TABLEROS DE DISTRIBUCION

The Capacity Market remains subject to significant further detailed design development. These further developments will be important for the ability of the Capacity Market to play a significant role in the realisation of the Government’s Gas Generation Strategy.

The Government recognises that the absence of clarity on the Capacity Market may create a disincentive to make investment decisions on a new plant until the Capacity Market is settled, which is not expected to be until later in 2013. It has therefore indicated that plants which begin construction between May 2012 and the first auction would be treated on the same basis as a new plant (if a distinction between new plant and existing plant is used in the Capacity Market), to seek to ensure that there is no disincentive for plants to be built before a Capacity Market is introduced.

The proposed length of contract is one year for an existing plant and between one and ten years for a new plant. It remains to be seen whether a ten-year term would be sufficient for a new plant to be built in reliance on the capacity agreement. Providers of Capacity (generation or non-generation) Electricity Suppliers Capacity Market

Sell electricity into the electricity market

Of

fer capacity Buy/of

fer capacity Required volume determined and auction held (around 4 years before delivery) Secondary trading of capacity between auction and delivery

Check quantity of contracted capacity available to electricity market; and administer

payment flows Around 4 years between auction and delivery

Costs shar

ed between suppliers

Penalties r

efunded to suppliers

Paid for availability

Pay penalty if unavailable

The structure of the penalties for non-delivery and whether there will be a cap on that liability will be of importance in determining the attractiveness of participation in the Capacity Market. Concern has also been expressed in impact assessments that there could be a risk of double liability under the penalty regime and under any contracts entered into to support the delivery of that capacity by secondary trading depending on how the penalty regime is structured. In the May 2012 paper, the Government moved away from the suggestion of a pure market mechanism and proposed combining market-based incentives (such as basing penalties on the price in a reference market) with physical checks to ensure capacity is in place. Government intends to develop the penalty regime in conjunction with Ofgem’s further work on cash-out pricing.

The structure of the auction has not yet been finalised but the proposal is “pay as clear” for both new and existing plants, so that every successful provider would be paid the clearing price set by the most expensive successful provider that bid into the auction.

It has been decided that responsibility for the payments will be shared between electricity suppliers, through a settlement agency model with the settlement agent making back to back payments within days between suppliers and capacity providers. This is different to the counterparty model proposed for the CfD. The settlement agent model would be underpinned by collateral held by the settlement agency and by mutualisation of any payment defaults by a supplier so that other suppliers would be charged a proportionate share of a defaulted payment. Although this is not expressly stated in the documentation, we assume that the statement that this is different to the CfD model means that this is intended to follow a multi-party approach. We need to see the full details of this when it develops, but given that the Capacity Mechanism is anticipated to underpin investment in gas generation, consideration needs to be given to some of the difficulties of a multi-party model which were discussed in relation to the previous CfD counterparty proposals and which resulted in the rejection of a multi-party model for the purposes of the CfD. Please see our comments on the draft Energy Bill available at http://www.allenovery.com/UK-Electricity-Market-Reform which include relevant observations in this regard.

Although the previous consultation paper in May 2012 suggested that the liability of suppliers to make payments could be based on a supplier’s peak load in the delivery year (which would incentivise suppliers to offer different payment terms to customers to encourage demand reduction in peak periods), the consultation accompanying the Energy Bill lists a wider range of possible options for apportioning liability and a decision has not yet been reached. There are also

provisions that would enable smaller suppliers to be exempted from the payment arrangements if considered appropriate. The May 2012 consultation suggested that penalty payments received from capacity providers would be returned to suppliers, but this is not elaborated in the consultation accompanying the Energy Bill.

The risk that capacity agreements may be awarded to providers who are subsequently unable to deliver capacity when needed (or cover any penalty payments incurred) is recognised. In addition to the penalty regime it is expected that some evidence of the physical backing of the capacity will be required to pre-qualify to participate and that there will also be requirements for the provision of financial support. However, the details of these have not yet been settled.

The intention is that demand side response (DSR) should participate in the Capacity Market on a full and fair basis but it is acknowledged that further work is required to set and verify reliable baselines for non-generation technologies and that there may need to be separate pre-qualification criteria for demand side participants. In the latest consultation the Government suggests that time-banded products, specifying delivery parameters such as duration and hours of operation may need to be developed for DSR and storage and this could be included in a secondary auction closer to the delivery year. The Government also says that it intends to run pilot auctions for delivery of DSR and Storage for delivery from 2015-18, (whereas the main Capacity Market is proposed to have its first auction in 2014 for a delivery year of Winter 2018-19).

The Government proposes to prevent a plant that receives an administratively set CfD from participating in the Capacity Market, as it thinks the administratively set CfD should provide a sufficient incentive for those plants. It does however note that in the future when the strike price for CfDs is determined through technology neutral auctions, the treatment of CfD funded plants in the Capacity Market may need to be revisited for investors signing CfDs after that point. The question of whether plants in receipt of RO support will be able to participate in the Capacity Market is not due to be decided until March 2013.

There is an interesting comment on interconnectors that, given the complexity of energy trading arrangements between markets, it may in practice prove too difficult for interconnected capacity to participate in the Capacity Market.

It is confirmed that the Capacity Market will be in addition to the Short-Term Operating Reserve market (STOR), but the interaction of the Capacity Market with the procurement of balancing services has not been fully resolved.

As previously stated the Capacity Market will not apply to Northern Ireland as there is a separate capacity mechanism as part of the all Ireland single market.

The Energy Bill contains enabling provisions allowing the Secretary of State to make regulations for the purposes of the Capacity Market (the first set of which regulations will require an affirmative resolution of each House of Parliament). Electricity Suppliers