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9 October 2014
Capacity
Market
Mark Walker
© Allen & Overy 2014
1
What we will cover






Rationale and aims of the Capacity Market
How the Capacity Market works
Recent updates and developments
Principal parties involved in the Capacity Market
Stages of the Capacity Market in practice
Future proposals and developments
© Allen & Overy 2014
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Capacity Market – rationale and aims
 Introduced as a precaution against the risk of failures in the energy
market
 Fundamental aim is to improve security of supply and prevent
blackouts
 This will be achieved by incentivising investment in reliable
capacity
© Allen & Overy 2014
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British power market in January 2030 with January 2000 weather
Source: Pöyry
© Allen & Overy 2014
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How the Capacity Market works
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Capacity Market – an update
– The Energy Act 2013 sets out powers for the Secretary of State to introduce the
Capacity Market
– The Capacity Market regime received state aid approval from the EC on 23 July
2014
– The Capacity Market Rules and the Electricity Capacity Regulations came into
force on 1 August 2014. The Capacity Market (Amendment) Rules 2014 came into
force on 22 August 2014.
– The first T-4 auction is due to start on 9 December 2014
– The Consultation on Capacity Market supplementary design proposals and
Transitional Arrangements was published in September 2014
– A new set of regulations, the Electricity Capacity (Supplier Payment) Regulations
2014 are expected to come into force in November 2014
– There has been a huge number of applications for the first Capacity Market
auction. A total of 513 separate applications were received, equating to nearly
70GW of de-rated capacity.
© Allen & Overy 2014
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Parties
Secretary of State
Delivery Body
National Grid
Capacity Market Settlement Body
Electricity Settlement Company
Settlement Services Provider
Electricity Market Reform Settlement
Limited (wholly-owned subsidiary of
Elexon Ltd.)
Auctioneer
National Grid or person appointed by
National Grid (Regulation 21)
Auction Monitor
As per Rule 5.14, the Delivery Body
must appoint a third party to monitor the
conduct of each Capacity Auction
Authority
Ofgem
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Stages of Capacity Market Operation
Amount
to
auction
Enduring reliability
standard
established by
Govt.
System Operator
develops
scenarios of peak
demand, and
advises on the
amount of
capacity needed
to meet the
reliability
standard.
Eligibility
and prequalification
Demand side
response and
storage eligible
as well as
generation.
Mandatory for
all licenced
generators to go
through prequalification
process or
submit an optout notification.
Auction
Central auction
held to set the
price for
capacity and
determine which
providers are
issued with
capacity
agreements.
Trading
Capacity
providers may
adjust their
position in
private markets.
Delivery
Providers of
capacity commit
to be available
when needed or
face penalties in
the delivery
year.
Payment
Costs of
capacity shared
between
suppliers in
proportion to
their share of
peak demand.
Capacity Market
does not
replace
electricity
market.
Source: DECC
© Allen & Overy 2014
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Amount of capacity to be procured
 National Grid carries out an annual security of supply analysis of the
amount of capacity required to meet the enduring reliability standard
and that is scrutinised by the independent panel of technical experts.
The target capacity level takes account of capacity available outside
the Capacity Market.
 The reliability standard published in the first EMR delivery plan is a
LOLE of 3 hours/year (a system security level of 99.7%)
 50.8GW of capacity is targeted for the first auction, for the first
delivery year 2018/19
 The capacity demand curve is determined by the Government 6
months ahead of capacity auctions. The target level of capacity and
an estimate of the net cost of new entry (or Net CONE) determines
the slope of the demand curve.
 Indexation of payments
© Allen & Overy 2014
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Net cost of new entry
 Net CONE is the central administrative estimate of the level of
capacity payment needed to incentivise new build
 Net CONE was estimated to be £29/kW by DECC in 2013. This was
based on the level at which a new build large scale OCGT was
expected to be able to bid into the first auction.
