Draft Electricity Supplier Payments (Amendment) Regulations 2017

Alan Whitehead Excerpts

Monday 20th March 2017 General Committees

[Dr Alan Whitehead (Southampton, Test) (Lab)]

It is a pleasure to serve under your chairmanship, Sir Alan. The regulations are, by and large, sensible, in that they clarify and extend provisions relating to the CfD counterparty that were originally set out, as the Minister has said, in regulations in 2014 and that have been further iterated since, including today.

The regulations change and make coherent references to settlement dates, set a new rate for the operational costs for the CfD counterparty and, interestingly—the Minister fleetingly mentioned this—introduce a new arrangement that allows the CfD counterparty to reduce the reserve fund if, in the opinion of the fund, it has too much in it. I would like to hear from the Minister about some issues relating to that particular provision.

In order to get to that position, we need to backtrack slightly in the narrative and establish why the CfD counterparty was set up in the first place. In effect, the issue arose during the passage of the Energy Act 2013, when it was acknowledged that a counterparty body was needed to hold the ring with regard to the operators, who would expect to receive regular payment for their possession of the CfD. That payment would cover the difference between the strike price at which they settled the CfD and the reference price or prevailing wholesale price of electricity. In order to invest, those operators would need to know that they would get paid from a fund containing the payments and a reserve fund levy paid in by electricity producers in general. The operators needed an assurance that they would get paid, and the other side also needed an assurance that money would go into a fund to enable that to happen. Both sides had to be fully assured.

The question that arose at the time was how to guarantee that transfer and ensure that the operators could be sure of receiving the payments, and that they could be made from a secure fund. The easiest option would have been for the Government simply to guarantee the transfer, but that was deemed not possible by the Treasury, because it would effectively have counted as public spending. A solution was found by the end of the legislation’s passage through Parliament: a separate company, the Low Carbon Contracts Company, would be set up to be the receiving and payment agency, not backed by Government but with a high enough level of probability in its operation to satisfy investors that payments would be forthcoming. That meant that a linking mechanism was needed between payments in and payments out and payments in and the reserve fund, to ensure that payments would continue if there was a hiccup at the receiving end. That was implemented in the 2014 regulations.

A leading law company’s brief synopsis of the LCCC states that

“the CfD will take the form of a bilateral private law contract between the generator and the CfD counterparty, a wholly owned subsidiary of the Government…the obligation of the CfD counterparty to make payments under the CfD is limited by the ‘pay when paid’ principle. This means that the CfD counterparty is channelling payments between generators and suppliers, but has no obligation to make payments if not previously received from suppliers or generator. There is no payment guarantee from the Government…the CFD counterparty will levy funds on a (likely) monthly basis from suppliers under the supplier obligation to cover the difference payments due to generators from the previous month and will transfer these funds to generators once received from suppliers.”

That is the position with regard to this independent company, which is not backed by the Government but is a subsidiary of the Department in its operational life.

Interestingly—hon. Members might think that this is not very interesting, but I think it is—the 2014 regulations, which the regulations under discussion repeat and extend, use probability theory. It is the first time that I have seen defined in law what probability theory has to say about ability to pay and the necessary arrangements that a company should make. Regulation 7 states that the LCCC should work towards, essentially, a 95% probability of being able to pay. That transfers and slightly extends the probability theory statement in the 2014 regulations. As the explanatory memorandum helpfully emphasises, that means that payment will take place in 19 out of 20 scenarios. The regulations do not specify what those scenarios might be; the company itself has to think about them and act accordingly. In other words, at that point the company is the judge of its own probable solvency.

I did not like that formulation in the 2014 regulations and I do not particularly like it now. The scenarios that the company is supposed to consider can be unbalanced, because the law provides no direction. For example, according to the National Audit Office, offshore wind has recently turned out to be far more efficient than was previously thought, so it will require far more CfD payments and draw more from the fund than it might previously have done. That is just one scenario and the explanatory memorandum emphasises another, namely that the counterparty will need to make arrangements for the massive Hinkley Point CfDs when they start being produced.

