Draft Electricity Capacity (No. 1) Regulations 2019

Chris Skidmore Excerpts

Tuesday 2nd April 2019 General Committees

[The Minister for Universities, Science, Research and Innovation (Chris Skidmore)]

I beg to move,

That the Committee has considered the draft Electricity Capacity (No. 1) Regulations 2019.

It is a pleasure to serve under your chairmanship, Mr Robertson. May I pass on the apologies of the Minister of State for Energy and Clean Growth? She would dearly have loved to be here to present the draft regulations, which were laid before the House on 28 February. Unfortunately, however, she is detained in Cabinet, so I am standing in for her as a fellow Minister in the Department for Business, Energy and Industrial Strategy.

The capacity market is a key element of the Government’s strategy for maintaining the security of electricity supplies in Great Britain. The security of our current electricity supply is robust; the electricity margin for winter 2018-19 is forecast to be more than 11%, the highest figure for five years, which shows that the capacity market works. The draft regulations will help us to maintain a strong security-of-supply position. They contain the modifications needed for the operation of the capacity market, pending fresh state aid approval by the European Commission, and make arrangements for a positive or negative state aid decision. These are not wholesale changes, but minor modifications to preserve the operation of the scheme to the extent possible while state aid approval is outstanding.

Before I go into detail, it may be helpful if I provide some context and background information. The capacity market ensures that there will be sufficient electricity supply in Great Britain during periods of peak electricity demand. It secures the required capacity by awarding capacity agreements in competitive, technology-neutral auctions held four years and one year ahead of delivery. The capacity providers that win agreements commit to providing capacity during periods of system stress in exchange for receiving capacity payments, the revenue from which incentivises the investment necessary to maintain and refurbish existing capacity and finance new capacity; it also ensures that those who are able to shift demand away from periods of greater scarcity are encouraged to do so.

On 15 November 2018, the General Court of the Court of Justice of the European Union annulled the European Commission’s state aid approval for Great Britain’s capacity market and introduced a standstill period until the scheme can be reapproved. Importantly, its judgment was based on the procedure that the Commission followed when approving the capacity market, not on the capacity market itself. The judgment prevents the UK Government from making capacity payments unless and until the scheme receives state aid approval, but it does not change the Government’s commitment to delivering secure electricity supplies at the lowest cost to consumers or our belief that capacity market auctions remain the most appropriate way of doing so.

The Commission is investigating the scheme. On 21 February, it confirmed that it was moving on to the next phase—an important step as we work to reinstate state aid approval in the capacity market as soon as possible. We are working with the Commission to ensure that it has everything necessary to reapprove the scheme as quickly as possible, and we are confident that it will be approved and that payments to agreement holders who have met their obligations during the standstill period will be allowed.

My Department published a consultation proposing modifications to allow the capacity market to operate as far as possible during the standstill period following the General Court’s decision. We received 61 responses from a wide range of stakeholders. There was significant support for the majority of the proposals, with constructive feedback that led to several changes. The House of Lords Secondary Legislation Scrutiny Committee also highlighted uncertainties associated with the state aid process. We are confident that the draft regulations will help to address those uncertainties, including the unlikely event of a negative state aid decision.

Let me expand on the provisions in the draft regulations, beginning with deferred payments. To maintain industry confidence, the regulations include modifications to ensure that capacity payments that are currently being prevented by the Court’s judgment can be paid to capacity providers after state aid approval is obtained. Those payments will remain linked to capacity providers’ performance of the obligations in their capacity agreements.

Secondly, in recognition of the disruption caused to capacity providers, the draft regulations will provide additional flexibility during the standstill period. Capacity providers will have to pay financial penalties incurred during the standstill period only on the scheme’s state aid approval. In most cases, the same will apply to the requirement to maintain credit cover. The instrument extends from six to 12 months the additional time existing agreement holders can request for taking steps to avoid termination. In exceptional circumstances, where the suspension of capacity payments means imposing a termination fee that would cause a capacity provider undue financial hardship, the Secretary of State may direct the delivery body to terminate the agreement without such a fee.

Moving on from terminations and penalties, the instrument sets out the conditions for rearranging the T-1 auction that was originally planned for earlier this year, securing the capacity required for winter 2019-20. The auction will award conditional capacity agreements, which will not entitle capacity providers to payments or require them to pay penalties or termination fees until they convert to full capacity agreements upon state aid approval, thus allowing the auction to be run before there is that approval. The instrument also allows the settlement body to hold payments made by suppliers to fund the scheme, where suppliers choose to pay during the standstill period. It also enables the collection of all outstanding supplier charges for the standstill period upon state aid approval, providing certainty that upon that approval capacity payments will be made promptly.

