbers of small distributed gas and oil plants. As she will be aware, the oil plants are probably the most polluting of those forms of generation. They tend to be at sub-20 MW level. 

The Minister also referred to interconnectors and the welcome announcement earlier this week that interconnectors can take part in the 2015 second round of capacity auctions. Frankly, that should have been the case in the first round of auctions, but I do not wish to be uncharitable; it is good news that it is the case in the second round. The potential for some of those interconnection projects, which could be in place by 2020, is significant. It is important to be able to improve our balance and deal with the intermittency issues of some of our lower-carbon-generating plant. 

Regulation 3 of the principal regulations amends the definition of “providing electricity” to enable interconnection, as the Minister said, to form part of that in future. There are two models by which interconnectors could bid in. Either foreign plant can bid in directly, using the interconnector as a vehicle for delivery, or the interconnector itself could bid in, subcontracting its capacity arrangements to plant at the other end of the wire. Will the Minister indicate which of those two models is preferred by the Government? 

The impact assessment notes that 

“a greater degree of interconnection could also help to reduce the role of the Capacity Market in the future”, 

but increasing the amount of interconnection could rely on interconnectors getting access to the capacity market. Interconnectors can reduce the need for the capacity market but cannot also rely on its existence. Will the Minister clarify that point? 

As it says in the regulations, the capacity market is intended as a transitional measure for at least 15 years. The impact assessment identifies two conditions that would have to be met for the capacity market to be wound down. One is the improvement of demand-side response. If demand-side response can help to transition out the capacity market, why has the Minister limited its role in the current framework to a relatively low-level one, and to the year-ahead auctions, rather than the four-year-ahead auctions? 

I am sure that the Minister is aware of work by NERA that suggests that the cost to the consumer could be reduced by up to £300 million if demand-side response was included in the full range of the capacity market. I understand that the Minister’s Department has said that it does not accept the key assumptions in that report. Will the Minister clarify which aspects of the report the Department has a problem with, so that can be interrogated further? 

Finally, the list of qualified plant for the capacity market includes existing nuclear power. Discussions that I, and I am sure many others, have had with various players in the industry reveal that the industry is intended to finance the cost of upgrade and life extension work. Will the Minister clarify whether existing nuclear plants are able to respond and increase their output within the four-hour despatch notice provided for under the capacity market? 

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What assessment has the Minister’s Department made of the increased loss of load expectation, were existing nuclear to be excluded from the capacity market? What evidence has she seen that life extension work could not be financed on the basis of the difference between the short-run marginal costs of existing nuclear and the wholesale price for electricity? Given the concept and the framing of the capacity market, it seems rather curious that nuclear power plants that have already been built, are already generating and are receiving revenues for electricity that is not hit by carbon pricing policy can bid and receive that subsidy. As everyone in the Committee is well aware, that subsidy finds its way back, in the end, to the bills that consumers pay. 

11.45 am 

Amber Rudd:  I thank the hon. Member for Rutherglen and Hamilton West for his questions. I will do my best to answer some of them; I will write to him on those that I am not able to address. Before turning to some of his questions, I welcome his support for the capacity market in principle. He asked about the results of the auction, which he accurately tells us will take place on 16 December. National Grid will announce the final auction results eight working days after the auction clears. If the auction clears on 19 December, the results will be announced on 5 January. He also asked about the interconnection capacity and foreign plant. I can give him some helpful information on interconnectors. Like him, I welcomed the announcement this week that

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they will form part of the capacity market from 2015. We have stated that the only direct involvement will be from interconnected capacity owners. Direct foreign plant involvement is not possible and will require a pan-European solution, which I am sure he is aware that everyone would like to see. 

On the hon. Gentleman’s points about the demand-side reduction for nuclear, he will be aware that those are fairly complex issues. If he will forgive me, I will write to him about that particular point. He should be in no doubt that my Department is committed to making demand-side reduction an important part of the capacity auction and will continue to support it. He asked about discussions we have had on mutualisation with suppliers. We have had those conversations, and suppliers accept this as a necessary measure to ensure capacity where payments are made. However, we do not have any specific costs at the moment. 

I hope that the hon. Gentleman will take those as the answers to some of his substantial points. On the other points he has raised, he can rest assured that I will write to him. It is good to see that he largely supports the legislation and the capacity market overall. We strongly believe that the capacity market will ensure the security of our electricity supplies, and that we will be able to deliver its structure in a way that secures value for money for consumers. I therefore commend the regulations to the Committee. 

Question put and agreed to.  

11.47 am 

Committee rose.  

Prepared 5th December 2014