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Utility Week 14 03 14

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14 | 14Th - 20Th March 2014 | UTILITY WEEK Policy & Regulation Market view A great deal has been written about Electricity Market Reform (EMR). Given its aims, it is not surprising that much of the discussion has centred on the consequences for generators. But EMR will have a significant impact on suppliers too. The proposals will see the introduction of two new mechanisms: the contracts for dif- ference (CfD) regime; and the capacity mech- anism. Under CfDs, low-carbon generators will receive a payment from the counterparty when the reference price is below the rel- evant strike price (and have to make a pay- ment where it is above it). Under the capacity mechanism, generators with a capacity agreement will receive a payment from the Capacity Market Settlement Body (CMSB) for making capacity available (and be penalised for not doing so). Neither the CfD counterparty nor the CMSB (both of which will be government- owned companies) will be generating their own income. Therefore each will need to be funded, and the source of those funds will be licensed electricity suppliers. The CfD payments will be recovered through a supplier obligation – a mandatory levy on all licensed suppliers. The system has been designed to ensure that the CfD counterparty can at all times meet its con- tractual obligations to make payments under all CfDs to which it is a party. That certainty is seen as essential in providing confidence to developers and investors. Following the closing of its EMR con- sultation in December, the government is considering the final detail of the supplier obligation. However, as currently envisaged it will be made up of a number of compo- nents. The principal element is the supplier levy payment, which will be used to fund the CfD counterparty's payment obligations to generators under CfDs. Those amounts will be estimated in advance and will give rise to a fixed rate per megawatt-hour. The daily amount payable by each supplier will be the product of that rate and the amount of electricity supplied by the supplier dur- ing each day (an obligation day). The daily levy amount will be invoiced on a daily basis seven business days aer the relevant obli- gation day, with payment due five business days later. Because the amount of a supplier's daily levy payment is based on a forecast of the CfD counterparty's costs, the regulations include a reconciliation process to ensure that the amount a supplier pays is based on actual CfD costs and the amount of electric- ity actually supplied. Potentially the biggest sting in the tail, certainly for smaller suppliers, is likely to be the requirement to post collateral (by way of cash or acceptable letters of credit) to cover 21 days' worth of upcoming levy payments. Collateral (in any form) is expensive, and in a sector where margins are already tight, the imposition of further collateral requirements is bad news. The levy is not the only pay- ment suppliers will have to make. They will also have to contribute to a reserve fund and an insolvency fund, and pay the CfD counterpar- ty's costs of administering the CfDs. The reserve fund is to ensure that the CfD counterparty has sufficient funds to make its CfD payments if it underestimates CfD costs. Pay- ments to the insolvency fund are based on the supplier's market share. The fund protects the CfD counter- party against the risk of an insolvent sup- plier giving rise to a short-term funding gap. A similar set of arrangements is to be implemented for the capacity market. Again, suppliers will be obligated to make payments to allow the CMSB to meet its liabilities. The principal payment, the capacity mar- ket supplier charge, will be calculated annu- ally based on a supplier's forecast market share at the time of total peak demand. In addition to paying the capacity market sup- plier charge to the CMSB on a monthly basis, a supplier will be required to make monthly payments to cover its relevant proportion of the forecast costs of the CMSB (the settle- ment body charge). Again, the payment timetable has been structured to ensure the CMSB has funds available to pay capacity providers. Invoices for the capacity market settlement charge and the settlement body charge will be issued by the second working day of the month to which the charge relates and must be paid within three working days of receipt. The capacity payment regulations also include a mechanism to credit suppli- ers with amounts paid by capacity provid- ers to the CMSB for a failure to make capacity available, and a reconcili- ation mechanism to cater for differ- ences between forecast amounts and actual outturns. Once again, because the CMSB will be entirely dependent on the receipt of monies from suppliers to meet its obligations, suppliers will be required to post credit. The cur- rent proposals envisage credit being required to be provided nine work- ing days prior to the start of each month and to cover one month's worth of charges. Other elements of EMR are also likely to affect suppliers – not least that, to ensure independent genera- tors have a route to market, certain suppliers will be obliged to enter into a backstop power purchase agreement if requested by an eligi- ble renewable generator, with the costs (or profit) from that arrangement being social- ised across all licensed suppliers. Suppliers are already familiar with arrangements that require them to identify industry charges and pass them on to their customers, but the level of complexity in the EMR proposals should not be underes- timated. Suppliers will need come to terms with the requirements in good time to ensure that (at the very least) their systems and cus- tomer contracts are structured in a way that does not leave them with an unexpected (and potentially very costly) system, finan- cial or cash flow challenge. Derek Goodban is head of the Energy team at Wragge & Co. EMR: the burden on suppliers CfDs and the capacity mechanism are designed to shape the generation market, but it is suppliers that will have to fund them and cope with their complexity, says Derek Goodban. The biggest sting in the tail is likely to be the re- quirement to post collateral

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