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Published: 20 October 2016
Sector: Energy

Consultation on investment by tax-efficient funds in the Capacity Market

In March 2016, the former Department of Energy and Climate Change (DECC) announced in a consultation paper a proposal that would totally exclude tax-efficient funds from participating in the Capacity Market. Perhaps not surprisingly, this proposal did not go down well with investors in such funds, and in a partial climb down DECC subsequently announced a proposal to “revert with a more focused consultation proposal in the Autumn”.

Late September 2016, the Department for Business Energy & Industrial Strategy (DBEIS), the government department which has taken over functions which were formerly undertaken by DECC, issued a further consultation. The proposal has now been somewhat softened: rather than excluding tax-efficient funds from participation in the Capacity Market altogether, the proposal now is to “offset investment” received through tax-efficient schemes from capacity payments received. The consultation was open to responses until 21 October 2016.

According to a report published in October 2016 by Ecuity Consulting the capacity market auctions “have been distorted in the past two years by players able to bid at a lower level than others by using investment with special tax relief”. Ecuity calculate that over 700 MW of projects with tax-efficient funds have benefited from participation in the auctions and their view is that the effect of these projects being able to benefit from tax-relief has been to reduce the price in the auctions to the particular disadvantage of large gas-fired power stations.

Capacity market proposal

The proposed new rules will apply to new plants that have not yet been commissioned. Existing generation and demand-side response capacity will not be affected.

New-build plant developers are required, under the Capacity Market Rules, to achieve their “Financial Commitment Milestone” and, upon achieving it, to submit a report (the “FCM report”) to the Delivery Body (National Grid) confirming that the capital expenditure and financial commitment requirements have been met. DBEIS is proposing that they will also be required to provide a “funding declaration” concerning any investment received from tax-efficient funds. Any such investment will be offset from capacity payments received and the payment body (the Electricity Settlements Company) will deduct the amount of the relevant investment from monthly CM payments until the total amount of the investment has been offset.

This offset arrangement will continue to apply even if the plant is transferred to another party or the rights and obligations under the agreement are transferred. The party to the capacity agreement will still be entitled to over-delivery payments and will remain liable for non-delivery payments. If a capacity payment is forfeited for non-performance that payment will not count towards the amount to be offset.

These proposed new rules will apply to capacity payments made from October 2017 in the case of the early capacity auction, and from October 2020 in the case of the T-4 auction.

What does this mean?

Whilst the apparent decision by DBEIS not to exclude tax-efficient funds from participating in the capacity market at all is welcome, the proposal to offset the entire investment by tax-efficient funds in a capacity market project seems heavy-handed.

We believe a fairer proposal, and one that accords with the government’s stated aim of avoiding “double-dipping” of tax-relief and subsidy, would be to calculate a notional amount that constitutes the “tax relief” element of the investment and to offset that amount.

For example, if EIS investors invest £1m in a generating plant that will obtain a capacity market agreement, it seems harsh that the entire £1m is offset from capacity payments made. Instead, a figure of £300,000, representing the 30% upfront income tax-relief benefit received by the EIS investors on their investment would be offset.

It is also hard to reconcile these proposed new rules, which only affect new build capacity, with one of the oft stated criticisms of the capacity market, which has been that it has delivered capacity market agreements predominantly to existing generating plant and not delivered the scale of new build capacity on to the grid as had been originally foreseen.

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