Capacity Market suspension following Tempus State aid judgment

Matthew Brown, energy lawyer at LexisNexis, examines the suspension of the Capacity Market following the Tempus State aid judgment of 15 November 2018.

First published in LexisPSL. Click here for a free trial. 

What has happened?

On 15 November 2018 the General Court of the Court of Justice of the European Union found in favour of Tempus Energy Ltd and Tempus Energy Technology Ltd (Tempus), who had challenged the validity of the European Commission's 2014 State aid clearance for the Great Britain (GB) Capacity Market (Capacity Market). As a result, the Capacity Market's State aid clearance has been annulled and its operation has been suspended. The immediate term consequences for providers or potential providers of capacity under the Capacity Market are explained below.

Brief background

Tempus (who are a provider of technologies for what is known as 'demand side response' (DSR) - in essence allowing large energy users to control the timing of their energy usage) believe that, while support under the Capacity Market can be won by DSR, the duration of support available under the rules of the Capacity Market is prejudicial to DSR compared to new/refurbishing electricity generation projects. Tempus was successful in overturning the Capacity Market's State aid clearance through arguing that, in granting the Capacity Market State aid clearance, the Commission should have found that sufficient doubt was raised as to compatibility of the Capacity Market with the internal market to invoke the 'formal investigation procedure' provided for pursuant to Article 108(2) of the Treaty on the Functioning of the European Union (TFEU).

This decision comes after the Capacity Market mechanism has been operating for a number of years, and therefore where:

  • a large number of projects are receiving capacity payments pursuant to 'capacity agreements' (note, despite the term, a 'capacity agreement' refers to the rights and obligations accruing to capacity providers under the legislation which underpins the Capacity Market (and the 'Capacity Market Rules' made under this legislation (SI 2014/2043, reg 30(1)))
  • electricity suppliers are funding such payments under legislation, and
  • where further Capacity Market auctions were scheduled to take place early in 2019, again under a process underpinned by legislation

In what is a deeply disruptive situation for (among others) central government, National Grid (as Capacity Market 'Delivery Body'), the government owned Electricity Settlements Company Ltd (ESC) (as Capacity Market 'Settlement Body'), and most importantly owners and funders of projects with Capacity Market support (or planning to bid in upcoming auction rounds), all of the above bullets are impacted by the annulment of the Capacity Market's State aid clearance. We explore this in more detail below.

Suspension of capacity market payments to existing projects (and supplier payments to the ESC to fund such payments)

The government has stated that the decision does not change its commitment to using the Capacity Market to deliver and support secure capacity, and that it is 'working closely with the Commission to aid their investigation and seek timely State aid approval for the Capacity Market'. However, ahead of such State aid approval it has, via the Capacity Market Delivery body, been confirmed (Advice Notice) that for the time being the Capacity Market is 'in standstill' and no capacity payments will be made. Linked to this, the ESC has stated that the charges levied on GB electricity suppliers to fund capacity payments will also pause: EMR Circular 169.

This suspension rides roughshod over the provisions of the Electricity Capacity Regulations 2014 (Capacity Regulations), SI 2014/2043 and Electricity Capacity (Supplier Payment etc) CM Regulations 2014 (Supplier CM Regulations), SI 2014/3354, which (together with the 'Capacity Market Rules' made under the Energy Act 2013) are the legal basis upon which the ESC is obliged to make payments to capacity providers and electricity suppliers are obliged to fund the ESC to make such payments. However, given the State aid clearance for the Capacity Market has been annulled, pursuant to Article 108(3) of TFEU (as incorporated and made supreme in domestic law by the European Communities Act 1972) the relevant payment provisions of the Capacity Regulations and Supplier CM Regulations are rendered illegal and hence must cease to be implemented by government.

Clearly, for those projects that were entitled to and anticipating these payments on an ongoing basis, this is a deeply problematic development. However, it should be emphasised that this development is not the equivalent of a UK government driven change in policy on subsidy schemes where judicial review routes of challenge could be pursued. Instead, what happens next is largely a product of how, when and for what the government can secure State aid clearance. The potential next steps are discussed in the final section of this blog.

Suspension of future Capacity Market auctions

As well as suspending capacity payments to projects that have historically won Capacity Market support, the Advice Note confirms that the Capacity Market auctions that were due to take place in early 2019 will not. While also disruptive, this is less damaging than the suspension of ongoing payments and indeed a mechanism exists for this under the Capacity Regulations, SI 2014/2014, reg 26(3)(a). This Regulation states that the Secretary of State may, before a capacity auction commences, cancel or postpone it if 'the awarding of capacity agreements or making of capacity payments to successful bidders could breach the law relating to State aid'. The Advice Note has however noted that the ongoing pre-qualification process for participation in the now postponed auctions will continue, in the hope such pre-qualification outcomes can be used a part of future Capacity Market auction processes.

