Background
The Capacity Market (CM) is a mechanism introduced by the UK Government as part of its Electricity Market Reform policy.227 The CM, which became operational in October 2017, was intended to ensure secure supplies of electricity through procuring capacity in capacity auctions. The CM was expected to ensure sufficient generation or load-management capacity in the system to cope with times of stress in the network. For example, when intermittent generation output is low or when there is a surge in demand in peak hours.
Market participants including new and existing generators, embedded generators, Demand Side Responders (DSR), storage providers and interconnectors, are paid a rate per megawatt (MW) for the capacity they make available to the market. This capacity must be available when providers are called upon by National Grid at any time during the contracted period. Non-delivery at times of system stress incurs a penalty.
In July 2014, the European Commission (EC) approved the CM under State aid rules, noting that it would “contribute to ensuring the security of energy supply in the United Kingdom (UK), in line with EU objectives, without distorting competition in the Single Market”.228
Subsequently, four auctions for delivery 4 years ahead (T-4) and one for delivery one year ahead (T-1) have been held. Two so-called “Transitional Auctions”229 were also held to support DSR. The Early Auction held in January 2017 was granted separate State aid
227 The EMR is a government policy to improve security of supply, affordability, and incentivise investment: https://www.ofgem.gov.uk/electricity/wholesale-market/market-efficiency-review-and-reform/electricity-market-reform-emr
228 European Commission Website: http://europa.eu/rapid/press-release_IP-14-865_en.htm and
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ:C:2014:348:FULL&from=EN
229 BEIS:
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_
data/file/753170/BEIS_Ofgem_Statutory_Security_of_Supply_Report_2018.pdf
163 approval.230 Collectively, these auctions have resulted in £3.8 billion of payments due to capacity providers.231
The CM suspension
In December 2014, Tempus Energy appealed the EC’s approval of the CM and won. The court ruling annulled the state aid clearance on November 15, 2018, effective immediately. The UK government put the CM into a standstill period, which means it is still operating as normal but with payments currently suspended. The EC has opened an investigation to reconsider the state aid case. If and once the CM has been re-approved, it is the UK government’s policy to reinstate payments. In the meanwhile, margins remain healthy at over 16%.
Market reaction
Prices reacted to fundamental demand and supply drivers rather than the CM suspension
Prices were muted following the announcement of the suspension, indicating that the market assessed security of supply as adequate for the winter. There was a brief reaction in prices after the announcement, but this was a continuation of a trend seen in the preceding days. Following this, forward contract prices fell for the rest of winter. Figure 6.15 shows that prices of the forward month and forward two months contracts and the winter 19/20 contract all fell after the CM suspension, reflecting the market’s view of a well supplied system for the rest of winter.
230 European Commission Website:
http://ec.europa.eu/competition/state_aid/cases/265707/265707_1850846_123_2.pdf
231 BEIS: https://www.gov.uk/government/collections/capacity-market-parameters-for-auctions-2019-to-2020-and-2022-to-2023, See also:
https://insight.lcp.uk.com/acton/attachment/20628/f-b4a526c5-7c8d-4b5a-97b3-a8a0f8ef6e14/1/-/-/-/-/Suspension%20of%20the%20GB%20capacity%20market.pdf
164 Figure 6.15: The price of Forward Power Contract for Month ahead (MON1)
and Two Months ahead (MON2) (£/MWh)
Source: Bloomberg.
Note: The figure shows the price of the delivery for the month ahead and two months ahead delivery (baseload and peakload), since the beginning of November 2018. The blue line indicates when the CM announcement was made.
We did not observe a price reaction to the suspension because sunk costs had already been incurred by CM contract holders at the beginning of winter, therefore capacity was already secured. In addition, the government was clear that it expected the CM would be reinstated, subject to State aid approval.
Security of Supply
There was no evidence of security of supply concerns during winter 2018/19 as seen in the muted price reaction to the suspension. The CM helped to support higher daily margins for the 2018/19 winter than in preceding years, and it continued to lower and stabilise cash-out prices by increasing system capacity.
