Ofgem warned over ‘rushed changes’ to embedded benefits

Ofgem has been warned that “rushed changes” to so-called embedded benefits could have significant unintended consequences, reducing security of supply and pushing up costs to consumers.

The regulator needs to examine network charging arrangements in an “orderly and holistic” manner rather than enacting “piecemeal changes”, Cornwall Energy has said in a new report.

“We have significant concerns that the current process will result in ill-considered changes that could have wide-ranging unintended consequences,” remarked Cornwall Energy chairman Nigel Cornwall.

“Many small-scale generators of less than 100MW depend on triad benefit payments. Arbitrarily reducing them in response to governmental pressure will cause significant customer detriment. Over the short-term, there will be reduced security of supply, and over the longer-term capacity market prices and the costs of balancing the electricity system could increase significantly.”

In January, Ofgem launched a review into the financial advantages enjoyed by small-scale generators connected to distribution networks after diesel engines secured the lion’s share of new-build contracts in the first two capacity market auctions. These embedded benefits include an exemption from the Transmission Network Use of Service (TNUoS) charges levied by National Grid and triad avoidance payments.

TNUoS charges for half-hourly metered non-domestic customers are determined by users’ load on the network during the three half hour periods each year separated by at least ten days when demand across Great Britain is highest – known as the triads. The power produced by distributed generators with a capacity of less than 100MW is treated as net negative demand during these periods. They can therefore collect triad avoidance payments from suppliers for reducing their charges.

In open letter in July, Ofgem said it was looking at two possible changes to the Connection and Use of System Code to prevent them from being over-rewarded.

TNUoS charges are made up of two parts: a locational element that reflects users’ impact on costs due to investments in new capacity and a residual element that covers the sunk costs of the existing network.

The first option would prevent embedded generators from receiving triad avoidance payments relating to both the residual and locational elements of the TNUoS charges, starting in 2017.

The second would only prevent embedded generators from receiving triad avoidance payments relating to the residual element of the charges, and only if they have a capacity market contract. It wouldn’t come into effect until 2020.

Cornwall Energy said introducing these changes on their own could have major unintended consequences, including “much greater levels of distortion than currently perceived” in the capacity market.

Pushing large volumes of distributed generation out of the system would harm flexibility and the security of supply, and would damage the confidence of investors who have already spent “many billions of pounds” on such generation. The clearing price of the capacity auction would rise, adding to the cost to consumers.

Ofgem said in its July letter it will not carry out a significant code review as it would take too long to resolve the distortion in the capacity market, which it said is large and growing.

However, Cornwall Energy said there are others distortions arising from the current network charging regime and wider market arrangements that need to be examined too. It said when considered as a whole the current arrangements to “do not unduly advantage smaller generation over transmission-connected generation” and there are many distortions which “favour larger players”.

The market intelligence firm urged Ofgem to conduct a significant code review to “properly unpack these issues and open the way for enduring change that is fair and sustainable”. The regulator should consider the incentives available to both to both distribution-connected and transmission-connected generation: “Otherwise it risks embedding further market distortions”.

Cornwall Energy called for a transitional arrangement to be put in place whilst the regulator comes up a long term solution. It suggested a cap on triad avoidance payments relating to the residual component of TNUoS charges.

“In 2011 Ofgem said it would take an in-depth look at the complex issues surrounding distribution-connected generation but it has so far failed to do so. Instead it is seeking change but is focussing on a single market distortion,” said Cornwall.

“Our report tries to set out the commercial arrangements surrounding embedded generation and the different incentives and costs which apply to it. We see a much more complex and potentially dangerous position than Ofgem from rushed changes.”