The ECJ’s declaration that the capacity market breaks state aid rules came as a bolt from the blue, and couldn’t have landed at a worse time.

The energy industry was already in turbulent waters. Suppliers were gearing up for the fast-approaching introduction of the price cap on default tariffs in January. Ofgem had confirmed that the mutualisation process for the Renewables Obligation scheme would be triggered for the first time ever due to missed payments – a sign perhaps of imminent failures. And ministers were resigning in droves in protest at the terms of the proposed EU withdrawal agreement, raising the prospect of both a no-deal Brexit and the collapse of the current government.

Then on Thursday last week the European Court of Justice (ECJ) revoked the state aid clearance for the capacity market granted by the European Commission in 2014 – rendering the scheme illegal and sending shockwaves through the industry.

The delivery body for the mechanism, National Grid, said the mechanism would be forced to enter a “standstill period”.

As a result, the government is now prevented from “holding any capacity auctions, making any capacity payments under existing agreements or undertaking any other action which could be seen as granting state aid until the scheme can be approved again”.

National Grid said it had received instructions from business and energy secretary Greg Clark to “postpone indefinitely” the upcoming T-1 and T-4 auctions, due take place in January and February respectively.

See you in court

The ruling came in response to an appeal lodged by Tempus Energy in 2015. The company claimed in its filing that the capacity market discriminated against demand-side response (DSR), for example, due to the shorter contract lengths available to DSR aggregators when compared with new-build generators.

Tempus argued during the court case it was paradoxical for the European Commission to grant state aid clearance to the UK scheme without holding a formal investigation, and then later to launch a sector inquiry into capacity markets in 2016.

The court agreed the commission had failed to scrutinise the mechanism properly. It noted in its ruling that the capacity market had been approved following a preliminary examination lasting just one month and that a formal investigation had not been conducted despite objections being raised by several industry players.

It said the commission should not have “simply relied” on information provided by the UK government to reach its conclusion and therefore annulled the decision.

Speaking to Utility Week, Tempus Energy chief executive Sarah Bell is in triumphant mood. “Every single point in our case apart from one was taken on board almost word for word in the judgement… We could not have got a bigger win,” she says.

Bell says the ruling has delivered a major blow to fossil fuel generators. She says their “unbelievable lobbying power” turned the capacity market into a subsidy scheme for coal and gas power stations – stifling competition, raising energy bills for consumers and slowing progress on decarbonisation.

According to Tempus, around £5.6 billion of capacity payments have been awarded in the auctions to date, of which £4.2 billion – or 74 per cent – has gone to fossil fuel plants.

“One of my biggest gripes about this whole scheme is that it’s such a big lost opportunity,” she says. “Just imagine if we put £5.6 billion into powering the smart energy economy.

“We’d be building businesses. We’d be having all different sorts of opportunities to grow the economy. This is the economic development opportunity of the century.

“We’ve got so much potential in this field… It’s so frustrating to watch.”

News of the ruling overshadowed Greg Clark’s speech to the Institute of Directors later that day, which in most other weeks would have garnered a great deal more attention.

Clark declared the end of the energy trilemma and made a raft of policy announcements, including a new white paper and a full review of industry codes and governance.

He briefly interrupted the main thrust of his speech to comment on the decision, telling his audience: “The judgement, as everyone knows that’s read it, is on a procedural matter – the commission’s process for granting state aid approval – rather than on the policy on capacity markets per se.”

According to National Grid, the government is planning to seek state aid approval for a “one-off” T-1 auction at some point in 2019 and then obtain reauthorisation for the main scheme to allow for a T-3 auction the following year.

But if Clark is hoping to resolve the issue without making changes to the capacity market, Bell believes he will be sorely disappointed: “There is zero chance of getting the same capacity market again,” she predicts.

Winners and losers

Unsurprisingly, many in the wider energy industry were unhappy with the decision. Around a billion pounds of capacity market payments for 2018/19 is in jeopardy.

It’s unclear for the time being whether these payments will be lost forever. But even if the capacity market is reinstated and the payments are made further down the line, many contract holders face a big hole in their finances over the intervening period.

Tom Glover, chief commercial officer at RWE Supply and Trading, told the Guardian he was “deeply disappointed” with the ruling and his company was facing a “significant negative hit” to its earnings.

“Given the serious financial implications for capacity providers, as well as the need for investor certainty and security of supply, this issue needs to be resolved as soon as possible,” said Energy UK chief executive Lawrence Slade.

Tempus Energy doesn’t have any capacity contracts and so does not lose any income. However, Bell claims to have strong support from fellow aggregators.

Flexitricity has been one of the biggest winners of capacity contracts for DSR. Founder and chief operating officer Alistair Martin says the suspension of the mechanism will leave a sizeable dent in the company’s revenues.

Nevertheless, he welcomes the ruling: “One doesn’t normally expect the little guy to win. It only usually happens in the movies.”

