Lords motion to approve the Electricity Capacity (No. 1) Regulations 2019 - Apr 3

That the draft Regulations laid before the House on 28 February be approved.

 

Relevant document: 20th Report from the Secondary Legislation Scrutiny Committee (Sub-Committee A)

My Lords, the capacity market is a key element of the Government’s strategy for maintaining the security of electricity supplies in Great Britain. Britain’s current security of electricity supply is robust. The forecast electricity margin for winter 2018-19 is over 11%, the highest for five years, showing that the capacity market works.

 

This draft instrument will help maintain a strong security of supply position into the future. It contains modifications needed for the operation of the capacity market, pending fresh state aid approval by the European Commission, and makes arrangements for a positive or negative state aid decision.

 

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

 

In November 2018, the General Court of the Court of Justice of the European Union annulled the European Commission’s state aid approval for GB’s capacity market and introduced a standstill period until the scheme can be reapproved. The judgment was based on the procedure the Commission followed when it approved the capacity market, not the substance of the capacity market itself. The judgment prevents the UK Government making capacity payments unless and until the scheme has state aid approval. It changes neither the Government’s commitment to delivering secure electricity supplies at least cost to consumers, nor our belief that capacity market auctions remain the most appropriate way to do this.

 

The Commission is investigating the scheme’s compatibility with state aid rules and recently confirmed it is moving on to the next phase. We are working with it to ensure that it has everything necessary to reapprove the scheme as quickly as possible. We are confident that the scheme will be approved and payments to agreement holders that have met their obligations during the standstill period will be allowed.

 

The Department for Business, Energy and Industrial Strategy 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 in December last year. Sixty-one responses were received, from a wide range of stakeholders, and there was significant support for the majority of the proposals raised.

 

The House of Lords Secondary Legislation Scrutiny Committee highlighted uncertainties associated with the state aid process. We are confident that the draft instrument helps address those uncertainties.

 

I will briefly expand on the provisions of the draft instrument itself. First, to maintain industry confidence, the instrument includes modifications that ensure that capacity payments currently prevented by the court’s judgment can be paid to capacity providers after state aid approval is obtained. These payments will remain linked to capacity providers’ performance of their obligations under their capacity agreements. Secondly, in recognition of the disruption caused to capacity providers, this instrument adds flexibility to termination, penalty and credit cover requirements during the standstill period. Thirdly, the instrument sets the conditions for rearranging the one-year-ahead auction that was originally planned for earlier this year, securing the capacity required for winter 2019-20. Agreements awarded by this auction will be conditional on state aid approval, allowing the auction to be run before there is state aid approval.

 

Moving on, this instrument 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 receipt of state aid approval. This provides certainty that, upon state aid approval, capacity payments will be paid promptly.

 

Finally, in the unlikely event of a negative state aid decision or no decision by October 2020, the instrument will terminate capacity agreements without any entitlement to receive capacity payments, and will require supplier payments held by the settlement body to be returned. We have also laid complementary amendments to the capacity market rules, which govern the technical and administrative procedures relating to capacity market operation.

 

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

My Lords, I am grateful to the Minister for a full and clear explanation of both the regulations and the need for them, which arises from the CJEU ruling. As he has said, the majority of the industry clearly supports these regulations, they are necessary, and they go a considerable way to reduce uncertainty. Therefore, we certainly will not oppose them and will support them.

 

First, on the theme of uncertainty, the Secondary Legislation Scrutiny Committee, to which the Minister referred, concluded its report to your Lordships by referring in paragraph 18 to the “considerable uncertainty” and suggesting that we might wish to explore further how the Government propose to deal with it. I will be brief, because this is not my subject. Can the Minister tell us specifically how the Government will continue to engage with the industry—I am sure they will wish to reassure the industry that that will be the case—and what steps they will take to try to perhaps restore and certainly to keep the confidence of the industry and investors at what is inevitably a very uncertain time?

