Ofgem to phase in embedded benefit reductions over three years

It is consulting until 10 April on an industry proposal to reduce peak-time payments to smaller generators from the current level of around £45/kW to around £2kW over a three-year period, from 2018 to 2020. This could potentially save consumers up to £7 billion on their energy bills by 2034 without any material impact on security of supply, according to the regulator.

The consultation only covers planned reductions to the Transmission Network Use of System (TNUoS) demand residual payments, or 'triad' benefits, that embedded generators receive from suppliers to help them reduce the biggest element of the electricity transmission charges they face at periods of highest demand. Ofgem intends to begin a review of the full range of other, smaller payments made to embedded generators later this month.

Energy law expert Jeremy Chang of Pinsent Masons, the law firm behind Out-Law.com, said that any changes to the charging regime would have a "far reaching financial impact" on the energy industry.

"Tackling embedded benefits has always been about creating a level playing field," he said. "But while this agenda is laudable, the method in which you achieve this is crucial. After widespread concern that the rug would be ripped from under their feet, there will be a relief in some quarters that the charging exemptions will not be scrapped wholesale with a phasing out of benefits helping to soften the blow."

"Despite this helpful cushion, this won't be plain sailing for generators. It could mean some projects are rendered uneconomic when charges are imposed, with the potential for them to be shelved or scrapped completely. At a time when safeguarding the UK's security of supply is of paramount importance, this seems like a dangerous unintended consequence," he said.

'Embedded benefits' is a catch-all term for the payments that small generators receive in return for connecting to the distribution network, as well as the charges that these generators avoid paying. Ofgem began seeking industry views on the treatment of these payments last year, in response to concerns that the cost of the payments to a larger number of small generators was becoming unsustainable as well as inadvertently providing incentives that could affect plans to build or close much-needed larger generating plant.

Ofgem is minded to accept two proposed modifications to the Connection Use of System Code (CUSC), proposed by the industry in response to these concerns and to a public letter published by the regulator in July. It has proposed cutting the value of the benefit by around one third each year for three years from 2018, to reach £2/kW by 2020. The final figure has been calculated to reflect the cost Ofgem would otherwise have had to invest in additional capacity at grid supply points, where the high voltage network meets the lower voltage distribution networks.

Affected generators would now have to revisit their financial models in order to assess the full potential impact of the proposals, according to Jeremy Chang. Power purchase agreements would also need to be reviewed, "to see if any opportunities arise to recover revenue lost from the removal of triad benefits", he said.

"Furthermore, we could see energy benefit sharing arrangements being re-opened if Ofgem proposals shift the goalposts so that triad benefits aren't available any longer," he said.