Finally, in the unlikely event of a negative state aid decision, or no decision by October 2020, the instrument will terminate capacity agreements and any entitlement to receive capacity payments, and will require similar payments held by the settlement body to be returned. Although we are confident that a state aid decision will be made by October 2020, we have included that long stop to ensure that supplier payments are not held indefinitely without the prospect of payments being made to capacity providers for performance against their obligations. We have also laid complementary amendments to the capacity market rules, which govern the technical and administrative procedures relating to capacity market operation.

In conclusion, the draft regulations are necessary to provide legal certainty and confidence to the industry about how the capacity market will operate until state aid approval is received, and I commend them to the House.

--- Later in debate ---

[Chris Skidmore]

I thank the hon. Members for Southampton, Test and for Kilmarnock and Loudoun for their considered contributions today. It is evident that they have spent a lot of time thinking about the policy perspectives when it comes to the capacity market.

The Government continue to believe that the capacity market is the right mechanism for delivering security of supply at the lowest cost to consumers. My Department is working closely with the European Commission to ensure that state aid approval in the capacity market can be reinstated swiftly. Meanwhile, the judgment of the General Court prevents the UK Government from making capacity payments unless and until state aid approval is obtained.

However, we do not consider that the judgment prevents other aspects of the capacity market from continuing to operate during that standstill period. The delivery body and the assessment body continue to operate aspects of the capacity market during the standstill period, facilitating ongoing compliance with the scheme and helping to limit that uncertainty following that General Court judgment, to which the hon. Member for Southampton, Test referred. It also ensures capacity in a way that promotes security of electricity supply and demonstrates that a provider should be entitled to back payments. It enables the scheme to restart full operations as quickly as possible after state aid approval.

The T-1 auction, referred to by the hon. Member for Southampton, Test, will ensure that successful bidders in replacement T-1 auctions will be eligible to receive capacity payments covering the entire delivery year if state aid approval is obtained before October 2020. We believe that this enables bidders to have confidence in the revenue they can expect to receive through the auction if it is approved by the European Commission, providing better value for bill payers and reducing the risk premium that might otherwise inflate auction bids.

The Government do not consider that holding this T-1 auction, or awarding additional capacity agreements in that auction, amounts to state aid. Conditional capacity agreements convert into capacity agreements only if there is state aid approval to make payments, meaning that any aid under the agreement awarded is entirely conditional on state aid.

I turn to the judgment of the General Court. We are clear that it was based on the procedure followed by the European Commission. The General Court gave examples of where the Commission should have had doubts and investigated them, but did not rule that the design was wrong. We are confident that the design of the capacity market is now compatible with the state aid requirement. We have carefully considered each of the issues raised through the Court judgment.

We cannot pre-empt the outcome of the Commission’s investigation, but we remain confident that the scheme will be approved by the Commission following investigation —not least because it has approved six other capacity markets since 2014.

The Commission has also appealed the judgment of the General Court to the European Court of Justice. The Commission might require policy changes to the design of the capacity market scheme when granting state aid approval, in which case the Government would seek to respond swiftly to consider and bring forward the required changes. My Department has been in regular discussion with the Commission since the judgment to better understand the process they are following to ensure that we can support the investigation in the most effective and timely way possible. It is for the Commission to establish its own timetable, but we expect it to make the final decision later in the year.

I turn to the general points made on the necessity of the capacity market. The Government continue to believe that the capacity market is the right mechanism for delivering security of supply at the lowest cost to consumers. This view was supported by the majority of stakeholders that responded to our call for evidence in September 2018 as part of the proposed five-year review.

The capacity markets have a direct and indirect impact on new-build capacity. Around 4GW of new resources were cleared in the most recent 2018 T-4 auction, leading to the point made by the hon. Member for Kilmarnock and Loudoun: when it comes to the transfer away from fossil fuels towards renewable and nuclear fuels, the capacity market provides a cost-effective mechanism for bringing forward new capacity as and when needed. Recent auctions have supported a wide range of new-build resources, and the capacities of the market have had an impact on new builds.

[Dr Whitehead]

On the particular point of the capacity market providing new build, will the Minister agree that the only combined cycle gas plant supported by the capacity market is one 400MW plant during the entire period of the auctions? The capacity that has been procured more recently has either been open cycle gas plants, which are more polluting than combined cycle gas plants, or diesel set generators, which are more polluting than coal. Does the Minister consider that that is a good method of procuring capacity for the future through the capacity market arrangements?

[Chris Skidmore]

I would also point to the fact that we have seen 150 MW of battery storage through the recent T-4 auction; 1.1GW of DSR and 2GW of new interconnectors. There is obviously a variation. When it comes to the capacity market, this technology is based on delivering the most cost-effective mechanism, but we have demonstrated the need to introduce new capacity as and when needed.