 

Secondly, probably the greatest uncertainty at this precise moment, which is not particular to this industry, is our place within the European Union. The regulations are brought forward at this stage on the assumption, quite rightly, that we are members of the European Union and that we will remain members of the European Union during the implementation period of a negotiated withdrawal agreement. The inevitable question comes: what if that is not the case? We may all hope—I certainly do—that that is the case; indeed, I hope that we remain members of the European Union, full stop. But at this moment, many would argue that the most likely scenario is a no-deal withdrawal, not in weeks but days. That may happen. Can the Minister give us any guidance as to what preparations have been made and how ready the Government are to deal with that scenario if, unfortunately, it actually happens?

 

My third point was raised in the other place when it debated the regulations yesterday. There was strong doubt whether the CJEU ruling was based solely on procedural grounds, as the Minister said and the documents on the regulations state. It was suggested that other grounds were included in the ruling, and it would be useful to know whether the Government recognise that to be the case and, if so, what steps they are taking to deal with those other concerns.

 

I thank the Minister again for bringing the regulations to the House. They are necessary in the light of the ruling and the uncertain times we are in, and I wish them a fair way for such time as they are needed.

My Lords, first, I support what my noble friend said and pick up in particular his final point about the scope of the judgment in the European Court.

 

I thank the Minister for his reply to my Written Question last week. I am pleased to have had the Answer, although not so pleased with what the Answer was. The point I was raising, which I want to raise now, is that in looking at the capacity market, the UK Government have not made sufficient allowance for demand reduction strategies. They have looked purely at providing capacity to fulfil forecast future electricity demand.

 

We know from the predictions made over the past decade and the reality of electricity consumption that those predictions have, year after year, been wrong, assessing an electricity demand that has not been reached. In other words, electricity demand is not rising as rapidly as the predictions, and the calculations being used by the Government in drawing up state aid do not provide a level playing field between cash available to those delivering additional capacity and cash available for those who have strategies to reduce the demand for electricity.

 

My Question sought to explore that point, but the reply I had was that that was not the case: there is an allowance for demand reduction and that, if I understood the reply, it would be possible, at least in theory, for those with a strategy to reduce demand to draw on the same aid as is available for those who would provide additional capacity to meet demand. Is that the case? In particular, is the calculation of the time period over which a capacity building strategy is calculated and over which a demand reduction strategy is built the same?

 

The point being made to me by those who might be willing to provide a strategy to reduce demand is that it is not a level playing field. My understanding of the European Court decision is that it was not just a technical and procedural point: the court believes that the British Government are fiddling the figures and not providing a level playing field for both sides of that equation. I would like the Minister to provide a more complete answer than the one he gave me last week and perhaps he will explain to noble Lords how in the future the requirements of the European court judgment will be met and how the calculations will be put on a more even footing so that we can do what is surely more sensible, which is to spend taxpayers’ money on reducing demand rather than spend it on fulfilling capacity commitments which are in fact unduly onerous and pessimistic.

I thank the Minister for his introduction and explanation of the regulations before the House. They are necessarily very technical and controversial as they involve the capacity market, state aid and a judicial review of the actions being taken by the Government.

 

This instrument was the subject of a lengthy report from Sub-Committee A of your Lordships’ Secondary Legislation Scrutiny Committee. The Government are embarking on a high-risk strategy and the committee’s 20th report concludes with the recommendation that,

 

“the House may wish to explore further how the Government are proposing to ensure that the Capacity Market can continue to operate in the future”.

 

The noble Lord, Lord Tope, raised this issue among his concerns.

 

As the Minister has explained, the situation arises following a case brought by a demand-side response provider, Tempus Energy, to the European Court of Justice that the construction of the capacity market discriminates against its interests. The European Commission has suspended the state aid clearance following the ruling, producing what may possibly be a lengthy standstill position that will impact on delivery year T1 2019-20, which is due to begin on 1 October 2019 and could continue beyond October 2020. Does the Minister agree that a delay of this magnitude beyond 2020 could bring about a complete suspension, or indeed termination, of the capacity market mechanisms with a high degree of certainty that that may result in unwinding the whole scheme, which has been in place since 2014? What is the Government’s risk assessment of that outcome?

 

I appreciate that the Minister is in severe difficulty as this period brings into play the interplay between the UK’s exit and the complexities around the state aid regimes of the EU and the UK post any implementation period and deal or no-deal scenarios. The Government seem to be making risky assumptions that not only will the ruling be swift but that this is only a procedural issue on the implementation of the state aid approvals. Does the Minister agree that the judicial review case negates those assumptions and that the robustness and fairness of the capacity market is secure?