As I have said, the regulations include a new provision that allows the CfD counterparty company to reduce its reserve fund without any notice, if it thinks it has been oversubscribed, but it has to be in a position to make payment in 19 out of 20 scenarios. The reserve fund is there, among other reasons, to ensure that the payments are made even if there is a hiatus in the money coming in. Under the regulations, the company will decide for itself the sample points that will go into its initial calculation of its own likely solvency. It will then be able to make a further subjective determination of the solidity, or otherwise, of its own reserve fund. As I am sure the Minister will agree, that will add a further subjective factor to each sample point, because of the company’s new ability to reduce its own reserve fund if it thinks it should do so.

All of that makes the provisions look a little wobbly. The regulations introduce a new factor that turns the probability position set out in the 2014 regulations into a further probability scenario of their own. In other words, what is the probability of a company reducing its own reserve fund without notice and therefore compromising its long-term likelihood of solvency?

I do not intend to divide the Committee, but will the Minister tell us whether he thinks that the arrangements proposed by the regulations, which are complicated by the new provision about reducing reserve funds, are a cause for concern with regard to the future solidity of the hard-worked arrangements set out in the 2013 Act, or does he think that everything is hunky-dory? I would assess the probability of getting a clear answer to that at a little over one in two, but of course I could be proved wrong by events, as all probability theory calculations have to acknowledge.

--- Later in debate ---

[Jesse Norman]

I am grateful to all hon. Members who have contributed for their comments and questions. If I may, I would like to correct something that I said earlier in response to my right hon. Friend the Member for Chelmsford. Officials have reminded me that regulations 1 and 19 will come into effect the day after the regulations are made. Regulation 14 will come into effect on 1 April, regulation 8 on 1 October, and all others on 1 July. I hope that that will comfort him. I apologise for misleading him earlier. I have been corrected on one other thing: it is not just the day, but the day after the day on which the regulations are made. I am doubly corrected

On the questions raised by the hon. Member for Kilmarnock and Loudoun, I hope he will correct me because I did not quite catch his final point about mutualisation. On onshore wind, as he is aware, the Government issued a consultation in November 2016 and continue to be heavily engaged in discussing the situation with the Scottish Government, developers, island communities and other Members. I hope that gives him comfort.

On the issue of costs, the hon. Gentleman will see that they have been included. We expect the costs for Hinkley Point to be in the region of £1.4 million for 2017-18. It is not at all clear why that should go up, but it is worth saying that Hinkley Point C is a complex contract and the Government’s approach is based on a flexible outsourcing model of getting professional advice to fit the needs, so that may change. If there is an issue of mutualisation, I invite him to come back to me because I did not quite understand the point he made.

The hon. Member for Southampton, Test was right to separate out the fixed levy portion from the lump sum reserve payment, and to point out that the intention of the lump sum reserve payment is to give 95% confidence that that will be paid. In the past, the effect of the previous regulations meant that the LCCC over-collected. The purpose of the regulations under discussion is to allow it to remit more quickly those funds that may have been over-collected, rather than trap them in parallel with the faster settlement process that has been introduced. Therefore, the question whether the organisations are under-constrained does not arise. As I have said, their operating costs are scrutinised by the Government, and of course they are subject to mutualisation and are therefore undoubtedly subject to question by the suppliers who pay their costs.

[Dr Whitehead]

I am sure the Minister will agree that the existence of the reserve fund still has some salience in this process, in so much as it functions as a backstop when there have been hiatuses—if that word exists—in payment or collection. The reserve fund can, in such circumstances, be brought in to smooth the passage and allow for the continuation of business, even if there are problems at either end. The question of reducing the reserve fund unilaterally and with no notice, which is in the regulations, is not just a technical issue; it is a real issue that has a bearing on how the rest of the company works, and therefore the probability within which it works overall.

[Jesse Norman]

I take that point, but I think the hon. Gentleman has got the incentives the wrong way around. The incentives are to maintain a large reserve fund because that gives a degree of comfort and prevents challenge. The point of the provision is to create an inventive if it is perfectly clear that more money has been accumulated than is required to be paid out. In general, the companies concerned will have a tremendous incentive to retain what reserves they can, precisely for the reasons he suggests. In reality, I do not think there is any real danger.

Question put and agreed to.