 However, it is unlikely that large scale OCGT will be built in time for
the first delivery year (2018/19) so for the first auction Net CONE is
based on the estimated level at which new build CCGT will bid into
the CM and has been increased to £49/kW.
 Net CONE is important because it is used:
• to construct the demand curve
• to set the price taker threshold (i.e. half of Net CONE, £25/kW)
 It is no longer proposed that the auction price cap is a multiple of Net
CONE. This cap has been administratively set at £75/kW year.
© Allen & Overy 2014
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Illustrative Capacity Demand Curve
Source: DECC
© Allen & Overy 2014
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Eligibility
 The following are eligible to participate in the Capacity Market:
• new and existing generation (including CHP)
• demand side response (DSR), including embedded generation
• electricity storage
 The following are not eligible to participate in the Capacity Market:
• capacity receiving support through the ROO, CfD, FiT, RHI, NER 300
or UK CCS grant
• long term STOR
• interconnected non-GB capacity, and the interconnectors themselves (it
is intended that this capacity will be eligible from 2015)
• capacity below 2MW threshold (if not combined)
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Pre-qualification requirements (1)
– Pre-qualification takes place 4 months before the auction
– The requirements that must be met depend on the Capacity Market
Unit (CMU) type
In order to pre-qualify for participation in an auction:
 All CMUs must
• Identify the applicant (for a generating CMU, this can be the legal owner or
the Despatch Controller)
• Provide details about the applicant (including legal status) and the CMU
• Provide various declarations
© Allen & Overy 2014
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Pre-qualification requirements (2)
 Existing Generating CMUs must
•
Specify highest physically generated net outputs in previous 24 months
•
Declare Grid Code compliance
•
Confirm connection arrangements
•
Provide details of metering arrangements
 New Build CMUs must
• Have a valid connection agreement (or confirm that a distribution connection
agreement will be in place 18 months prior to the start of the relevant delivery
year)
• Have all planning consents (or for the first T-4 auction confirm that planning
consents will be obtained by 17 working days before the first bidding window)
• Provide a construction plan including dates for achieving construction
milestones
 Refurbishing CMUs – similar to New Build
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Pre-qualification requirements (3)
 Proven DSR CMUs must
• Include a DSR Test Certificate
• Include details of On-Site Generating Units
• Include a business model
• Include details on metering arrangements
 Unproven DSR CMUs must
• Include a business plan
• Confirm that it will complete the required testing
The application window for pre-qualification for first T-4 auction ran from 4 August
to 29 August 2014. A total of 513 separate applications were received for the first
auction, equating to nearly 70GW of de-rated capacity. Over 62GW have already
been accepted by National Grid as eligible to participate. A further 5GW was
initially unsuccessful but it is expected that the majority of these will be able to
prequalify successfully following the dispute resolution process.
© Allen & Overy 2014
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Routes to auction for eligible providers
Auction choices
for CMUs
Opt Out of CM
Participate in CM
CMU Retirement
Prequalification
Process
Existing CMU
(1yr contract)
Auction
Price Taker:
Price Maker:
Can set price up to
threshold; no
justification needed
Sets price; provides
justification to
Regulator
Refurbishing
CMU
(up to 3yr contract)
New CMU
(up to 15yr contract)
Price Maker:
Price Maker:
Sets price; no
justification needed
Sets price; no
justification needed
Source: DECC
© Allen & Overy 2014
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Auction
 Auctions will be held four years ahead of delivery,
supplemented by a further auction one year ahead of delivery.
The first T-4 auction is due to start on 9 December.
