 Chairman, Excellencies, members of the Institute, ladies and gentlemen, thank you very much for the kind introduction. I've been coming here for many years and it's a great pleasure to be here before you to explain the electricity capacity market that, subject to the will of Parliament and subject to the lawfulness of the state aid that's associated with this, we will be opening in August, one month from now, with a view to having an auction for electricity capacity commitments in Britain by 2018. So it's a tremendously exciting time for us in the press release on your chair there, which the Secretary of State issued just yesterday, which is referring to the opening of this market. It's also really interesting because it is the UK's answer to the security supply situation it's been facing for some years and we're really looking forward to opening it. Now what I'm going to speak about is the capacity market design and the institutional mode and some of the implementation things. There are some other security supply measures which I just mentioned really briefly and I'm not going to be touching on, but there's a tender on the street for capacity for winter 2014, this coming winter, and there's a tender soon to be on the street for 2015. So we have not only this mainstream capacity market but we also have these interim measures which are seeking the security supplies for the very coming winters. EMR, electricity market reform of which this forms a big part of, is 110 billion scheme which is there to deal with the decarbonisation of the electricity sector and also to put the security supply and get the capacity into the ground in order to back up the renewables and to provide the power for enterprise. I suppose it's really important for me to say and maybe even goes without saying but none of what I'm going to speak about constitutes investment advice and anybody who's out there who's thinking of investing in this market, well to take their own advice and look at the particulars of the contracts that are out there which is the proposition for investment. I first want to speak about the diagnosis of the security supply situation, what we faced back in 2010 and where it is today and the first thing to mention in 2010 obviously there was a new government in place, the supplies of gas production on the continental shelf had been declining for some years, we were looking at a situation facing deep emission cuts and an aging plant and so the security supply situation was causing a lot of concern and was the top priority for the new government and the projections were showing that the capacity constraints were going to start biting and about a quarter of the capacity was going to retire over the coming years. That's quite an astonishing figure, a quarter of the capacity for a modern state and what needed to be done about it was the question. So the first thing that we said about doing was looking at the situation that we faced and I suppose the first observation was that the existing system had produced investment for two decades and here we were at this part a third wave of change that needed to be done for the next period and the energy only market I suppose was fit for purpose, it had delivered the investment but there were some known problems with the operation of the energy only market and in particular, if you can see that chart there, there's nothing wrong with electricity, there's nothing wrong with economic theory but when it's applied to the electricity sector it does rely on extremely high prices and these extremely high prices occur at times of shortage and at times of shortage these are the times when customers are paying the most and investors are being remunerated and so the question was always there for investors would the political system with the regulatory system allowed prices to spike to the necessary levels that would encourage the investment and was so desperately needed for investment and so we didn't think that we could just leave the system alone, the other thing that we observed was that there were weaknesses in the functioning of the existing system and that often times electricity prices did not reflect the scarcity that underlined the market conditions and so the supply and demand curves were not crossing properly and so off-chem subsequently went and solved those issues so we had I suppose a combination of issues that gave rise to a prima facia case for intervention they were again weaknesses in the application of the electricity market design, problems with the functioning of it and an underlying change in the underlying cost curve character where year zero cost renewables were coming on to the system and they were being subsidized all of these factors together gave enough concern to the department and the political system that needed to make an intervention and with that decided in 2010 I'm afraid to say that the investment froze because now there's going to be a government intervention there's a problem with security supply what's going to be the solution and so we needed to get along and do this as quickly as possible so looking just again at the investment proposition that was out there with the energy owning markets what I'm showing you here is three years of peaks so you're looking at the electricity production on the left hand side along the right hand side three years and I'm just eyeballing and finding three or four peaks and those are those are the peak times when generators or investors will be relying on the return from the market and the question would always be what if they missed one of those they're going to happen so infrequently what about when the prices spike when those happen with a political system intervene and take that money that the generator so desperately needed and the third part of it was what customers put up with the high prices and generators and investors would find themselves adverse to the customer's interest at those times and so that system was was a little hit-and-miss and what we needed to do was one give the investors they certainly that those high prices would materialize in the form of the new capacity