Martin says the disruption the industry now faces is the fault of the government for failing to address the concerns of DSR aggregators for years on end: “The government has been vulnerable for this whole time because the capacity market was pushed through in a bit of a rush and they left this vulnerability in there”.

He says the persistent refusal to resolve the problems “baked into the design” left few alternatives to such a challenge: “I’m not going to point the blame at Tempus because the solution is in the government’s hands and has been for a long time.”

Now its hand has been forced, Martin hopes the government will grab the opportunity to finally make the necessary changes to put DSR on an even footing with generation.

He worries it will merely return to the European Commission with “essentially the same capacity market”, preventing its reinstatement: “That will be a classic case of it taking longer to do things quickly.”

In the meantime, Martin wants “urgent clarity” over what will happen to existing contracts: “This industry doesn’t run on massive margins and the place where the margins are thinnest is often around these sorts of areas. There’s a hole right now and the industry needs to know what the government is going to do about it.”

He continues: “Once state aid approval is achieved, then what happens for the payments that were due for this year? The market needs to hear clear statements from the government on these points.”

Quick restart essential

Tim Rotheray, director of the Association for Decentralised Energy, shares Martin’s desire to see more equitable treatment of DSR within the capacity market

But he says many companies with decentralised energy portfolios have managed to build business models around the mechanism, despite its flaws: “If a substantial income stream like the capacity market is brought to a halt then that has got to put those businesses under considerable financial strain.

“I don’t know if it will put companies’ survival at risk; that probably depends on how long this hiatus lasts.

“If it’s quite quick then I think that might be okay. But I’m concerned this might be a lengthy hiatus of many months, which will put significant pressure on businesses.”

As much as he would like to see reforms to the capacity market, on balance he considers it more important to get the scheme up and running as soon as possible. Once revenues have begun flowing once more, the government can then set about resolving any remaining issues.

Rotheray hopes the situation will spur ministers to match their stated ambitions with “real action”. He says they have lacked a strong “sense of urgency” up until now and this needs to be “ramped up”.

Thomas Edwards, senior consultant at Cornwall Insight, says there is “no reason” why the capacity market should not ultimately be reapproved. The government is committed to the mechanism and the UK is not the only country in the EU to operate one.

He is more concerned about how generators will respond to the loss of capacity payments in the meantime.

Edwards believes it is unlikely to cause problems for security of supply over the current winter. Generators have already spent a lot of money to remain on the system and will want to claw back as much of these sunk costs as possible through other markets. He says the more important question is what will happen in the next winter and beyond.

Large transmission-connected generators have to pay for transmission entry capacity in April. If there is still no clarity on the situation by then, Edwards says, some power stations – coal plants in particular – may consider shutting down: “If you’ve got a big outage planned why bother coming back?

“Why spend the money if there’s no significant clarity on what the future of the capacity market is and your future agreements will be.”

“There is probably a risk that some of the older coal and gas units that might need some tender love and care might decide not to come back,” he adds.

Edwards says new-build projects yet to begin construction or just starting out may also be at risk, with implications for security of supply and wholesale power prices.

Weijie Mak, GB power market lead at Aurora Energy Research, says its modelling indicates that 15GW of capacity will be dependent on capacity market payments to stay open in 2018/19. “I think that most coal plants wouldn’t be able to continue in the market without capacity market payments,” he explains.

If this amount closed, wholesale power prices could soar to as much as £150/MWh. He says some of the 15GW would likely stick around to capture the higher prices, but not much; an indication of the imminent return of the capacity market would be better an encouragement to stay online.

Clearly the stakes are high. Unless the government can provide the industry with some reassurance over when the scheme will be reinstated and whether the payments due for this year will be returned to contract holders, the UK could soon be facing a capacity crisis.

Lawrence Slade, chief executive, Energy UK

“Given the serious financial implications for capacity providers as well as the need for investor certainty and security of supply, this issue needs to be resolved as soon as possible”

David Oliver, energy expert, Inenco

“Suspending the capacity market, and with it capacity payments for existing agreements, poses grave questions about the future security of supply, threatening the closure of plants without the certainty of new generation to replace it.”

Richard Black, director, Energy and Climate Intelligence Unit

“BEIS is seeing this as a challenge, but actually the court has presented it with a massive opportunity to constructively rethink a measure that while keeping the lights on is working against other government aims on cost and decarbonisation.”

Sebastian Blake, head of markets and policy, Open Energi

“There have always been flaws in the capacity market, not least that it solves a problem which doesn’t yet exist… The suspension of the capacity market at a time when the mechanism was coming under review anyway provides an opportunity to address some of these flaws.”

Mark Hollands, head of energy strategy, British Solar Renewables

“The capacity market is flawed and needs restructuring with a balanced approach to all ­technologies… However, the way this point has been made and the resulting ­suspension of the capacity market is ­potentially damaging to ­investor ­confidence.”

 

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