When it comes to the Government’s record on switching away from coal, I should say that we have invested £92 billion in clean energy and quadrupled the renewable electricity capacity since 2010: the share of electricity from low-carbon sources is now 56%. In quarter 3 of 2018, 33% was from renewables, an increase from 6.9% in 2010.

If the Minister of State for Energy and Clean Growth were here, I am sure she would expound on the recent offshore wind sector deal, which was published two weeks ago. We now have the ability in offshore wind to exceed 30GW of installed operational capacity—more than we expected. We have already met the 2020 renewable targets. That is the same for solar capacity: in 2013, we estimated it would reach between 10GW and 12GW by 2020. The latest figures indicate it has reached 30GW, enough to power more than 3 million homes.

Important progress has been made. In terms of the five-year review of the capacity market that the hon. Gentleman mentioned, in line with the requirements set out in the Energy Act, we intend to publish a report that summarises our five-year review of electricity market reform this summer. One chapter of that will cover the five-year review of the capacity market.

On the hon. Gentleman’s specific point about meeting the Minister for Energy and Clean Growth, I should say that she will be delighted to discuss the opportunities for reform of the capacity market and to look at how we can deliver the best capacity market in the future.

When we look at the issue of agreements, the hon. Gentleman is right that the majority of capacity types can only access one-year agreements. An exception is obviously made for new and refurbished plants because investors require more certainty when investing in large capital projects; those agreements are for up to four years. However, we believe that longer-term agreements, where not needed, risk needlessly locking consumers into paying a long-term price, while there are challenges to encouraging business to engage in demand-side response. The same capital costs do not apply there. No clear evidence suggests that longer-term agreements are necessary to ensure demand-side response can compete effectively.

[Jeremy Lefroy (Stafford) (Con)]

Opposition Members have referred to the long-term problem with capacity, particularly with the nuclear baseload coming off-stream in the late 2020s and coal stopping between 2023 and 2025. At the same time, the Government are quite rightly encouraging increased uptake of electric vehicles—I declare an interest in that I drive one myself. This will place great demands on the grid and generation capacity. What plans do the Government have to make sure that the increased demand will be met by increased supply and to replace the energy that is coming offline?

[Chris Skidmore]

The question here is one of short-term capacity. We mentioned earlier that the electricity margin is 11%, which the highest it has been for the past five years. However, we cannot be complacent about ensuring that we have that insurance mechanism in place. That is why the capacity market is so important.

I point to the importance of investing in future technologies, while, side-by-side, we look at existing technologies and ensure that the capacity market adopts those providers. We have the Faraday battery challenge, which is quite close to where the hon. Gentleman is in the Midlands—that is £280 million worth of investment. When it comes to the supply of electricity, making sure that we have efficiency within a system, particularly with electric vehicles, is a key part of our grand challenge for Motability, particularly in cities. Work is being done to ensure that we can deliver on the power supply for that upscaling in electric vehicle manufacture and uptake, and I am struck by that work.

I am equally passionate about future technologies that we will need to invest in. We talked about nuclear fission, but we need to continue to work towards nuclear fusion with our European partners. The European Commission recently allowed a £100 million extension of the Joint European Torus contract at Culham. Going forwards, we are keen to associate with ITER, the international thermonuclear experimental reactor in France.

The point that the hon. Gentleman raises is right. We need to ensure that we have a portfolio of energy supplies as we reduce our dependence, as we have done successfully on fossil fuels and gas, but we can and will do more. It is important to recognise that this country has the most successful record when it comes to the introduction of renewables as a percentage of the overall grid supply.

We appreciate that the Court’s judgment has created the uncertainty and the potential difficulties that the hon. Gentleman mentioned. The Commission is investigating the scheme and has confirmed that it is moving on to the next phase. That is an important step as we work to reinstate state aid approval for the capacity market as soon as possible. The regulations provide legal certainty and confidence to industry and the electricity system about how the capacity market will operate during that standstill period pending state aid approval and about what we expect after that period. We continue to believe that the capacity market is the right mechanism for delivering security of supply at the lowest cost. The regulations are essential to preserving the operation of the capacity market to the extent that is possible when state aid approval is outstanding. The regulations provide vital confidence to industry and safeguard a secure system.

We have had an important and detailed debate about some of the wider policy implications. I have set out an opportunity for the hon. Gentleman to have a meeting with the Minister for Energy and Clean Growth. The regulations prescribe for the immediate future of the capacity market. That is important, and I urge all Members to support them.

Question put and agreed to.

Resolved,

That the Committee has considered the draft Electricity Capacity (No. 1) Regulations 2019.