While CM payments are suspended, revenue from the wholesale and ancillary markets are the only income streams for power plants. So while in theory we could have seen higher wholesale prices and price spikes at times of system tightness as the most
165 marginal plants seek higher prices to cover missing income, in fact we have not
observed such price spikes as conditions in the market have been benign. Comfortable margins have been reflected in the downward price trends since Q4 2018 and cash-out prices have remained well within the normal range.
Next steps
On the 6th March 2019, Tempus Energy issued a claim for judicial review against BEIS, arguing that BEIS is prevented from continuing to operate the CM during the
suspension period. Tempus is asking for domestic courts to order that the government recoup payments made related to auctions in January 2016 and March 2017, and it has also asked that the replacement T-1 auction not take place. BEIS has said it will defend its position.
Summary
Despite the CM suspension, the price reaction has been muted with margins remaining in excess of demand, although clearly some market participants are under financial stress due to lost revenues. The government is working to get the CM reinstated, and both BEIS and Ofgem have supported these efforts through holding replacement auctions, contingent on the EC State Aid decision and continuing development of the CM through Five Year Reviews. In the context of the state aid case, BEIS is seeking immediate state aid approval for a replacement T-1 auction for winter 2019/20 delivery and has already held a T-1 auction on 11th and 12th of June 2019 with an urgent submission aid clearance.
166
7. Energy networks
Introduction
7.1. This is the first year we have included energy networks in our State of the Market report. We aim to expand our coverage of networks in future years, and welcome any comments as to which areas would be of most interest.
7.2. Sitting at the heart of the energy system, GB’s gas and electricity networks are essential to the functioning of society and the economy, moving energy from where it is produced to the homes, businesses, and other premises where it is needed. The electricity network consists of around 821,000km of lines and cables, while around 284,000km of pipes make up the gas network.
Summary of findings
GB’s energy networks continue to provide safe and reliable energy to consumers, with high levels of customer satisfaction and reliability and availability levels at around 99.99%.
The financial returns earned by the network companies in providing these services remain above Ofgem expectations, with most of the network companies achieving double-digit, or close to double-digit financial returns.
Growth in low carbon and distributed energy continues. In 2017/18, nearly 1.7 GW of smaller scale generation was connected to the electricity network, bringing the total to almost 9 GW connected over the last three years.
Environmental performance of networks has also improved, with electricity
network companies (transmission and distribution) reducing their carbon footprint by the equivalent of over 1 million tonnes of CO2 over the past three years.
In 2017-18 over 16,000 electric vehicle chargepoints were connected to the electricity distribution networks, up 80% from the previous year.
167 7.3. The cost of operating, maintaining and strengthening these networks is significant,
currently averaging around £12.5 billion each year. These costs are ultimately reflected in the prices that consumers pay for their energy, representing around one quarter of the costs of standard energy bills, or in the region of £250 for a typical household. The average GB customer in 2019-20 pays around £114 per annum232 for gas distribution costs, £87 for the costs of electricity distribution networks, £35 for electricity
transmission, and around £10 for gas transmission.
7.4. The GB energy networks are run by private companies, who have a monopoly on their operation. Ofgem sets price controls to incentivise these companies to act in the best interests of energy consumers. In doing so, we have a principal objective to protect the interests of current and future consumers, including those in vulnerable situations. We must also ensure that companies are able to finance their activities and efficiently deliver services to consumers.
7.5. Since 2013 we have used the RIIO (Revenue = Incentives + Innovation + Outputs) framework to set price controls for the gas and electricity networks. This new performance based framework sought to put consumers at the heart of network
companies’ plans for the future and encourage longer-term thinking, greater innovation and more efficient delivery.
7.6. In this chapter we provide a high level summary of network company performance to date under the RIIO price controls. For each year of the price controls, Ofgem reports on how network companies in each sector have performed against a broad range of measures, including outputs, expenditure and financial returns. The latest reports for 2017-18 were published in March 2019.233