market and also to give it to them in a more predictable and more certain way so that they could clear their way to do the investment and so what we call this is the missing money so if we look at any of the peaks and what you're looking at here is a price curve and the peak it should spike to a value of lost load at the peak but it doesn't it doesn't for two reasons there's either an explicit price cap a functioning a block in the functioning of the market or a political intervention all of these things we conceptualize that the missing money and so the problem of the designing the capacity mark becomes just that replace the missing money for investors just taking a look at the enormity of the problem or the size of the problem we were trying to solve these charts are the security supply charts are forecasts of the derated capacity margin so this is the capacity that you could count on to produce electricity at a time of system peak and I bolded one of them there on the left-hand side you're looking at numbers which are dropping from 10% in 2013 to a low of two or three percent in the early part of this decade but bigger part in the mid part of this decade on the right-hand side you're looking at the loss of load expectation which is a statistical estimate estimate of how the system will perform and in particular the number of hours the customers will be interrupted in a particular year and what you're looking at here is a body of evidence that's been produced year after year after year I'm only showing you a snapshot of an unacceptably low margin the standard of loss of load expectation for most modern countries is is three hours the French have a standard of three hours the Americans have a standard of one and a half and some of their markets and you're looking at that corresponding in the dotted line the dotted line on the right-hand side and you're seeing that the situation is is is in need of intervention so that's if you like the measurement of the problem that we had before us I know I want to turn chairman to the intervention itself what exactly what exactly the nature of the intervention is and how it came about I want to talk a little bit about the market design the institutional design and the implementation of that so the first thing is reliability is is clearly a public good it's got positive externalities and the market cannot solve public good problems by definition and what it takes is a political intervention to solve that problem and that takes the form in this case of the Secretary of State on behalf of the customers on behalf of the people that have elected him making a political choice of the standard of reliability of electrical system and he has made that choice and determined it to be three hours that is the first formal security supply standard in Britain since 1986 and so what the Secretary of State is basically saying is it is unacceptable to have a standard of less than three hours and that is an expectation it's not a prediction so over the long run it's like saying you might crash your car once every 10 years doesn't mean that you will crash it every once every 10 years but it's an expectation and so when the Secretary of State has decided that level here we have that will immediately translate or engineers can immediately translate that into a quantum of capacity that is needed to meet that standard and so the press release that you're looking at is the Secretary of State just yesterday determining the quantum of capacity needed for 2018 and he has determined that after lengthy analysis that was performed by National Grid the system operator and he was also empanelled a bunch of technical experts for notables in electricity industry to scrutinise the work of National Grid and after he listened to a long debate about the amount of capacity and reliability is determined the amount that will be procured for 2018 and in round figures that's 50 it's 50.8 to be precise and so there's an auction going to happen this year with a procurement exercise of 50 gigawatts that's basically what we're looking at and in terms of the second thing then is now that we've decided that this is the amount of capacity that needs to be procured if I use that word then we use market forces to procure that and there's three things that need to be asked by this market first of all what exactly is the quantity what money goes with this capacity and determine that to determine who is who is in need of this money which precise investors will invest and the third thing is how to distribute that money and so my metaphor for that is to check I need three things I need to pay I need the amount and I need the terms and conditions of that and so what we're going to use is market forces to determine the quantum of this missing money and distribute it in exactly the same way as a fully functioning energy market would now it's a little regrettable that some of the communications around this has got to got to where they are what we're doing with the capacity market intervention is we're simply adding some certainty to the energy market in it so that it will function in exactly the same way as it should do ordinarily we're not creating a separate capacity market we're adding on we're working in a systemic way with the existing in the existing system and so the sort of things that we were looking at when we started this intervention first of all is an incremental reform we're just going to bolt on these extra capacity market rules onto the existing system we're going to like muddle through as Ling Broom would have said we're looking at questions around market design so what exactly this market would look like questions about institutional design pre-existing fitting in with the existing system the codification and governance so it's one thing about doing market blueprints is another thing about writing all that down in legal contracts and in this case it required primary legislation and then there's a question about implementation of this at the same time given the urgency of the situation and so what we decided to do was to was to break down all of these things and work on them