 Capacity Market is a descending clock, ‘pay as clear’ auction
meaning that all successful bidders are paid the same price
(set by the most expensive successful bid)
 Generators will participate as “price makers” or “price takers”
• Price takers can only bid up to a threshold of half Net CONE
• Price makers can bid up to the auction cap
© Allen & Overy 2014
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Timetable 1st T-4 Auction
Date
Event
4 to 29 August
Application window for prequalification
21 October
Notification of updated Auction Parameters and
confirmation of the conditional Prequalified Applicants
which have fully Prequalified pursuant to Rule 4.6.3
18 November
Notification of Prequalified CMUs pursuant to Rule
5.5.10(b) and associated update of affected Auction
Parameters
25 November (T–10
Working Days)
Price Maker decisions notified to Auctioneer
9 December
Start of auction
© Allen & Overy 2014
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Auction Parameters 1st T-4 Auction
Category
Parameter
Target capacity for 2014 T-4 Capacity
Auction
50,800MW
Demand curve coordinate – target
volume at price cap
49,300MW
Demand curve coordinate – target
volume at £0/kW
52,300MW
Price cap
£75/kW/yr
Price Taker Threshold
£25/kW/yr
15 Year Minimum £/kW Threshold
£250/kW de-rated capacity
3 Year Minimum £/kW Threshold
£125/kW de-rated capacity
Indexation base period
1st October 2012 to 30th April 2013
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Illustrative supply curve
Price
(£/KWyear)
Price Cap
£75/kW/yr
Threshold for Price Takers
£25/kW/yr
Capacity Outside CM
(inc CfD, Opt Out etc)
Price Takers
Price Makers
Capacity
(MW)
Source: DECC
© Allen & Overy 2014
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Auction format (1)
 The Auctioneer must use its reasonable efforts to conduct the Capacity Auction in an
efficient manner consistent with any guidance from the Secretary of State so as to minimise
the Capacity Auction duration (Rule 5.5.3)
 The Auctioneer must notify and seek advice from the Secretary of State if it considers that
the Capacity Auction will not or is likely not to be concluded within 5 Working Days of the
beginning of the first Bidding Window (Rule 5.5.4)
 The Capacity Auction must be run as a series of price spread bidding rounds (each a
“Bidding Round”) on a descending clock basis (Rule 5.5.5)
 The price spread for a Bidding Round (the “Bidding Round Price Spread”) must be
expressed as a range from a highest price (the “Bidding Round Price Cap”) to a lowest
price (the “Bidding Round Price Floor”) (Rule 5.5.6)
 The Bidding Round Price Cap in the first Bidding Round must be the Price Cap. In each
subsequent Bidding Round, the Bidding Round Price Cap must be equal to the Bidding
Round Price Floor in the previous Bidding Round (Rule 5.5.7)
 The Secretary of State must issue instructions to the Auctioneer as to the process for
determining the size of the decrement to be represented in each Bidding Round Price
Spread (Rule 5.5.8)
 Bidding Rounds continue until the Capacity Auction clears (Rule 5.5.9)
© Allen & Overy 2014
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Auction format (2)
 No later than 15 Working Days prior to the commencement of the first Bidding Round for a
Capacity Auction, the Delivery Body must publish:
•
the date and time on which the Capacity Auction will start;
•
the identity of the Prequalified CMUs for the Capacity Auction and their aggregate Derated Capacity;
•
in the case of a T-1 Auction, the aggregate Contracted Capacity in the relevant T-4
Auction adjusted for any cancellation or termination of Capacity Agreements and/or
delays in the commissioning of Prospective Generating CMUs; and
•
the identity of the Auction Monitor for the relevant Capacity Auction (Rule 5.5.10).
 Between the dates falling 15 Working Days and 10 Working Days prior to the
commencement of the first Bidding Window, the Applicant for each Prequalified Prospective
Generating CMU, Refurbishing CMU and DSR CMU that wishes to participate in a Capacity
Auction must submit a notice to the Delivery Body which:
•
confirms that it will participate as a Bidder; and
•
in the case of a Prospective Generating CMU or a Refurbishing CMU, specifies the
duration of Capacity Agreement in whole Delivery Years (not being greater than the
Maximum Obligation Period for that CMU) that it requires at the Price Cap (Rule 5.5.14).
