Draft Electricity Capacity (Amendment) Regulations 2016

Andrea Leadsom Excerpts

Monday 27th June 2016 General Committees

[The Minister of State, Department of Energy and Climate Change (Andrea Leadsom)]

I beg to move,

That the Committee has considered the draft Electricity Capacity (Amendment) Regulations 2016.

The draft regulations seek to amend the main secondary legislation package for the capacity market scheme, which was part of the electricity market reform programme in 2013. The powers to make this implementing secondary legislation are found in the Energy Act 2013, which, following scrutiny in the House and the other place, received Royal Assent in December 2013, with cross-party support.

As a reminder to hon. Members, the capacity market will address our electricity needs and ensure that there is sufficient electricity supply towards the end of the decade and beyond. It will achieve that by making a regular capacity payment to providers that are successful in capacity auctions. In return for that payment, providers must meet their obligations to provide supply or to reduce demand when the system is tight, ensuring that enough capacity is in place to maintain security of electricity supply. Ensuring that hard-working families and businesses across the country have secure, affordable energy supplies that they can rely on is our top priority, which is why we already have firm mechanisms in place, working closely with National Grid and Ofgem, to maintain comfortable margins on the system in the coming winter.

Beyond that, it is essential that generators have confidence that they will receive the revenues they need to maintain, upgrade and refurbish their existing plant, and to finance and build new plant to come on stream as and when existing assets retire. Equally, we want to ensure that those who are able to shift demand for electricity away from periods of greatest scarcity without detriment to themselves and to the wider economy are incentivised to do so. That is why we have the capacity market.

The first two capacity market auctions took place in 2014 and 2015, and the first of two separate auctions focusing on demand-side response took place at the beginning of 2016. Those resulted in a good outcome for consumers, as fierce competition between providers meant that we obtained the capacity we need at prices below the levels many had expected. That translates to lower costs on consumer bills.

In order to ensure that the capacity market remains fit for purpose, my Department has reviewed the capacity market mechanism in the light of the experience gained in those first auctions. The clear message from industry and investors is that the mechanism retains their confidence and is the best available approach for ensuring our long-term security of supply. They also stressed that regulatory stability is crucial. At the same time we heard concerns that we must do more to protect against delivery risks, that we need to tighten the incentives to honour agreements for those that have been awarded them, and that we must avoid the risk of under-buying or buying too late.

UK electricity market conditions have changed considerably since 2014, when the capacity market was established. The huge reduction in global commodities prices has lowered consumers’ energy costs but pushed many generators into loss-making territory. As a result, several plant closures have been announced earlier than was anticipated in 2014, and other generating plant may be at risk.

In order to address those points, these regulations will provide for a new supplementary capacity auction for delivery of capacity in 2017-18, together with minor reforms to help the capacity market deliver its objectives. In the context of those amendments, it is important to consider the capacity market as an insurance policy against a material risk of plant closures. As with all insurance policies, there is a premium to be paid. However, this premium is worth paying to ensure a secure and affordable electricity supply.

The risk that we are ensuring against is largely the result of recent declines in wholesale market prices. We should remember that this in itself has led to welcome reductions in energy bills for consumers. The insurance premium they are being asked to pay now is only a small fraction of those benefits. What is more, as with all insurance policies, we must be sure that the insurance will pay out in times of need. That is why we are today debating amendments to the regulations that will increase termination fees for those who renege on their capacity market agreements. The amendments further incentivise capacity market participants to deliver on their commitments and contribute to our security of supply.

I will briefly expand on the amendments. First, the regulations make provision for a supplementary capacity auction to be held this coming winter for delivery in 2017-18. Running that auction mitigates the emerging increased risk to security of supply in 2017-18 by ensuring that enough capacity is available that year. It acts as an insurance policy against a material risk of plant closures because of low wholesale prices. Our analysis shows that that approach is expected to be up to £8.4 billion cheaper than an alternative scenario in which further plant closures would have occurred.

The regulations also provide for a number of amendments in the light of my Department’s review of the capacity market. Our public consultation exercise outlined the need for a robust system of checks, both on new build projects, to ensure that they are on track to deliver, and on existing plant, to ensure that agreements are honoured. At the same time, the consultation recognised the importance of ensuring that the system is not so punitive that legitimate projects will be dissuaded from participating in the first place.