in parallel so ordinarily would do design and you would do legislation then you do implementation we broke that down and we moved all of these along in parallel paths so that gave a rise to a project of some great complexity because obviously trying to legislate for something that's not properly completely designed is is full of unknowns we also had knew that we're into a lengthy development cycle and would take the entire resources of government to deal with that right up until now from 2010 in fact and we wanted to disrupt as little of the existing commerce that we could possibly do and that that meant that we had to do widespread stakeholder consultation to do this behind a pane of glass but also to access the expertise that were out there from the industry who was affected and from individuals who could help us with that and at the end of all of that we were in a situation to restore the missing money to the electricity market and restore it with more certainty that otherwise would have obtained. Chairman I want to move on to a little bit about the consultation. I mentioned that we had to have a detailed consultation on these. I've counted up the pages there's greater than 1500 pages of consultation documents lasting four years dealing with all manner of topics including a market design, institutional design, how does the existing how the system would fit in with the existing system, how it would deal with state aid because at the same time the European Commission were modernizing the state aid guidelines and that was that was also needed. There were regulatory impact statements which were laid alongside the legislation going into parliament there was legislation itself in the House of Commons, the House of Lords and pre-legislative scrutiny in there. There's some really interesting papers on the website if any of you are interested about the delegated powers. We're obviously proceeding with legislation to make capacity regulations and we had to seek delegated powers from parliament. For the capacity market we had seven of them, for the EMR program we had 71 of them and so the we had to make a good case the delegated power subcommittee on that. In the capacity market we even had a Henry VIII power which is the ability of the executive to amend an enactment itself. So asking for delegated powers is is is tricky with parliament and that had to be that had to be handled really really carefully. We had an expert group who helped us with the technicalities of this and they met with us every two weeks. I counted up a hundred plus discussion papers with them and each time we published something like legislation and parliamentary regulatory impact assessments looking at customer bills, looking at clearing prices, looking at the net welfare benefits to society and so forth. And so that is all on the DEC website and is I think a good record of public consultation. Not only that we're consulting in the middle of trying to implement this because the security supply problem had some urgency so we're at the same time we're designing, we're asking people to help us with implementation, we're asking them to be prepared to invest, to get their boards to agree to them putting down money in a scheme that's not quite clear to them. So we asked a lot of people and we're still asking a lot of people because our legislation is not in place but we're telling them it's opening in 30 days so I wanted to record my appreciation to everybody who's shown us the good will to do this. But the implementation questions were questions around approval, compliance, investment strategies, business processes, interfaces between organisations, communication devices and so communication modes and so on. And so we have the National Grid who has helped us as a delivery partner to deal with the intricacies of all of this. I'll turn my to move on to the three topics that I promised which was to do first of them to do with market design. What we're looking at here again is a system to embed with the existing energy markets such so that it and the energy market taken together would represent the best possible implementation of an electricity market that could be achieved and so the two of them, the two of them operating together are simply one electricity market and it's called the capacity market that's fine it's an additional chapter of the rulebook to do with the electricity market and the way that we approached all the design questions was to ask the question if we include this component in the design would the incentive that would be generated by it operating with the existing system would that equal to the same incentive that would obtain in a perfectly functioning market that was our design principle and we adhered to that in so far as we could the other thing we did was test the investability of this because we're putting a scheme up to people who were asking them to put their money down and so we talked to the city and we went up and down visiting with the investment banks the sovereign wealth funds and the equity providers and we also introduced some interesting features into the market one is an agreement length and we've given a 15-year agreement length we've also given capacity market warnings so the penalties won't come in other than a warning is given and we also introduced caps and caps are very important to investors caps on liability so there was some departure from this this principle but there's also we held on it on other issues such as excuses for forcement sure and for maintenance outages of plant all of this I'm glad to say I pulled the city just recently and they tell me they're tooling up to lend money on the basis of this new capacity market now so I think we've accommodated the concerns of the of the investment community as best we could and we have a good statement from them about their their business readiness on the market design itself and this is probably the most technical area that there is and I'm going to give you a very brief summary of it and again looking at what we're trying to do here quantified amount of the missing money what we say really with our market proposition