 

The noble Lord, Lord Stunell, has raised serious issues in relation to this situation and the way the Government have implemented the scheme. Perhaps I may further underline the contention that the capacity market has not been entirely equal in the Government’s assessment to providers that they appear to be adjusting the mechanisms as they consider their approaches to the first five-year review? Would not a safer and less risky strategy have been to halt all auctions and bring forward the review of the workings and results of the capacity market against the original objective; namely, that the capacity market was set up to bring forward long-term new technological capacity to reform the energy market away from fossil fuels?

 

As the Minister has explained, the UK has an 11% capacity margin and these T1 auctions are mostly short-term capacity builders. Can he outline how and why a suspension pending these reviews while the ruling is being reconsidered could be interpreted to undermine more longer-term solutions coming on board? I appreciate that the confidence of industry investors is crucial, but what is the rush? This shadow system outlined in the Minister’s remarks at the beginning, on the assumption that the ECJ ruling is merely procedural and confirmatory, appears to have the backing of industry generally. I am grateful for the considerations on the issue from Simon Markall on behalf of Energy UK.

 

I appreciate that continuity and consistency of the capacity market is important to industry and that competition between technologies could be maintained through policy evolution. Any perceived lack of level playing field in winning CM contracts could be solved while maintaining the working capital and cash-flow stability of the market through these shadow, deferred, contingent mechanisms under the instrument. Labour would not wish to undermine either the security of electricity supplies or the market that relies on this scheme. We understand that over the longer term, industry confidence in the capacity market as an investable mechanism is an important driver for change, with cost savings and value for money overall. Nevertheless, there are concerns that the transfer from fossil fuels towards renewable and nuclear fuels is not proceeding at pace—as the debate yesterday on the climate emergency revealed.

 

The capacity market has brought forward essentially only one combined-cycle gas plant of 400 megawatts against recent open-cycle gas plants, which are more polluting. The Government have given contracts to diesel generators—more polluting than coal—when they refused to set a decarbonisation target for 2030. The response that the nuclear industry is in turmoil despite a sector deal agreement underlines the situation. The 2 gigawatts of new interconnectors is slightly beside the point.

 

I assure the Minister that I appreciate that progress has been made. I welcome the share of electricity from low-carbon sources now reaching 56%. Nevertheless, the issue is not being taken seriously enough or the necessary pace of change being achieved. I ask the Minister to commit to publishing the Government’s five-year review of the electricity market reform this summer and for it to include a full review of the capacity market. Can he assure the House this afternoon that the Government have a full appreciation of all the risks by outlining all the discussions the Government have undertaken with the Commission? With that assurance and the assurances that the Treasury will guarantee all the conditional payment obligations to be underwritten, that his department will continue dialogue with all parties on this review and that this instrument is supported by industry, I am happy to approve it today.

I am grateful to the noble Lord, Lord Grantchester, for his support for this instrument, and I look forward to that support in a few minutes when I conclude my words. At the same time, he called for a halt. Since we are talking about security of supply, I simply cannot go along with him. It is the Government’s view, widely supported by the industry, that the capacity market is the best way to deliver security of electricity supply at the lowest cost to consumers. We will debate this matter tomorrow at Question Time. It is important that we have security of supply and that we have it at the best price. As I said in my opening remarks, our current security of supply positon is robust. I cited the figure that we reckon the margin this winter will be over 11%, the highest for five years. That shows that the market works.

 

A number of concerns have been raised and a number of questions put, and I hope I can deal with them. I will first get on to the question of uncertainty and engagement that the noble Lord, Lord Tope, raised, echoed by the noble Lord, Lord Grantchester. It is important to recognise that there is uncertainty. We appreciate that any judgment of the Court of Justice of the European Union creates uncertainty and potential difficulties for the industry.

 

As I made clear, the Commission is investigating the scheme, and recently confirmed that it is moving on to the next phase. This is an important step as we work to reinstate state aid approval for the capacity market as soon as possible. We are working with the Commission to ensure that we have everything necessary to reconsider the scheme as quickly as possible. I assure the noble Lord, Lord Tope, that we will continue to engage regularly with stakeholders; we will provide them with updates on progress and the re-notification process, and clarity on arrangements during and following the standstill period.

