© allen & overy 2014 capacity market 1 9 october 2014 mark walker

© Allen & Overy 2014

CapacityMarket

1

9 October 2014

Mark Walker

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 2

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

British power market in January 2030 with January 2000 weather

Source: Pöyry



How the Capacity Market works

5

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.


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

7© Allen & Overy 2014


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 pre-

qualification

Demand side response and storage eligible as well as generation.

Mandatory for all licenced generators to go through pre-qualification process or submit an opt-out 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.

Capacity Market does not replace electricity market.

Payment

Costs of capacity shared between suppliers in proportion to their share of peak demand.

Stages of Capacity Market Operation

8

Source: DECC


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

9


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.



Illustrative Capacity Demand Curve

11

Source: DECC


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

13


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

14


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.

15


Auction choices for CMUs

Participate in CM

Refurbishing CMU

(up to 3yr contract)

Price Maker:Sets price; no

justification needed

Price Maker:Sets price; provides

justification to Regulator

Price Taker:Can set price up to

threshold; no justification needed

Price Maker:Sets price; no

justification needed

New CMU(up to 15yr contract)

CMU RetirementOpt Out of CM

Existing CMU (1yr contract)

Prequalification Process

Auction

Routes to auction for eligible providers

16

Source: DECC


Auction

17

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


Timetable 1st T-4 Auction

Date Event

4 to 29 August Application window for prequalification

21 October Notification of updated Auction Parameters andconfirmation of the conditional Prequalified Applicantswhich have fully Prequalified pursuant to Rule 4.6.3

18 November Notification of Prequalified CMUs pursuant to Rule5.5.10(b) and associated update of affected AuctionParameters

25 November (T–10 Working Days)

Price Maker decisions notified to Auctioneer

9 December Start of auction

18


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

19


Capacity Outside CM (inc CfD, Opt Out etc)

Price (£/KW-year)

Price Takers Price Makers Capacity (MW)

Threshold for Price Takers

Price Cap

Illustrative supply curve

20

£75/kW/yr

£25/kW/yr

Source: DECC


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)

21


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 De-rated 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).

22


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

23


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).

24


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

25


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

26


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

27


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)


• Failed to obtain a connection agreement offer


• Failed to maintain TEC


• Failure to achieve a satisfactory metering test (if required)

28


Trading

29

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


Delivery

30

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


Payment - Overview of Capacity Market Payment Flows

Capacity providers

Capacity Market Settlement Body assisted by settlement agent (Elexon)

Licenced suppliers

Capacity payments from capacity agreements

Payments from over delivery

during a stress event

Penalties from under delivery during a stress

event

Monthly funding of capacity payments

Payment of residual penalty charges (if any)

Funding of settlement body

costs

31

Source: DECC


Capacity Market Settlement Timetable

32

Source: DECC

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)


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


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


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


A&O EMR site

http://www.allenovery.com/UK-Electricity-Market-Reform


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 capacity market 1 9 october 2014 mark walker

Documents

capacity market auction

capacity market rules

capacity market rationale

gw of capacity

capacity markethow

capacity marketstages

capacity auctions

level of capacity payment