is we ask the investors to give us bids to perform to produce electricity that's their performance requirement to produce electricity at times of system stress and we ask them to tell us how much money they need to do that over and above what they've already projected they will earn in the energy market and so that by definition is the missing money and we line all these bids up and we get a clearing price and we pay the clearing price to everybody that's that as the essence of the market it's a little more complicated than that the market is a multi-round descending clock combinatorial logic market it's very interesting it's modified Dutch auction proposal where the price comes with a price cap down the idea of that is that every bidder can see the value that other people place on the on the product that they have and it mitigates it mitigates issues like winners curse so that's that's the market there's some really interesting issues in there about market power mitigation a lot of controls about market power and market power abuse electricity markets are notoriously volatile and notoriously susceptible to market power and market power abuse and so we've quite quite a range of market power mitigation measures which I don't go into here but they're quite interesting the second thing is that who receives the capacity payment the second piece who's the payee on that check it is the participants in the market who are missing the money and those that are about to invest who wish to invest and the what we're asking them to do is only what they would ordinarily do in the electricity market to produce to produce energy at times of system stress at their derated capacity derated capacity being a measure of the performance at system peak and so that is that is who gets the money and in order for us to have this price only selection process we have a pre-qualification process to enable us to distinguish the quality of all of those resources and to see who's who's eligible for long-term contracts who's eligible for short-term contracts and then the third thing is to pay the money so when we get the clearing price it's really really simple the impact assessment that was laid in parliament last week has a central clearing price of 39 pounds we take that 39 pounds we divide it out into the various months and we pay it out to the generators and we pay it to them almost in trust because when the when the time comes and there's any system stress event we reckon their performance if their performance is as the baseline would have suggested to keep the money if they produce more to get an extra bonus if they produce less there's a penalty cloud back off them and so that is the way that we true up for the missing money over over the years and it's really interesting to say that this is not a central buyer type market is not a procurement exercise of any kind it's a market it's a system where we give a market price for this missing money if we the final thing I wanted to say about it really is if we were to add up the quantity I gave you a moment ago which is 50 gigawatts and the price that's in the impact assessment 39 so I've said 50 by 39 get 2 billion that's the size of the scheme that's about to open next month and that's the central estimate and it was a trade it was a price cap announced in March as part of the budget uh the chancellor in the in the floor of the house of commons as part of the budget speech amazingly announced the price cap for the capacity market of 75 pounds so we're estimating 39 it could come in anywhere up to 75 and and and so that uh that is our that that that is our best estimate of where it is that money I should say is gross money and our impact on customer bills we estimate that's around around two pounds per year for an average an average house and that's the best estimate we can we can make of that of course being a counterfactual exercise to to work that out I'm happy to say also that I think that this is a buyer's market for this first round there's a lot of new supply pent up in the system ready to go there's a lot of existing supply the market is a forward market for commitments in four years time and so the two together the old and the existing and refurbishment they're all in the same in the same pile and I think it's a buyer's market I hope it's a buyer's market Chairman the other thing I want to speak about was the institutional design and the mode of implementation of this there's there's one thing blueprint of the capacity market design is a whole other thing about institutional frameworks that need to give effect to this and it's quite a complex quite a complex framework here we have obviously the government who has the responsibility for the public good and the secretary state whose ultimate political responsibility for security supply also it has been deemed it's not been formally found but that the capacity market intervention is a tax and spend measure and so it's a hypothecated voted expenditure so it has to be brought to the parliament each year to spend this much money on capacity providers and so the bill of rights means the parliament is the only one that can raise taxes and therefore government has an ongoing role in managing the public money that's associated with this and that's the role of government the delivery body we chose asked and we're very grateful to national grid who stepped in to do this they will continue their role as system operator naturally but they're also going to do the roles in relation to pre-qualification the roles in relation to the auction and the role in relation to monitoring the performance of the resources as the system stress events arise and so national grid has has taken on that role and there was a lot of discussion over the course of the design about potential conflicts of interest in that role and we've for that reason put in place a panel of technical experts to give extra scrutiny on their advice and also put some ring fences around the delivery role that national grid have there's a settlement company which is the the government owned company which takes responsibility for the public