Last week, the General Court of the Court of Justice of the European Union (ECJ) found, in favour of Tempus Energy, against the European Commission, annulling the European Commission’s decision not to object to the UK Capacity Market on state aid grounds.
As a consequence, the UK Government has suspended the operation of the Capacity Market. The Government declared that they will be working closely with the Commission so that the Capacity Market can be reinstated as soon as possible.
However, the suspension seems more based on a procedural matter (the commission’s process for granting state aid approval) rather than on the capacity markets policy itself.
What is the Capacity Market? …
The Capacity Market is a mechanism introduced by the UK Government to ensure that electricity supply continues to meet demand ensuring there is sufficient generation or load-management capacity in the system to cope with times of stress on the network or there is a surge in demand.
Back to the energy trilemma, the objective of the Capacity Market is to achieve long-term security of supply. The Capacity Market was proposed following the UK Government’s comprehensive review of the electricity market. This is a tool, along with Contracts for Difference, Carbon Price Floor and Electricity Demand Reduction, to reform the UK electricity market to deliver low-carbon energy and reliable supply, while minimising the cost to consumers.
Moreover, the Capacity Market operates alongside the current Energy Market. On one hand, participants are (or were) paid per MW rate for the capacity they offer to the market while on the other hand, the capacity needs to be available when providers are called upon by National Grid at any time during the contracted period.
Background to the Court’s decision …
In July 2014, the Commission decided not to raise objections to the UK Capacity Market on the ground that that scheme was compatible with the EU rules on state aid. Tempus Energy brought a case against the Commission in December 2014 and the Court heard the case in July 2017. On the 15th of November´s judgement, the Court has found that the Commission should have initiated a formal investigation procedure in order better to assess its compatibility. While the Court’s decision today does not mean that the Capacity Market contravenes EU state aid rules, it will require the Commission to carry out further work to establish whether the scheme is compatible with state aid rules.
Although, market participants will be at a very early stage in assessing the impacts, the consequences will be highly dependent on the length of a final agreement. A short term will have a much less impact onto market, players and potentially consumers but leaves in a serous uncertainty in if it takes longer term.
The immediate one is the suspension of the Capacity Market. The UK Government has concluded that it no longer has the legal power to operate the capacity market and has suspended it with immediate effect. The Government has said that it will not hold any capacity auctions, make any payment. Nevertheless, they will complete the current pre-qualification process for the auctions planned for early 2019 in case it is required for future auctions.
After the Immediate cessation of payments, around a billion pounds of capacity market payments for 2018/19 is in jeopardy. Therefore, it is going to have financial consequences for capacity providers that were relying on them. Although this may vary per company, it is expected to have a negative hit in earnings.
Further to that (capacity providers would not receive future capacity payments) if the scheme does not receive state aid clearance, then there could be a requirement for the Government to recover capacity payments already made.
Another potential (short-term) consequence is the security of supply for the winter of 2018/19. UK does not believe that the suspension will have any effect on security of supply for the winter.
While electricity supplies were unlikely to be at risk, it is unclear the impact in wholesale power prices instead as the the market price might go up.
Long-term consequences are far more difficult to establish. However the capacity market has been one area of relative stability for investors. So, this ruling will add to the challenges and uncertainty faced by investors in new capacity.
… Next steps. Action/s to reinstate the Capacity Market
The Government has said that it is doing everything possible to re-obtain state aid approval from the European Commission as soon as possible and is expressing confidence that they will be able to do this. They believe that the Commission will need to undertake a formal stage 2 investigation.
UK gov has other potential courses of action, such as asking for suspension of the enforcement of the court’s decision or appealing against the decision or back to the drawing board in tems of capacity markets regulation.
Last week, the UK’s scheme for back-up electricity generation was suspended after the European General Court found that the payments system should be subject to a state aid investigation.
The surprise judgment imposed a “standstill period” on the UK’s capacity market, which guaranteed power companies extra payments for generating electricity when supplies are tight. Therefore, the UK Government is now barred from holding auctions scheduled for early next year and from making payments under the mechanism pending an investigation by the European Commission. It is still early to evaluate consequences but clearly it is casting doubt over companies’ plans to invest in increased back-up generation for the grid.