We have evidence that, despite the termination fee regime already in place, there have been instances when capacity providers have viewed their obligations as relatively low-cost options and have contemplated reneging on their commitments. I am therefore proposing measures to help ensure that new build capacity that wins a capacity agreement has the appropriate incentives, and is exposed to a robust assurance regime, to deliver against their agreement.

These measures include increases in credit cover for projects that cannot demonstrate sufficient progress against the required milestones, and limited but material increases to the termination fees that all those with an agreement must pay if they renege on their commitments. Through the supporting capacity market rules, I am also proposing a prohibition on failed projects from participating in future auctions, and also increased monitoring and reporting milestones.

The regulations must also include measures to make sure that a secondary trading market can develop that supports investment in capacity market units. Those changes will improve the current regulatory framework by dealing with the interaction between transfers of agreements and the penalty regime.

Finally, the transitional arrangements auctions are aimed specifically at the demand-side response sector, recognising that it is a relatively small and immature sector at the moment. We are keen to ensure that funding provided through the next transitional arrangements auction is targeted at those types of resource that need it most. The regulations therefore refine the eligibility criteria for the second transitional arrangements auction so that it focuses on genuine demand-shifting, turn-down demand-side response, rather than the small-scale generation, including diesel, that won many of the agreements in the first auction.

My Department consulted on the changes across two consultations in October 2015 and in March this year. In total, more than 200 responses were received across the two consultations. There was significant support for the majority of the Government’s proposals, particularly the supplementary capacity auction for refinements to the eligibility criteria for the second demand-side response transitional arrangements auction and the core proposals relating to delivery incentives. These regulations implement the proposals. I look forward to hearing what hon. Members have to say about the proposed changes.

--- Later in debate ---

[Andrea Leadsom]

I am grateful to hon. Members for their comments and questions. It will be a great pleasure to answer them all and hopefully my answers will please hon. Members.

The hon. Member for Southampton, Test asks whether there is mission creep. The capacity market is there as an insurance policy for energy security. It is true that it has the secondary goal of bringing on new investment in new, lower-carbon plant, but its core goal is as an insurance policy that ensures that the lights stay on. As he pointed out, a 15-year deal is not available in the supplementary capacity auction. The reason is that, because it is only for 2017-18, there is not time to build the plant and start dispatching electricity between now and the delivery date. However, the T-4 auctions are indeed designed not only to provide energy security, but to bring on new investment.

The hon. Gentleman says that that has not been successful, but that is not true. We have had a variety of new build plants, including more than 800 MW of small scale gas and the CCGT that he mentioned. It is crucial that we provide opportunities for new investment, which is why we have announced separately that we will buy more capacity and do so earlier. We will announce shortly what that means for the next T-4 auction.

The hon. Gentleman talked about the counterfactual of the supplementary capacity auction versus the £8 billion cost of early closure. To be clear to all Members, he is exactly right that our best estimate of what the supplementary auction will cost is £2 billion to £3 billion. It is very difficult to assess exactly what that means per consumer bill, but it will be in the region of £11 to £20. As he has acknowledged, the reason for having the auction is the drop in wholesale prices, which has meant that the economics for wholesale generators have been difficult. In fact, the average dual fuel bill is roughly £200 a year lower than it would have been. We cannot be clear about what the bill impact will be, because it is subject to a competitive auction, but our estimate is that it will be between £11 and £20, which is less than 10% of the reduction in wholesale costs for consumers. In net terms, it is a very good deal for consumers and provides energy security at a time of low wholesale prices.

[Dr Whitehead]

I would be grateful if the Minister confirmed that the estimate she has just given is post the estimates about the dampening effect of wholesale prices of this particular measure, and not the gross effect of what the measures might produce. That is to say, this is the figure after that presumed effect is deducted, and if that presumed effect was not deducted, the cost would be substantially higher to consumers.

[Andrea Leadsom]

I will have to write to the hon. Gentleman on that point. I am not sure I completely understand his concern. The impact assessment is clear that our best guess is that the bill impact will be in the region of £11 to £20. I have just been informed that that is net. I will write to him if he wants a fuller answer, but I hope that clarifies things.