money and that company hires alexon which is a pre-existing entity in the market to calculate to do all the calculations associated with this and so there's a lot of money flowing through this entity and a lot of credit to be checked and a lot of calculations and reconciliation and a lot of detail associated with that and then off-gym obviously has the role of continuing to regulate the sector now in this institutional mode of implementation the way that we did this was picking activities for each and every one of these each and every one of these bodies and so should national grid do this should off-gym do that and what are the interfaces what are the conflicts how does it fit with their pre-existing roles and relationships so off-gym is the regulator of national grid so it isn't appropriate to usurp that relationship but anyway it's also to make sure that it builds on the synergies and expertise that are already there and our main issue here chairman was to make sure that we could build investor confidence around the scheme so our hope was that we could de-politicize this as much as possible to to sort of get a government department away from all this technicality and market design stuff and put it into the hands of the regulators who who are natural naturally naturally work in that sphere an independent sector regulator in fact we were constrained in our ability to do that by by the taxation of public money issues but we've devolved this as much as much as possible and we've given the rule book over to off-gym to to manage after this first auction so I'm nearly drawing to an end the last thing I wanted to talk about was governance and codification it is one thing to design a market is a whole other thing to write it down in the legal contracts and to put it in all the the legal documents that we had to face with including the primary primary legislation the regulations the codes and everything else and the most important thing that I tried to tell the stakeholders is this is not an event this is not a 2014 auction this is a continuous process for maybe the next decade and so I'm going to make this intervention now I'm going to make some errors in it but it's got to change for the second and third and fourth and it starts to evolve and it will stabilize after a number of years that's not a get out of jail card try to a very best but that that very thing I've said chills the investors to say you're going to change the scheme in the second and third and fourth year and so we've got to balance these two things and the existing system was based on all these acts that I mentioned the codes the licenses to go with it and self-governing arrangements between the industry parties this was a major spending scheme and we could not put it on a self-governing footing and so we came up with a new concept called the capacity market rules and regulations or in our for short and the regulations deal with the matters that are to do a government the rules deal with the matters that often can deal with an often can change those as time goes on and government can change the regulations as time goes on obviously coordinated together and obviously because this is not a contractual scheme this is a statutory scheme this would be unusual for investors to invest in a scheme that's statutory based and there was a lot of controversy around this during the design process and so what we came up with was obviously the normal controls that are on administrative law with regulators and governments changing rules that they must consult that they're held back by fear of judicial review. But in this case we've also added rules that Ofgem will have to achieve when they change the change the codes and they change the licenses so that they haven't got a completely blank sheet and those rules are set out in the regulations and the other thing we did was create a whole capacity market register which is often like the land register and what we've committed to is once we enter in your key commercial terms into this register they are fixed for the period of the contract or agreement and so the I leave you with a quote from a famous US jurist Roscoe Pound he said the law must be stable but never stand still and this is the case here we're trying to keep it stable but also allow it to adapt grow and change as time goes on the last thing I should say apart from market design institutional design implementation codification we also had changes to the existing licenses and codes to allow this market to sit in and the Secretary of State has laid in parliament the changes that are needed to those industry documents which are quite extensive and they gave rise to a complete implementation when parliament votes votes on this package of measures last thing I want to say is just to look to the future we have so far prioritized delaying in parliament of the regulations that deal with pre-qualification that deal with option and that deal with value for investors so an investor is assessing its bid there are other things that we need to lay and we were laying some of them already this summer which are the cost recovery mechanisms for suppliers so how do we actually recover the money associated with this we put commitments out to capacity providers we have to recover the money for the suppliers so we have a sister set of regulations to be laid imminently and then after after this first round is over we have new regulations to put in place to deal with issues like interconnectors how can interconnectors participate how can resources in other countries participate in the capacity but how could I accept the bid for the power plant in France for example and we have regulations that are going to deal with that consultation regulations going to deal with that for 2015 I can tell you that the European Commission were really interested in that as obviously as part of the internal energy market and this is a departure for that Chairman the last thing I wanted to say was to thank the department for allowing me to come to speak with you today and to thank my own my own boss Andy Shields for making it happen thank you very much for this