Out-Law News 2 min. read

‘Difficult balancing act’ ahead for Ofgem on treatment of embedded benefits, says expert


Energy market regulator Ofgem has a “difficult balancing act” on its hands as it concludes a review of network charging arrangements for small-scale distribution connected electricity generators, an expert has said.

The deadline for responses to an open letter on so-called ‘embedded benefits’, published by the regulator at the end of July, has now passed and industry will be keen to learn the outcome of Ofgem’s deliberations, according to energy law expert Jeremy Chang of Pinsent Masons, the law firm behind Out-Law.com.

Embedded benefits cover both payments that small generators receive in return for connecting to the distribution network and charges that these generators avoid paying. Ofgem is particularly concerned about specific payments that these generators receive from suppliers to help them reduce the biggest element of the electricity transmission charges they face at peak times, which they receive in addition to the price that they get for selling their electricity in the first place, according to the open letter.

“Generators connected to the high-voltage transmission network and larger generators connected to the lower voltage distribution network do not get these payments,” Ofgem explained when it published the open letter. “This puts them at a competitive disadvantage.”

The problem, according to Ofgem, is that some of the small generators connected to the distribution network who get these payments include some diesel, gas and combined heat and power plants. There are now far more of these generators connecting to the distribution networks than when the arrangements were first entered into, meaning that the cost to the regulator of providing these payments has increased significantly – and, more importantly, the payments may be providing incentives to small generators that could affect plans to build or close much-needed large generating plant.

“Ofgem’s review wasn’t a surprise, particularly when the government flagged how embedded benefits may contribute to giving diesel engines an unfair advantage in the capacity market in its consultation in March this year,” said energy law expert Jeremy Chang of Pinsent Masons.

“In its response to its March consultation, the then Department of Energy and Climate Change recognised that the treatment of embedded benefits was a complex issue and one that was hotly debated. Certainly, the impact of reducing the availability of embedded benefits risks potentially delaying or constraining investment in embedded generation projects at a time when the need for investment in generation capacity generally is increasingly. However, it is equally true to say that the success of diesel generation in the capacity market was an outcome which was not intended from a policy perspective,” he said.

“It is to be hoped that Ofgem’s decision to deal with reform of embedded benefits in a piecemeal way, through industry code modifications submitted to it for decision such as CMP264 and CMP265, will not undermine Ofgem’s ability to take a holistic view of the complexities and avoid creating further unintended consequences which will require course corrections in the future. In this context, Ofgem’s open letter to canvas opinion at an early stage was welcomed,” he said.

According to its open letter, Ofgem is particularly concerned about the Transmission Network Use of System (TNUoS) demand residual payments that certain sub-100MW generating capacity plant receive from suppliers during the so-called ‘triad’ demand periods, referring to the three half-hour periods each winter when electricity demand is at its highest in the UK. These payments are currently worth around £45/kW, and are set to increase to about £72/kW over the next four years. The payments are worth considerably more than those that will be paid out to those generators that bid to provide guaranteed capacity during the 2015 capacity market auction.

Ofgem has ruled out a full significant code review (SCR) looking at every aspect of embedded benefits, on the grounds that this would take too long, according to the open letter. Instead, it expects to be able to take immediate action through proposed modifications to the industry codes. CMP264 aims to stop any new embedded generation connected after 30 June 2017 from receiving demand residual payments, while CMP265 would prevent any embedded generation with capacity market agreements from receiving any demand residual payments from 1 April 2020 onwards.

The regulator intends to consult on some other aspects of embedded benefits and related matters later this autumn.

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