The Energy Transition | Government proposes Capacity Market reforms

This week we look at proposals to improve delivery assurance in the Capacity Market, potential changes to the windfall tax on oil and gas profits, and more

Capacity Market penalty hike put on back burner

In January 2023, the Department for Energy Security & Net Zero (DESNZ) consulted on a range of policy proposals to improve delivery assurance in the Capacity Market.

Within its recently published response, DESNZ explained how it intends for these proposals to be implemented in two stages. Phase 1 proposals will be implemented prior to the 2024 Capacity Market auctions. Phase 2 proposals will be given further consideration, and potentially implemented by the 2024 auction at the earliest. These proposals are being made in response to changes to the wider electricity generation market, as well as the in response to the government's net zero targets.

Examples of phase 1 proposals include:

• reforming the way in which connection capacity is determined to better reflects export capabilities;
• allowing up to 35 working days for calculating non-delivery penalties; and
• clarifying auction clearing mechanics.

Plans to strengthen the non-delivery penalty regime by changing the figure used in calculating the penalty rate from 1/24 to 1/4 have been allocated to phase 2, due to these proposals requiring further analysis and development. This comes as consultation feedback raised concerns about the change creating unintended consequences for the security of energy supply. Stakeholders commented that an increase in the penalty rates raises the risk of higher costs for capacity providers and a potential imbalance between the penalty rate and the monthly penalty caps, which may reduce participation in the Capacity Market.

The phase 1 proposals will be implemented by making amendments to the Capacity Market Rules and Electricity Capacity Regulations 2014. The government is currently considering if another consultation is needed to gain further feedback from stakeholders on the phase 2 proposals.

Windfall tax on oil and gas to be scrapped if energy prices fall

The UK government has announced plans to scrap the windfall tax on excessive oil and gas profits, if prices return to the levels seen prior to the war in Ukraine. The Energy Profits Levy, introduced in May 2022 and set to end in March 2028, currently imposes a 75% tax on North Sea oil and gas production. The government has said that the tax has raised around £2.8 billion which has been used to fund reductions to consumer energy bills. It estimates that, by July 2023, the tax would have saved the typical household £1,500. In the face of stakeholder concerns about the reduction in investment in the sector, the government has proposed a replacement scheme, the Energy Security Investment Mechanism. This will lower the tax rate to 40% if average oil and gas prices fall below specific thresholds for two consecutive quarters.

Critics of the regime have denounced the government's plans, criticising its decision to ease the tax burden on oil and gas producers, but retain the tax on renewable electricity generators, particularly in light of the government's net zero targets. Emma Pinchbeck, chief executive of Energy UK questioned why the government is "disincentivising the very technologies that will help insulate the UK from future energy price crises."

Energy crisis: National Grid to keep blackout prevention scheme for coming winter

Demand Flexibility Services (DFS) may return for the winter period 2023/24, according to the National Grid Electricity System Operator's (ESO) early winter view.

In its report, the ESO stated that, "it is prudent to maintain our Demand Flexibility Service for next winter, and the service terms are now out for consultation, reflecting feedback from industry stakeholders."

The ESO launched the DFS scheme last winter, the success of which was discussed in a previous edition of this publication. As a result, the ESO has engaged with industry stakeholders to review the DFS and improve the system in preparation for winter 2023/24. The ESO confirmed that its winter review and consultation is now open, which looks at the reintroduction of the DFS scheme. The consultation will close on 17 July 2023.

The ESO's predicted forecast for this winter is that there will be sufficient available capacity to meet demands, with a de-rated margin of 4.8 GW (around 8%) according to the base case. The base case margin is higher than last winter, but the ESO has reported that it is broadly similar to recent winters. The ESO has said that it is continuing to monitor risks and has identified steps to mitigate such risks and build additional resilience.

The ESO will publish a full Winter Outlook Report in September/early October.

UK's offshore wind pipeline nears 100GW, while grid upgrades lag behind

The UK's offshore wind pipeline is rapidly nearing 100GW, having seen an increase of over 6.6GW in the past year, according to Renewable UK. The trade association's report predicts that, by 2029, capacity will reach around 40GW, just short of the government's 2030 goal of 50GW. Renewable UK CEO, Dan McGrail, stressed the need for further support to ensure both that the 50GW target is reached, and retain the UK's global ranking as the second biggest provider of offshore wind energy. McGrail called for a "double down on our efforts to support and accelerate offshore wind development" and commented that the government should, "bring forward new measures in the autumn budget to incentivise manufacturing investment into the UK that might otherwise go overseas."

In related news, Carbon Tracker, a financial think tank, reported that inadequate grid upgrades resulted in enough wasted wind generation to power one million homes in 2022. The report highlighted that 1,300 GWh of wind energy has been wasted since September 2021 due to grid infrastructure being unable to keep up with the rapid growth of wind power. In its report, Carbon Tracker emphasised the need to prioritise strategic investment in wind power, with author Lorenxo Sani stating that, "[w]ithout significant improvement in the permitting timeframes for critical energy transmission infrastructure, the grid can’t support the government’s plans to decarbonise generation by 2035 or deliver on its vision of ‘affordable, homegrown, clean energy.”

This article was written with the assistance of Amy Lewis and Sophie Myatt, trainee solicitors.