The average dual fuel bill is £200 lower than a year ago as a result of lower wholesale prices, which make it more difficult for wholesale generators to cover their costs. Bringing forward the supplementary capacity auction will therefore ensure that there is security of supply. The best estimate is that that will cost £11 to £20 per bill, which is very good value for consumers.

The hon. Gentleman also questioned the £8 billion counterfactual. That £8 billion counterfactual assumes that we do not bring forward the supplementary capacity auction. There would therefore be nothing available for wholesale generators, and they would have to deal with the consequences of the poor economics of low wholesale prices. He asked about the contingency balancing reserve. Our estimates show that it would be more expensive than the supplementary capacity auction. That is why we are doing this. The SCA is more cost-effective and provides energy security. I hope that that answers his questions.

The hon. Member for Coatbridge, Chryston and Bellshill asked about interconnector links. I can tell him that they will go ahead. I confirm for all Members that my view is that energy policy will not be impacted at all by the public’s decision to leave the European Union, because we will continue to have our energy trilemma and our commitments to decarbonisation at the lowest possible price, to energy security and to interconnectors, which after all are all commercial decisions made between businesses. Our policy for more interconnectors will endure, provided that Ofgem finds on a case-by-case basis that they offer good value to consumers.

[Callum McCaig (Aberdeen South) (SNP)]

That is interesting. May I ask whether the Minister envisages the emissions trading scheme continuing?

[Andrea Leadsom]

Obviously, the emissions trading scheme is an EU-wide scheme, and the UK’s participation will be subject to the negotiation of the terms of our leaving the European Union. There has been a lot of discussion in this very room about the ETS, the amendments the UK would ideally like to make and whether it should count towards our decarbonisation goals at all. I say to the hon. Gentleman that those discussions are not for today, but will of course be part of the negotiation.

The hon. Member for Coatbridge, Chryston and Bellshill raised the question of storage and, as I have said to him before, we remain completely committed to that. The Department believes that storage presents a huge opportunity to provide the certainty that intermittent technologies cannot provide for energy security. We are big supporters of it. Work is going on in the Department to look at what we can do to facilitate storage and to remove any barriers, whether regulatory or structural, to allowing storage to deploy. I hope he will appreciate that nothing has changed and that that enthusiasm will continue. I think I have mentioned to him before that I have met all the trade bodies and developers for storage to hear their views, and we are completely supportive.

[Callum McCaig]

I am interested in that answer. Is there any indication of the timescales for that review and of what any forthcoming changes may be?

[Andrea Leadsom]

I am so sorry, but I have to say to the hon. Gentleman that we will announce that as soon as possible. He will be aware that there are a number of announcements that we are keen to make as soon as we can. Some of this work is very complicated and we are keen to get the right answers. During the passage of the Energy Bill, we had a good discussion about storage. We are all on the same side; we all want to see progress. The key thing is to make sure that we get solutions that benefit the deployment of storage and that there are no unintended consequences of the solutions that we choose; it is important that they do not have the opposite effect. We have had that discussion before, so I will leave it there.

The final point made by the hon. Member for Coatbridge, Chryston and Bellshill was on transmission charges for Scotland. As he knows, the transmission charging regime is a matter for Ofgem. As he also knows, it is designed to be cost reflective to ensure the economic and efficient use of the network across Great Britain and, importantly, to keep costs down for consumers. It is true that there are higher charges for generators in Scotland as a result, but that reflects the actual cost that those generators impose on the transmission network. He will also be aware that the greater part is paid by the electricity supply companies, also on a cost-reflective basis. That means that the majority of transmission charges are in fact recovered through consumers in areas of highest demand—namely in England and Wales. Although generators pay more in Scotland, consumers pay less. Ofgem has concluded, having done a recent study on transmission charges, that there would be winners and losers from any change away from cost-reflective charging, and it does not feel as if there is a case for that.

I hope that the responses I have given have been helpful. As I said at the start of the debate, I am confident that with the changes we have discussed today, the capacity market will ensure the security of our electricity supplies in a way that provides the best value for money for consumers. I therefore commend the regulations to the Committee.

Question put and agreed to.

Resolved,

That the Committee has considered the draft Electricity Capacity (Amendment) Regulations 2016.