Is Ofgem causing more harm than good with its embedded benefits review?

Proposals to withdraw embedded benefits from small-scale distributed generators suggests a broader review of network charging is necessary. Tom Grimwood reports.

The current network charging arrangements give an “unfair advantage” to small-scale distributed generators, preventing a level playing with competitors.

It was on this basis that Ofgem began a review of embedded benefits in January last year. However, there have been warnings from experts, industry groups and developers that the proposed reforms amount to an overreaction. Utility Week has been told that, in trying to solve one problem, Ofgem may be creating several others.

The Connection and Use of System (CUSC) panel, which is responsible for reviewing code modifications, has been looking at two potential charges that would reduce or eliminate triad avoidance payments.

What are embedded benefits?

Embedded benefits refer to a series of favourable charging arrangements enjoyed by small-scale generators  (less than 100MW) connected to – or embedded within – distribution networks. 

They are not only exempt from paying transmission charges themselves but can also earn triad avoidance payments from suppliers for reducing their charges. They are able to do this because the power they sell is counted as net negative demand during the triad periods used to set the charges for half-hourly metered non-domestic customers. It is these payments which are the focus of the reforms being considered by Ofgem.

Transmission charges are split into locational charges, which reflect users’ impact on costs due investments in new capacity, and residual charges, which cover the sunk cost of existing assets. Ofgem estimates that the triad avoidance payments relating to the residual component – the lion’s share of the total – are worth about £45 a year for each kilowatt of capacity.

The first, proposed by Scottish Power, would get rid of both the locational and residual elements of triad avoidance payments for projects connecting after June 2017.

The second, put forward by EDF Energy, would remove payments relating to just the residual element of the payments and only for generators with capacity market contracts.

Cornwall Insights senior consultant Tom Edwards says removing these income streams would be a significant blow to those affected: “When you look at the revenue available to a distributed generator, especially one that’s built itself around peak power prices or flexibility, the triad can be something like 40 per cent of the business model.”

Almost 6GW of distributed generation won new-build contracts in the first three four-year-ahead (T-4) capacity market auctions – mainly gas and diesel peaking plants. If triad avoidance payments are removed, Edwards says there is a “significant risk” that a “bunch” of this capacity will not be built.

“We wouldn’t be surprised if people start taking their termination fee options in the capacity market rather than develop a plant that can’t make money.”

If this happens, he says the only solution will be to re-procure existing capacity through one-year-ahead (T-1) auctions, perhaps at a higher price, because alternative new capacity could not be procured and built in time.

“So, we’re going to pay some of the older power stations that missed out in the first round of the auction to stay around,” he says. “That could be plant like Fiddler’s Ferry or Eggborough – coal-fired power stations which the government ostensibly wants to get rid of… There’s not really much else we could do.”

Edwards says there could also be a “double whammy” as the overall capacity procured may have to be increased. The triad avoidance payments have been suppressing peak demand and so getting rid of them would reverse that.

Nevertheless, he does agree with Ofgem that there is an problem to be resolved. Triad avoidance payments are not only too high but growing steadily because of a feedback loop.

The costs avoided by suppliers still have to be recovered through transmission charges. As more and more distributed generation comes online, the residual charges increase and so does the reward for avoiding them. This in turn encourages even more distributed generation to be built.

On the other hand, he believes the proposals being considered go too far. Although the CUSC panel has looked at variations that are less drastic, the base modifications suggested by EDF and Scottish would reduce the value of the residual element of the triad avoidance payments to zero.

“While the system was not sustainable, these proposals have not properly reflected the value that embedded generators bring to the wider network”, he argues. National Grid estimates the true value of avoided network reinforcement to be just £1.65/kW. Cornwall puts the figure at £32.30/kW.

Ofgem plans to reach a position on embedded benefits in the first half of 2017 after consulting on a minded-to decision early in the year. It has dismissed calls for a significant code review, at least in the short term, because this would cause “considerable delay” to the reforms.

Although the regulator has legitimate concerns about the high and rising value of embedded benefits, it will have to be careful to avoid overshooting and being left with a capacity shortfall that could be costly to fill. Over the long run, the need for a more comprehensive examination of network charging is becoming ever more apparent.