20 Nov 2018

State aid or state hindrance?

A decision by the European Court of Justice (ECJ) means that the Government: 

  • may not run the 2019 capacity market auctions;
  • may not make payments under existing capacity market agreements
  • may have to recover sums paid under existing capacity market agreements.

Context 

As part of the Government’s Electricity Market Reform package, the capacity market was introduced to provide security of electricity supply. It was designed (i) to enhance the security of our electricity supply by ensuring sufficient reliable capacity was in place to meet demand and (ii) to support the development in the electricity market of more active demand management.

By offering all capacity providers (new and existing power stations, electricity storage and demand side response capacity) a steady, predictable revenue stream (capacity payments) on which they could base their future investments (encouraging the replacement of older fossil fuel power stations); those capacity providers were required, in return, to deliver energy when needed to keep the lights on and provide backup for more intermittent and inflexible low carbon generation sources - or face penalties. 

The cost to consumers for this capacity was minimised by the competitive nature of the auction process setting the level of capacity payments.
The European Commission (Commission) confirmed State aid approval of the capacity market on 23 July 2014 and the first capacity T-4 auction took place in December 2014 – to put capacity in place for the 2018 winter. 

Tempus Energy Capacity Market State Aid Challenge

Last Thursday (15 November 2018), the ECJ found in favour of Tempus Energy (Tempus), against the Commission, annulling the Commission’s State aid approval for the UK capacity market. 

Tempus is a demand side response (DSR) provider that challenged the unequal treatment of DSR projects, which can only apply for one year capacity agreements, while generating plants can apply for 15 year agreements. 

The impact of the judgment is to suspend State aid approval for, and therefore the legality of, granting aid through the capacity market. As a result the capacity market has entered a ‘standstill period’ preventing the Government from:

  • holding any capacity auctions; 
    • the upcoming T-4 and T-1 Auctions for Delivery Years 2022/23 and 2019/20 respectively have been postponed indefinitely, 
  • making any capacity payments under existing agreements; 
    • the Government hopes that capacity payments will resume as soon as possible but these are subject to the Commission giving State aid approval to the capacity market and agreeing that the UK can make payments under existing capacity agreements.
  • undertaking any other action which could be seen as granting State aid, until the scheme can be approved again. 

BEIS has released a statement that the judgment was decided on procedural grounds, namely that the Commission should have consulted more fully before granting State aid approval in 2014. BEIS state that they remain of the belief that the capacity market is an effective mechanism, designed to minimise costs to consumers and that their focus is on ensuring it can be reinstated as soon as possible. 

National Grid has confirmed that they do not believe the judgment will cause any risk to security of supply this winter.

What next?

National Grid can continue with activities which do not involve the grant of State aid, including completing the Prequalification process for 2019 in case it is required for future capacity market auctions. 

BEIS state that they are doing everything they can to re-obtain State aid approval from the Commission; that the Commission will now need to undertake a formal investigation before providing State aid approval; and, that BEIS will support the Commission’s investigation where required (including careful consideration as to whether any changes to the design of the capacity market are required). 

At this stage it is not known how long it will take for the Commission to conclude their formal investigation but Brexit will not have an impact on this issue. Other than in the case of a "no deal" Brexit, the UK will need to continue to comply with the EU State aid rules notwithstanding any departure from the EU on 29 March 2019.

The road ahead

The Government is intending to seek separate state aid approval from the Commission to run a one-off ‘replacement’ T-1 Auction. 
Subject to the Commission completing its formal investigation and providing State aid approval for the main capacity market scheme, the postponed T-4 auction will be run as a T-3 Auction in next year’s auction round - but BEIS acknowledge that this may be problematic for certain construction lead times.

All applicant credit cover currently held for the postponed T-1 and/or T-4 Auctions and/or for future Delivery Years will be returned. A formal procedure is in place to request the return of credit cover; agreement holders may also request the return of credit cover for capacity agreements arising from past auctions.

The Government is taking no steps to recover capacity payments at this stage, and hopes that this can be avoided. BEIS will discuss with the Commission the extent to which aid already paid may need to be recovered, as part of the Commission’s formal investigation, and the final position will not be known until the Commission’s investigation is complete.

Much uncertainty

This ECJ decision has created a very complicated scenario, with the electricity generators and DSR providers - and not least BEIS - taken by surprise.

BEIS is currently reviewing the judgment and has said that it will provide guidance as to whether a capacity provider which fails to comply with its agreement during the standstill period will still be subject to penalty payments or termination fees; similarly whether a capacity provider is able to withdraw from its agreement during the standstill period. 

But many more questions remain unanswered, including:

  • if credit cover is returned, is the obligation to provide capacity suspended?
  • should a capacity provider think twice before applying for the return of credit cover?
  • how can the Government's obligation to pay be suspended while the generator/DSR obligation to perform remains in place?
  • if a generator performs, will it be paid in future for having done so?

Please contact Chris Towner if you would like to discuss any of these issues or any related queries.