Ofgem has published its ‘minded to’ decision (together with an Impact Assessment) to accept an industry proposal to reduce significantly the payments that certain embedded generators receive for producing electricity at times of highest demand.

In summary and subject to a consultation closing 10 April 2017, the regulator proposes:

  • to reduce TNUoS Demand Residual (known as Triad) payments from the current level of around £45/kW to around £2/kW;
  • implement this by way of a phased reduction over three years from April 2018 to 2020; and
  • no grandfathering of the existing level of payments for operational embedded generation.

Embedded Benefits

Embedded benefits are the payments from suppliers, along with exemptions from other charges, that smaller (sub-100MW) generators benefit from, which were originally designed to reflect the value which small-scale distribution connected generation provides to the wider electricity network. The specific TNUoS Demand Residual payments are made by suppliers to embedded generators for providing electricity during ‘Triads’ (the three half-hour settlement periods each winter when electricity demand in Great Britain is highest, separated by 10 clear days).

Wednesday’s announcement by Ofgem follows the publishing of an open letter (summarised here) in July 2016 in which it highlighted its concerns about the impact that certain embedded benefits were having on the wider electricity market, along with an update (summarised here) on the review of such benefits in December. The regulator received two proposals from members of the CUSC Panel that attempted to address these distortions, with a further 23 modifications to the proposals being proposed during the workgroup process involving the wider industry (such modifications known as WACMs, or workgroup alternative CUSC modifications). Ofgem now proposes to direct that one such modification, WACM4, is made, under which the TNUoS Demand Residual payments will be gradually reduced by a third each year over a three-year period, starting in April 2018.

Impact assessment

In the impact assessment that accompanies the announcement, Ofgem contends that the current system results in a transfer of around £350m/year from consumers to smaller embedded generation, a figure that could reach £650m/year by 2021. Furthermore, it is claimed that TNUoS Demand Residual payments to these generators creates a distorting effect on other markets such as the capacity market, wholesale and ancillary services markets, by disproportionately incentivising such generators.

Ofgem cites evidence that smaller embedded generators can simply offset the need for reinforcement which arises from an increase in demand at each Grid Supply Point (“GSP”), being the point at which the transmission and distribution networks meet), meaning that the payments made do not necessarily reflect the savings that these generators bring to the system. The lower TNUoS Demand Residual value of £2/kW is said to reflect the estimated cost of investing in extra capacity at GSPs, which the suppliers avoid by virtue of these payments.

During the three year transitional phase, Ofgem intends to conduct its Targeted Charging Review (“TCR”), which will examine other areas of the charging regime. It was considered that reviewing TDR payments in a significant code review (a proposal favoured by some stakeholders), would have led to at least two further years of “escalating distortive payments” and “distortion to CM auctions”. At the same time, the regulator argued that the model of phased transition under the recommended proposal will prevent a ‘cliff-edge’ scenario and sudden behaviour change among the relevant industry participants, which may improve forecasting and security of supply and allow existing generators and the wider industry to adapt to the reform. Crucially, WACM4 does not propose grandfathering existing embedded generators. This is a continuation of the position which Ofgem had set out in its open letter in July. In the impact assessment, Ofgem highlights the potential negative impacts of grandfathering on competition, along with the additional administrative efforts that would be required to change the charging arrangements for exempted users if any changes were delayed for up to another 15 years.

Next steps

The consultation closes on the 10th April 2017 before a final decision is made by Ofgem in May this year, at which point it can decide to accept, reject or send the modifications back, for example if it feels that further analysis needs to be carried out in the workgroup process. If the proposal is accepted, Ofgem has stated that it believes the three-year implementation should start from the next charging year, meaning the payments would be gradually reduced from April 2018.

Stakeholder views can be submitted beneath the relevant announcement on Ofgem’s website.

Comment

The announcement to reduce sharply the embedded benefit payments will in itself come as no great surprise to the industry, given the direction of travel from the regulator in this area both before and after its initial open letter in July 2016, and its statement of intent to review charging methodologies in light of the rapidly transforming energy market. However, the extent of the cuts to the payments can be said to be somewhat more unexpected, given that they represent a reduction of over 95% from current levels.

Although the proposals are still subject to consultation, it is clear that Ofgem has taken a firm position in this controversial area in the face of criticism from sections of the industry, including some energy intensive manufacturers who argue that their energy costs could increase by millions of pounds as a result.