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Energy Bill update - The Capacity Mechanism – bright ideas for keeping the lights on

The Capacity Mechanism – bright ideas for keeping the lights on

In Short

The Government refers to the capacity mechanism as its insurance policy against the possibility of future blackouts.  It marks a significant departure (and intervention into the market) as compared with how deployment of capacity is currently incentivised. 

Section 3 of the draft Energy Bill contains the provisions relating to the capacity mechanism (see clauses 20 to 30).  Effectively, Section 3 contains enabling provisions.  They confer powers on the Secretary of State to make regulations (subject to affirmative resolution), amend legislation and modify electricity licences to enable the implementation of the capacity mechanism.

High level design of the capacity mechanism

The powers granted under the draft Bill are broad enough to deliver the high-level design of the capacity mechanism which was settled on in the Technical Update which the Government published in December 2011.  To recap briefly, the capacity mechanism will include:  

  1. Government forecast of future peak demand;
  2. competitive auctions a number of years ahead to procure capacity.  The auctions will be run by the GB System Operator (GBSO);
  3. capacity agreements between GBSO and successful bidder under which capacity is provided when required in return for a steady capacity payment; and
  4. the costs of capacity payments are shared between suppliers (and ultimately consumers).

Detailed design of the capacity mechanism

Whilst the high-level design of the capacity mechanism is understood, the Energy Bill does not provide substantially more answers on the detailed design of the capacity mechanism.  For example, work remains ongoing in relation to whether there should be an enduring reliability standard, the design of the auction process (such as "pay as bid" or "descending clock"), how to accommodate non-generation technologies (such as Demand Side Response, interconnected capacity and storage), the penalty regime, the interaction with cash out reform etc.

The Government has stated that it will publish a further document on its thinking towards the end of this year and will consult on detailed design in 2013.

Nevertheless, Annex 3 to the EMR Overview Document contains a design and implementation update which does give some insight into the Government's current thinking.  Highlights include: 

  1. the Government is minded to exclude plants in receipt of an administratively set Feed in Tariff with Contracts for Difference from the capacity market to avoid overcompensation of low carbon plants; and
  2. if a distinction is made between the treatment of new and existing plant (in the capacity market) the Government expects that plant that begins construction between now and the introduction of the market would have the option of being treated as "new".

Although helpful, the Government is at pains to stress that substantial development work needs to be carried out, engagement with stakeholders needs to continue and a consultation process run.  As such (and given the Government's previous shift in preference from a targeted mechanism to a market-based one), it is perhaps premature to draw any firm conclusions from the Government's current position.  

Summary

So far as the capacity mechanism is concerned, there are no real surprises in the Energy Bill.  It contains the arrangements that you would expect to see in order to enable the Government to implement the high-level design.

However, the key to the capacity mechanism's success will be to get the detailed design right and to conclude it in a timely manner.  As the continuing engagement with stakeholders and consultations demonstrate there a significant number of issues to settle. 

Although the Government is of the view that there is no immediate threat to security of supply, they recognise that capacity margins will tighten significantly over the second half of this decade.  Increased risk of a shortfall within scenarios being considered by Government is being driven by the anticipated change in the energy mix as generation becomes increasingly intermittent (e.g. wind) or inflexible (e.g. nuclear) against a back drop of old nuclear and fossil fuel plant being taken off-line.

Finalising the open issues in time to enable a first capacity auction in 2014 - should it prove necessary - is likely to be a challenge.

Return to our Energy Bill update.