Embedded benefit review

Both National Grid and Ofgem have recently (seemingly independently) announced their intention to review the current embedded benefit arrangements in place for distributed-connected generators (DGs) in the UK, which arise when generators are connected to the distribution network rather than transmission network.

In March 2016 DECC announced Ofgem's plans to review whether it would be in consumers' interests to change the charging arrangements for DGs; they plan to set out their conclusions and next steps this summer. In April, National Grid (Grid) revealed its plans to revisit a review of embedded benefits (previously begun in April 2014), asserting their view that the real value of benefits received by avoiding Balancing Services Use of System (BSUoS) and Transmission Network Use of System (TNUoS) charges, and transmission losses were a third of what they were stated to be in the market.

Reasons for review

The catalyst for the analyses stems from the government's Capacity Market Review (CMR). To date, the Capacity Market (CM) has seen two auctions in which relatively little new long-term gas-fired capacity was secured. This type of capacity, which typically would be connected to the transmission system has been losing out to DGs.  Some market participants are now alleging that DGs have been receiving an unfair advantage over gas-fired power stations due to their ability to be price competitively based on their ability to also participate in the short term operating reserve market (STOR), exemptions from certain policies (e.g. the EU Emissions trading scheme) and avoidance of charges (such as TNUoS and BSUoS). Reform is therefore considered necessary in order to incentivise new gas build: the government's answer to security of supply through to the mid- 2020s.

Although a formal consultation has not yet been announced (Ofgem have not yet decided whether it will be necessary) the issue is being given a lot of attention in the renewables sphere, given the potential impact that the removal of these benefits could have for renewable DGs. In the context of an industry that is already suffering from a loss of investor confidence due to recent government cuts, the proposal would almost certainly affect the sector disproportionately.

Impact on operational and future projects

An embedded generator avoids the need to use the transmission network because they connect directly to the distribution network and locate close to the demand. This presents operational savings for both Grid and the generator themselves. For this reason, they have historically not been charged transmission network use of system charges. Generally the benefits (and avoidance of charges) are shared between the supplier and the generator, and the allocation of these is negotiated through PPAs. In turn, these benefits can be passed through as savings to the consumer.

An alteration to the way in which embedded benefits are viewed would likely impact both current and future PPAs which include these benefits. Depending on the detail of the contractual drafting and negotiations; going forwards, some benefits may need to be separated out or definitions tweaked to account for any changes. There is also concern that the balance of risk and reward of contracts will be disrupted if charging is altered, leading to change- in- law clauses being triggered as parties attempt to rebalance the contract. At best, there will be a cost to both suppliers and generators to re-examine their current arrangements. At worst, these changes could affect the financial viability of operating and future projects, with smaller generators being most disadvantaged the most by any increase in operational costs.

An ill thought-through review?

The problem, from the government's perspective, is that the CM is not operating as they had intended or expected. Amber Rudd has made it clear that in the government's opinion, the future of energy security in the UK lies with gas; however, the CM has not leant itself to new CCGT stations being built. The CM has allegedly caused an unfair advantage to "dirty" diesel generators, sparking the benefits review. The problem with this review is that it is in danger of leading to a short-sighted and ill thought-through intervention to an energy market which is already volatile. The main 'culprit' or issue that needs redressing is the ability of diesel fired generators to outbid other competitors in the CM; but any steps taken to redress this imbalance through changing embedded benefits will also markedly affect the "clean" renewables industry. Even an energy system based on CCGT needs the flexibility of DG to respond to fluctuating energy demand; dis-incentivising DG affects both the ability of the system to cope in the new energy world and the carbon benefits that renewable generators are achieving.