© Allen & Overy 2014
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Auction format (3)
 Failure to submit a confirmation will result in:
•
the Applicant for that Prequalified CMU not being permitted to participate as a Bidder for
that CMU in the relevant Capacity Auction; and
•
the release of any Applicant Credit Cover relating to that Prequalified CMU in accordance
with the Regulations (Rule 5.5.16).
 An Applicant for a Prequalified CMU will not be permitted to participate as a Bidder for that
CMU in a Capacity Auction if that CMU is:
•
a Defaulting CMU;
•
an Excluded CMU in relation to that Capacity Auction; or
•
an Existing Generating CMU that has Opted-out in relation to that Capacity Auction (Rule
5.5.17).
 Prior to the start of each Bidding Round the Auctioneer must announce:
•
the Bidding Round Price Spread for that Bidding Round;
•
the Clearing Capacity at the Bidding Round Price Floor for that Bidding Round as
determined by the Demand Curve; and
© Allen & Overy 2014
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Auction format (4)
•
except in relation to the first Bidding Round, the spare capacity as at the start of the
Bidding Round (rounded to the nearest 1GW in a T-4 Auction and the nearest 100MW in
a T-1 Auction) being the Remaining Auction Capacity at the end of the previous Bidding
Round minus the Clearing Capacity determined by the Demand Curve at the Bidding
Round Price Floor for that previous Bidding Round (Rule 5.5.18).
 The Capacity Auction clears in the first Bidding Round for which the Remaining Auction
Capacity at the end of that Bidding Round is less than or equal to the Clearing Capacity for
the Bidding Round Floor Price in that Bidding Round (the “Clearing Round”) (Rule 5.9.2).
 The Auctioneer must rank the Relevant Exit Bids in a Clearing Round as follows:
• according to their respective Exit Prices (lowest Exit Price given the highest ranking);
• if Relevant Exit Bids have the same Exit Price, according to their size (largest first);
• if Relevant Exit Bid have the same Exit Price and the same Bidding Capacity, according to
the duration of Capacity Agreement (with the shortest duration of Capacity Agreement
given the highest ranking) followed by random number allocation (Rule 5.9.5).
© Allen & Overy 2014
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Market manipulation
 Rule 3.4.9 (conduct of the applicant) requires each applicant to
declare:
• Compliance with laws prohibiting anti-competitive practices
• No engagement in market manipulation
• No breaches of Bribery Act
• No inducements offered to any officer of an Administrative Party
• No disclosure of confidential information
© Allen & Overy 2014
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Capacity Agreement (1)
 A capacity agreement notice will be issued by the Delivery Body in
respect of each successful CMU. A capacity provider can request an
amendment of a factual inaccuracy in the capacity market notice
 A Capacity Market Register, maintained by the Delivery Body, records
each successful CMU. This is the definitive document.
 Neither the Capacity Market register entry nor the capacity agreement
notice is intended to create a contractual relationship. A capacity
agreement is an instrument created by statute (as opposed to CfD).
 The length of capacity agreements will typically be one year though plants
in need of refurbishments and new plants will be able to receive longer
term agreements of up to 3 and 15 years respectively
© Allen & Overy 2014
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Capacity Agreement (2)
 Additional rules for refurbishing plant:
• Financial commitment milestone
• Substantial completion milestone
 Additional rules for new build plant:
• Financial commitment milestone
• Collateral
• Substantial completion milestone
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Capacity Agreement (3)
 Termination events include:
• Insolvency of the capacity provider
• Failed to achieve a financial commitment milestone (new build)
 Termination fee £5,000/MW
• Failed to achieve minimum completion requirement (new build)
 Termination fee £25,000/MW
• Failed to obtain a connection agreement offer
 Termination fee £5,000/MW
• Failed to maintain TEC
 Termination fee £25,000/MW
• Failure to achieve a satisfactory metering test (if required)
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Trading
FINANCIAL
TRADING
VOLUME
REALLOCATION
OBLIGATION
TRADING*
Eligibility
Parties can trade with
whomever they choose
(e.g. each other or
insurers)
Parties can reallocate
excess output to another
CMU
Parties can only move
obligations to pre-qualified
resources to the limit of their
de-rated capacity and which
do not have obligations (i.e.
empty vessels)
Payment
for holding
capacity
obligation
Unaffected
Unaffected
Payment goes directly to
whoever holds the obligation.