 

We are confident that the Commission will approve the scheme following its investigation. We hope that that investigation will conclude ahead of October 2019, the start of the 2019-20 delivery year. We consider it very improbable—although it is possible—that the decision will be delayed into 2020. In the unlikely event of a negative state aid decision, or no decision, by October 2020, the instrument will terminate capacity agreements and, as I said in my opening remarks, any entitlement to receive capacity payments. Supplier payments then held by the settlement body will also be returned, which will ensure that supplier payments cannot be held indefinitely.

 

The noble Lord, Lord Tope, asked about the position after a no-deal Brexit. The Government have made it clear that no deal is exceedingly unlikely. However, while the UK remains a member state or is subject to an implementation period following a negotiated withdrawal, the current state aid regime will apply and the Commission will need to approve the scheme. The Government intend for there to be a domestic state aid regime after the UK leaves the EU. The draft State Aid (EU Exit) Regulations 2019 are currently before Parliament. In a no-deal exit, the UK will be subject to a domestic state aid regime, for which the Competition and Markets Authority, rather than the Commission, will be the regulator. This assumes that the draft State Aid (EU Exit) Regulations are agreed by both Houses and made. If, at the time the UK leaves the EU, the Commission has not yet approved the scheme, it will then be a matter for the CMA to investigate and approve that scheme.

 

The noble Lord, Lord Tope, asked whether the decision of the court itself was purely procedural. This question was echoed by the noble Lords, Lord Stunell and Lord Grantchester. The court gave examples of where the Commission should have had doubts and should have investigated them, but it did not rule that the design was incompatible with state aid requirements. We have carefully considered each issue raised through that court judgment and remain confident that the design of the capacity market is compatible with the state aid requirements. We cannot pre-empt the outcome of the Commission’s investigations, but we are 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 noble Lord, Lord Stunell, asked whether the capacity market did not sufficiently support demand-side response. As I made clear, the purpose of the capacity market is to ensure security of supply, at least cost, for the consumer—something we all desire to achieve. It is technologically neutral and allows all types of capacity, including DSR, to participate without discrimination.

 

The design of the capacity market provides for features that support demand-side participation, including lower credit cover, participation as price takers and three metering options. The Government are also taking broader action to support DSR, as set out in the smart systems plan. The five-year review of the capacity market, which the noble Lord, Lord Grantchester, asked about, will also explore further ways in which DSR participation can be supported.

 

The noble Lord, Lord Grantchester, also asked about the judicial review and the case raised by Tempus. We are confident about our position. The Government will robustly defend this challenge and, as I said, we are confident in the steps we are taking to reinstate the capacity market and to operate the scheme to the fullest extent possible during the standstill period within state aid constraints.

 

Turning to renewable generation and carbon reduction, the noble Lord, Lord Grantchester, implied that we were not serious about switching to low-carbon electricity generation. As he will be aware, we are committed to switching away from coal. We have announced that we will be giving up coal in 2025 and increasing the share of renewables and gas in electricity generation while reducing the cost of renewables. We have seen a dramatic reduction in the cost—I recently cited the figures for offshore wind—and we have invested £92 billion in clean energy since 2010. We have quadrupled our renewable electricity supplies since 2010 and the share of electricity generated from low-carbon sources reached a record high of 56% in the third quarter of 2018, with 33% from renewables. I hope the noble Lord will accept our commitment in that area.

I thank the Minister for what he has said so far and for his shopping list of money well spent. I do not wish to challenge that but is he satisfied that the Government’s investment is rightly balanced between generating new capacity—renewable or otherwise —and demand reduction? He said that the system takes account of DSR but he did not answer my point about whether there are equal investment opportunities to reduce a kilowatt hour as there are to increase capacity by a kilowatt hour.

My Lords, I am satisfied but I will consider carefully what the noble Lord has said and look again at the Written Answer to which he referred, which I sent to him last week. If I can elaborate on it and provide him with further examples of how we have taken DSR sufficiently into account, I shall write to him on that if I feel it necessary. However, I do not accept his basic premise that there is not a level playing field.

 

I believe I have answered all the questions put to me. This is an important statutory instrument and I commend it to the House.