Will the government need to recover payments historically made under the Capacity Market?

The Advice Note states that the government is taking no steps to recover payments at this stage, and hopes that this can be avoided. This will presumably be on the basis that, while the judgment has annulled the Commission's State aid clearance for the Capacity Market on the basis the correct procedure was not followed, this does not mean that State aid clearance for the scheme will not ultimately be obtained. This segways into the next section below, 'What could happen next?'.

What could happen next?

In the Advice Note, the Delivery Body has stated that:

'The Government hopes that capacity payments will resume as soon as possible but these are subject to the Commission providing state aid approval for the capacity market and agreeing that the UK can make payments under the existing capacity agreements"

It is clear from this and other comments made by government that it wishes to continue to use the Capacity Market mechanism, which to an extent is reassuring for most of the industry. However, ultimately this depends upon State aid clearance being obtained. While the position is evolving, it appears the avenues (and approximate timescales) for this are as follows:

  • the Commission reopens its investigation into the Capacity Market scheme, potentially with the UK offering amendments around the DSR position. In principle, from the point of notification State aid clearance can be given within a matter of months of notification where the Commission decides formal investigation is not required. However, where formal investigation is required (as appears likely given the government comments referred to below) many cases last for over a year. In addition, (i) there is likely to be further dialogue between the Commission and the relevant UK, and (ii) the government will need time to consider how/if it would propose to amend the mechanics of the Capacity Market (and run any consultations processes associated with this) to help with the State aid position, or
  • in principle, the Commission could appeal the judgment to the Court of Justice on a point of law. However, this would ordinarily take many months (and often into the years) to go through the process, with no guarantee of success

The Advice Note and the subsequent Minister of State for Energy and Clean Growth written statement to Parliament on the suspension (Written Statement) states the government is intending:

  • to run the postponed 2019 four year ahead (T-4) auction as a three year ahead (T-3) auction next year, subject to the Commission completing its formal investigation and providing State aid approval for the main Capacity Market scheme. The Written Statement adds, 'we are working to reinstate the full Capacity Market regime and are discussing the swiftest means of doing so with the Commission', and
  • to seek separate state aid approval from the Commission to run a one-off ‘replacement’ T-1 Auction (in respect of the T-1 auction that would have taken place on 29 January 2019). The Written Statement adds, ‘we are seeking immediate State aid approval for a T-1 auction that will cover winter 2019/20’

As set out above, this appears ambitious on timescale, but clearly both the government and the Commission will be motivated to move matters forward quickly, given how damaging the position is to the market. The State aid clearance position may be somewhat easier for the T-1 auction, which is less controversial from a DSR perspective as only one year Capacity Agreements can be won by any technology type.

Finally, it should also be noted that any future Commission approval could of course be challenged again by interested parties. Pursuant to Article 263 of TFEU, there would be a two month period from the date of publication of the approval for such a challenge to be instituted.

On money paid historically under existing capacity agreements, the Advice Note states, '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'. This all very much suggests that the government is planning to re-apply for State aid approval, and is assuming the Commission will need to go down the formal investigation route. It should be noted that, if there is no approval by the Commission, the UK government could be ordered to recoup all money found to amount to illegal State aid. How mechanically the government would impose this upon recipients of relevant capacity payments would be for them to decide.

Capacity providers are also very legitimately asking the question of where they stand on the obligations imposed upon them under existing capacity agreements, given they are not getting paid. On this point, the Advice Note states the government will provide advice to the Delivery Body 'as soon as possible'. Capacity agreements do not provide for a right for capacity providers to choose to terminate and therefore there is no existing obvious mechanism for this, but clearly government recognises that there is a serious question mark over whether capacity providers should continue to be bound by capacity agreement obligations to deliver capacity in the current circumstances.

Finally, as referred to above, as a corollary of the above position the ESC has confirmed that electricity suppliers' obligations to make payments to ESC to fund capacity payments, pursuant to the Supplier CM Regulations, SI 2014/3354, will not apply during the period when capacity payments are suspended. In some senses this is an unexpected windfall for suppliers, however suppliers will obviously have to be cautious on what assumptions to make on when/how such payments may re-commence and indeed what impact this should have on wholesale and retail electricity prices. At the retail end of the market, for example, it is interesting to note that the price caps increasingly being introduced on domestic supply (most notably the upcoming price cap on all SVT and default tariffs) make certain assumptions around the costs of funding the Capacity Market - Ofgem will therefore need to carefully consider how such caps are impacted in this unprecedented and unanticipated scenario.

Filed Under: Energy

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