Timing
As privately negotiated
Volume reallocation can only
happen ex post in 11 to 19
working days following
months in which there have
been stress events
Obligation trading can take
place following the T-1
auction up to near real time
Size of
trading
blocks
As privately negotiated
No restrictions on size
Minimum trading blocks to be
determined
*Not yet enabled
© Allen & Overy 2014
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Delivery
 National Grid will issue a ‘Capacity Market warning’ in advance
of any anticipated stress event
 In stress periods providers’ obligations come into force four
hours after the triggering of a Capacity Market warning
 Providers that do not deliver sufficient energy at the relevant
time to meet their obligations will face a financial penalty
• Penalty rate is 1/24th of the relevant clearing price
• Penalties are capped at 200% of monthly revenues and
100% of annual revenues
 National Grid will have the ability to spot test providers where
they have failed to demonstrate their ability to deliver the level
of capacity specified in their capacity agreement
© Allen & Overy 2014
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Payment - Overview of Capacity Market Payment Flows
Capacity providers
Capacity
payments from
capacity
agreements
Payments from
over delivery
during a stress
event
Penalties from
under delivery
during a stress
event
Capacity Market Settlement Body assisted by settlement agent (Elexon)
Monthly funding
of capacity
payments
Payment of
residual penalty
charges (if any)
Funding of
settlement body
costs
Licenced suppliers
Source: DECC
© Allen & Overy 2014
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Capacity Market Settlement Timetable
Source: DECC
© Allen & Overy 2014
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Supplementary design proposals
 DECC published the Consultation on Capacity Market
supplementary
design
proposals
and
Transitional
Arrangements in September 2014
 The Government plans to implement the changes as a result in
2019/2020
 Proposals include:
• Including interconnectors in the CM
• Technical changes to enable Obligation Trading
• Price duration curves (to enable the evaluation of bids to be
based on contract duration as well as price)
© Allen & Overy 2014
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Interconnector capacity
 Interconnector capacity would contribute to security of
electricity supply and provide value for money for consumers
 Eligibility for the December 2014 auction is GB capacity only
but the consultation sets out an interim proposal for
interconnectors to participate from December 2015
 Under the interim proposal interconnector owners would
participate in a very similar way to domestic bidders
 The consultation also sets out a more long term plan for
interconnector capacity
© Allen & Overy 2014
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Capacity obligation trading
 Obligation Trading is where capacity providers transfer their
capacity obligations to other CMUs (Capacity Market Units)
 Amendments need to be made to the Electricity Capacity
Market Rules 2014 to give statutory backing to Obligation
Trading
© Allen & Overy 2014
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Price duration curves
 There are inherent risks associated with the Government
offering longer term capacity agreements for new build
generators
 The Capacity Mechanism Rules and Regulations contain
provisions which allow the Secretary of State to set price
duration curves
 Aim of setting these is to render Government indifferent
between longer and shorter agreements
 The proposals set out a methodology for setting the price
duration curves
© Allen & Overy 2014
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A&O EMR site
http://www.allenovery.com/UK-Electricity-Market-Reform
© Allen & Overy 2014
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Questions?
These are presentation slides only. The information within these slides does not constitute
definitive advice and should not be used as the basis for giving definitive advice without checking
the primary sources.
Allen & Overy means Allen & Overy LLP and/or its affiliated undertakings. The term partner is
used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent
standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP's
affiliated undertakings.
© Allen & Overy 2014
38
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