Embedded benefits update

United Kingdom

Embedded benefits have been an important source of revenue for distribution connected generators. The regulator, Ofgem, forecasts that the value of these benefits will rise substantially to a level that may not properly reflect the value of distributed generation to the wider system. Accordingly, on Friday 2 December, Ofgem published an update on their review of embedded benefits (the “Update”). The Update follows on from Ofgem’s open letter issued in July (the “July Letter”) (as summarised here), which set out the regulator’s concerns in relation to the impact that certain embedded benefits were having on the wider electricity market, particularly Transmission Network Use of System (“TNUoS”) Demand Residual.

The Update confirms:

  • that a reduction in the TNUoS Demand Residual (and therefore in the value of embedded benefits) is highly likely to result from the review; and
  • the timetable for Ofgem’s consideration of the Connection and Use of System Code (“CUSC”) Final Modification Report and implementing its decision.

Ofgem will publish a “minded to” decision and draft Impact Assessment in relation to the Final Modification Report for consultation in early 2017, with a final decision anticipated in the first half of the year. Ofgem aims for the modifications to be implemented by April 2018, with any changes to payments to be implemented no later than 2020/21.

TNUoS Demand Residual

Smaller-scale distribution connected generation receive a range of embedded benefits, which were designed to reflect the value that such generation being embedded in the distribution network provides to the wider electricity system. The TNUoS Demand Residual element of embedded benefits was Ofgem’s particular focus in the July Letter, which is forecast to increase substantially up to £72/kW by 2020/21. The July Letter set out Ofgem’s concerns about the current arrangements, including that the approach to TNUoS Demand Residual is distorting investment decisions, leading to inefficient outcomes and does not reflect the actual benefit provided to the wider system, increasing costs to the consumer. In light of the evidence received from industry participants in response to the July Letter, Ofgem still considers the TNUoS Demand Residual to be a major issue and that early action is needed to reduce the value of TNUoS Demand Residual by way of the current CUSC modifications.

CUSC modifications

Ofgem stated in the July Letter that it would consider the ongoing CUSC modification proposals in relation to TNUoS Demand Residual payments. The two modifications are:

  • CMP264, which aimed to stop any new embedded generation connected after 30 June 2017 from receiving the TNUoS Demand Residual payment until Ofgem has completed its consideration of the issue and implemented any resulting changes; and
  • CMP265, which would prevent any embedded generation with Capacity Market agreements from receiving any TNUoS Demand Residual payment from 1 April 2020 onwards.

The CUSC Modification Panel has recently submitted its Final Modification Report in relation to the proposals, which also considers the 23 CUSC Workgroup Alternatives (known as “WACMs”). The CUSC Panel did not agree by a majority vote on a single modification, however, the CUSC Panel’s preferences will be taken into consideration by Ofgem in making its decision.

Potential impact on Capacity Market

Whilst Ofgem has not yet considered the Final Modification Report, the Update suggests:

it would be prudent for participants in the [Capacity Market] auction to assume that by no later than 2020, TNUoS demand residual payments to [embedded generation] could be as low as the most significant reduction proposed in the code modifications and WACMs under consideration.”

In making its decision, Ofgem is required to consider the proposed modifications against the current arrangements and decide which modification best facilitates the CUSC objectives. As a result, whilst the industry widely expects a reduction in the TNUoS Demand Residual payment, the exact application of the any final Ofgem decision (for example, whether it would apply to new projects only) remains unclear.

Responses and wider network charging review

There were 145 responses to the July Letter (see here). Whilst a “large number” were supportive of the concerns set out in the July Letter, many respondents stated that a wider holistic review of charging by way of a Significant Code Review should be undertaken. However, Ofgem’s view is that postponing a decision on the Final Modification Report pending such a review could cause considerable delay, leading to investor uncertainty and market distortion. In addition, some of the responses included alternative or complementary proposals from industry, including:

  • increasing the number of “Triad” periods;
  • reviewing the Demand TNUoS charging regime itself; and
  • considering TNUoS Generation Residual payments, particularly when/if these become negative due to the €2.5/MWh cap on overall generation TNUoS charges.

Ofgem will set out its initial thinking on the wider reform of the regulatory and market arrangements governing the energy system in its draft Forward Work Programme later in December (the “Wider Review”). This should include consideration of other elements of embedded benefits and the treatment of sunk and fixed costs, including for storage, behind the meter and private wire generation. However, the Wider Review is anticipated to take “at least two years to complete”.

Some respondents voiced their fears of unintended consequences that any “piecemeal” CUSC modification may have, as well as the impact on security of supply and investor certainty. The Update indicates that some of these issues will be considered in one or all of:

  • Ofgem’s CUSC decision Impact Assessment;
  • the Wider Review; and/or
  • the Call for Evidence on a Smart, Flexible Energy System (as summarised here).