Capacity market: what next?

Claire Millard and Jayne Harrold explore the risks and uncertainty presented by the suspension and litigation over the capacity market.

In the latest developments in the challenge to the capacity market, Tempus Energy has launched a judicial review of the continued operation of the capacity market (albeit with payments suspended), and the European Commission has both appealed the European Court of Justice’s (ECJ’s) decision and announced a state aid investigation.

The Department for Business, Energy and Industrial Strategy (BEIS) has given effect to the initial ECJ decision by suspending payments to capacity providers. However, the capacity market itself has continued to operate and providers have been encouraged to continue to meet their obligations.

Tempus Energy’s judicial review complaint is that the continuing operation of the capacity market, even with payments suspended, is not sufficient and that demand-side response operators continue to be disadvantaged by the aid granted to capacity providers under the scheme. If it is successful in its challenge, this could result in complete suspension of the operation of the capacity market.

In terms of the Commission’s investigation, an open letter to the UK was published on 22 March 2019. All interested parties are able to contribute and have four weeks to do so. Input into the investigation by key stakeholders: capacity providers; demand-side response operators; energy suppliers; regulators and industry bodies; will be key to ensuring that affected parties are heard. Participation presents an opportunity to influence the outcome of the investigation. The Commission has stated that the outcome of its investigation will not be pre-judged.

Brexit does not affect the power of the Commission to initiate state aid proceedings, including the potential clawback of any “aid” unlawfully given by the government during the period of Britain’s membership of the EU. If a withdrawal agreement is adopted or if there is an extension to Article 50 [which Theresa May is travelling to Brussels to seek as Utility Week goes to press], this could include a transition period during which the Commission will continue to have power in relation to state aid for a specified period (such as until December 2020).

The outcome of the Commission’s investigation will either be to approve or reject the capacity market from a state aid perspective. Rejection could lead to permanent suspension. The natural consequence of this is also the clawback from recipients of the aid granted under the scheme. This would most likely be the capacity market payments already received. Alternatively, the Commission may approve a modified version of the capacity market. Again, there remains the question of whether there will be a clawback.

If the capacity market is not approved and payments need to be clawed back, consideration will need to be made as to how that will take place. It may require the involvement of Ofgem to determine whether and how payments can or should be refunded to customers.

This underscores the importance of all affected parties making their voices heard now and engaging with both the Commission and BEIS. The key point at issue is whether the scheme unfairly distorts competition, and effective engagement will need to address that question.

Legal and commercial considerations

It could take time for the Commission investigation and the various strands of litigation to be resolved, which will extend the period of uncertainty for capacity providers.

Capacity market operators may wish to consider their rights and obligations and the impact on their business models, including decisions with regard to whether planned new capacity or refurbishments are deferred, as well as whether penalty provisions can be enforced when payments are suspended and the scheme is under investigation.

Capacity market operators and energy suppliers may also wish to consider whether they need to recognise a contingent liability or provision for potential state aid clawback or future liabilities for payments not made.