The auction will result in Capacity Providers ("CP") taking on Capacity Obligations ("CO") and receiving up-front payments to reimburse them for the energy market's 'missing money' component. The CO is a promise to deliver energy and/or demand reduction in periods of system stress. A system stress period ('Stress Period') is defined as a Settlement Period where voltage reduction or controlled load shedding occurs anywhere on the system for 15 continuous minutes or longer; excluding faults or deficiencies on the transmission or distribution systems.
The System Operator (SO) will issue a Capacity Market Warning ("CMW") which will serve as a 4 hour notice to CPs to make good on their CO. Should a CP fail to perform in the first settlement period after the elapse of the notice they will be required to pay a penalty on their deficit based on the VoLL minus the prevailing System Buy Price (as that term is defined in the Balancing and Settlement Code).
This penalty exposure will be subject to a portfolio-wide cap based on the product of a multiple of CONE and the de-rated capacity of the portfolio.
CPs who increase their delivery output at times of system stress, relative to their status immediately prior to the CMW, will be eligible for a payment at the penalty rate from the moment the CMW has been issued, providing at all times that the CPs are in compliance with the Grid Code and any obligations arising from the Balancing and Settlement Code and other relevant requirements. CPs who decrease their output, relative to their pre-warning status, will be penalised. This method of calculation will last until the first settlement period after the elapse of the warning.
• The capacity market will be technology neutral and all existing and new forms of capacity will be eligible to participate, except for capacity supported by Contracts for Difference, small scale Feed in Tariffs or the Renewables Obligation, and interconnected capacity.
• Demand side response (DSR) capacity will be eligible, and will be supported by transitional arrangements to develop the capability of the sector.
• Government has amended the Energy Bill so that projects that deliver permanent reductions in electricity demand (EDR) could also participate in the capacity market.
• Eligible capacity providers will offer capacity in a pre-qualification process run by the system operator.
• Pre-qualified capacity will enter competitive central pay as clear auctions also run by the system operator. There will be an initial auction four years ahead of delivery, and a further year-ahead auction
c. Secondary market:
• Between auction and delivery and in the delivery year, participants will be able to hedge their position through secondary trading.
• Capacity providers will receive payment for capacity in the delivery year.
• In return, they will be obliged to deliver energy in periods of system stress and will be financially penalised (following the publication of a capacity market warning) if they do not deliver in stress periods.
• The costs of capacity agreements will be met by suppliers based on their market share.
• Payments will flow from suppliers, via a settlement body, to providers of capacity.
• Where penalties are applied to capacity providers, the funds will flow from them, via the settlement body, to suppliers.
• The upfront costs of capacity are expected to be offset by reductions in the wholesale electricity price.
The System Operator will undertake several roles including providing advice on the level of capacity to auction, administering the auction and issuing capacity agreements.
A panel of technical experts will provide independent scrutiny of the system operator's advice on the level of capacity to auction. Ofgem will be responsible for governance of technical capacity market rules after the first auction has taken place and will continue to regulate the system operator and enforce the rules and competition law within the capacity market.
Settlement agent for the UK capacity market
The intention to designate Elexon Ltd. as the capacity market settlement agent has been also announced. Elexon will be responsible for:
- The collection and administration of market and participant data relevant to the capacity market
- Calculating and administering payments due to capacity market participants,
- Calculating and administering charges due from capacity market participants,
- Calculating and administering penalties due from capacity market participants,
- Invoicing, collection and payment of the sums owing or due,
- Calculating and enforcing credit requirements where they are due,
- Administration of the governance of the capacity market,
- Collection and administration of bid bonds.
Capacity obligations may be physically traded at any time from a year ahead of the delivery year provided sufficient notice is given to the system operator. The system operator's consent to these trades must be obtained and this will require an assessment by the system operator of the receiving party's eligibility and pre-qualification.
• Plant that was unsuccessful in the capacity market auction; and
• New plant that had commissioned early
• Capacity that had not participated in the auction or opted out but that has subsequently been verified by the system operator as providing eligible physical capacity (for instance new demand side services (DSR) or a de-mothballed plant).
The above-mentioned DECC Capacity Market Strawman brings once more crucial remark when it comes to trading environment of the new capacity market, i.e. that the capacity instruments will most likely not be a financial instrument for the purposes of the Markets in Financial Instruments Directive (2004/39/EC)("MiFID"). Accordingly such instruments would also not be within scope of European Market Infrastructure Regulation (EMIR). UK government also believes that the intended capacity instruments will not fall under the proposed MiFID II new definitions of the multilateral trading facility and the organised trading facility.