UK Capacity Ruling May Cost 'Billions'

British generators could lose up to £4.3bn ($5.5bn) in scrapped capacity payments following the UK government's announcement that it was suspending the capacity mechanism with immediate effect, ratings agency Moodys' has calculated. Before the court's decision, it said it had regarded capacity revenue as highly predictable for generators, a credit positive.

In a note circulated late November 19, Moody's said: "Although the UK government can appeal the ruling and is already advancing plans for a replacement scheme, there is no certainty that revenue under a new scheme would be the same as the old. Because payments under the scheme will stop immediately, revenues earned in October 2018 will not be paid in December as anticipated and no further revenues will be recognised. Generators will therefore lose three months of revenue in 2018, around £300mn, and one month of cash flow. Lost revenue will rise to £1.1bn in 2019 if the ruling is not successfully appealed or offset by a new scheme from October 2019," it said, and will stay at that level until 2021-22, it said.

According to a statement from National Grid Electricity System Operator (ESO) which manages the scheme in its role as Electricity Market Reform delivery body, the government will seek separate state aid approval from the European Commission to run a year-ahead (“T-1”) auction to procure capacity for the period from October 2019 to September 2020. However, there are currently no plans to replace capacity market revenue for the 2018-19 year, Moody's said.

For generators that are also suppliers, the loss of capacity revenue will be offset in the short term by higher retail profit because they are no longer required to pay for capacity; and payments already made for October and November 2018 will be reimbursed, Moody's said. But by mid-2019, it assumes retail prices will fall to reflect these lower costs.

UK consultants WatersWye said that parties in the capacity mechanism will now be going into winter with a missing revenue stream, so will need higher prices to "make up" the money that the mechanism was meant to cover. This may not be forthcoming if it is windy and warm, which poses "a considerable risk to them. The decision will also  undermine investor confidence and capital that was earmarked for the capacity mechanism may go elsewhere," instead of waiting for the government and the EC to find a way forward.

On security, the ESO may need to consider if it requires more reserves, it continued in a note to clients. Larger plant may decide to mothball for winter as, with no capacity payments, they will simply be too marginal to stay on.

A power generation source told NGW that "the consensus seems to be that things will probably be alright in short term – i.e. this winter – but further than that, concerns increase". 

A briefing note from consultancy, Timera, agreed that a "temporary halt of a couple of months before payments are reinstated may be painful but is unlikely to precipitate major closures or defaults. The costs of operating capacity are largely sunk over this time horizon. But a prolonged or indefinite suspension of payments will have real implications for more vulnerable capacity owners relatively quickly. This may mean mothballing, accelerated closures and defaults".

Timera warned: "For that reason, expect a sharp and strong lobbying response from affected owners. The interests of utilities, independent power plants, flexibility developers and aggregators in pressuring the government to reinstate payments appear to be strongly aligned. The main hurdle to achieving this seems to be one of legal process rather than overcoming structural conflicts within the industry."

Further out, it said that after this year, the suspension of payments "represents a major threat to security of supply. The capacity market has been the cornerstone of the government’s policy platform to ensure enough flexible capacity is operational to keep the lights on... The alternative stop gap solution is for the government to get Grid (as system operator) to "do all it takes to ensure security of supply".