Ofgem cuts payments to Embedded Generators

On 20th June, the UK energy regulator OFGEM announced a decision to cut the payments to some smaller embedded generators for producing electricity at peak times given their concern that the current level of payments is distorting the market, having cost around £370m in the last year.

What is Embedded Generation?

Embedded generators (otherwise known as Distributed Generators or Dispersed Generators) are power plants connected to the lower voltage distribution networks (DNOs) and are typically below 100MW capacity.

There has been a significant growth of Embedded Generation in the UK market as we have seen the continued growth of a more dynamic generator sector and a shift away from the historic model of larger centralised power stations connected to the main transmission network.

Larger and more prominent generators, such as large-scale gas, coal and nuclear, are not classified as Embedded as they are connected to the transmission network. A typical Embedded Generator will be smaller in scale and connected directly to the localised distribution network and will range in generation fuels from gas (small scale), diesel, CHP, biomass, solar and wind (not exhaustive).

There is around 30GW of Embedded Generation capacity connected to the localised DNOs. Roughly one third of this generation is made up of diesel, small-scale gas, CHP and biomass and the remainder from renewable sources.

Embedded Generation helps to circumvent the national transmission network as they do not transmit electricity over the network as its connected to the localised distribution networks. Therefore, electricity generated by Embedded Generators avoid transmission charges paid by larger generators and can be netted off transmission charges paid by customers in the area.

What are the changes?

Embedded generation can receive payments from suppliers for generating electricity during peak “Triad” periods (which in turn they receive a share of the benefit from the supplier), helping to reduce the overall strain on the network and help to support the balancing of the market. This is separate to the payments they receive for selling their electricity.

The current level of this payment is around £47/kW and it is forecast that this will increase to circa £70/kW over the next four years as more generators choose to connect to the distribution network. OFGEM’s view at this time is that the level of payment is distorting the wholesale and capacity markets and if action is not taken now this will continue to increase.

Therefore, OFGEM have approved CMP264 and CMP265, which are two modifications to change the way in which transmission charging arrangements are paid to Embedded Generators.

OFGEM have confirmed its intention to adopt the WACM4 modification, under which the portion of Triad avoidance payments relating to the TNUoS (Transmission Network Use of Systems) charge will be gradually reduced by a third each year over a three-year period. From 2018 through 2021 the price will gradually be reduced to a level of between £3/kW and £7/kW making for a more efficient system. This range is higher than the £2/kW which OFGEM had originally proposed.

Who is affected?

This change is largely going to affect diesel, small-gas, CHP and biomass generators who are more flexible in their generating hours and generally speaking are more likely to generate electricity during peak periods. As noted above this accounts for around one third of the UK’s 30GW Embedded Generation capacity. The remaining two-thirds (traditional renewable sources) are not likely to be impacted as they generally do not receive this payment and are not capable of maximising generating hours during specific time periods.

Triad payments represent considerable revenue for some generators. As such these changes are likely to have significant consequences on existing generation and planned generation dependent on how sensitive their pricing models are to this change.

While continuing to develop the UK’s long-term decarbonisation ambitions is clearly always going to involve change and evolution, this change is going to cause concern to those decentralised and flexible generators who might ultimately play a key role in keeping the grid balanced and stable. It is difficult at this time to take a firm view on how technology will react to this change but there is a risk that forthcoming projects may not be as economically viable where margins are tight or ROI periods are required to be shorter.

However, the decision today does not address the major fundamental issue, which is OFGEM’s approval for the significant increase in the cost of the transmission network from £943m in 2007 to £3.7bn in 2021. This poses a significant long-term risk to energy consumers through the application of non-energy costs.

Are energy consumers at risk?

This legislative change does not directly impact energy consumers and delivered energy bills as the TNUoS cost applicable to end-users is based on the overall UK demand and their specific demand during the three retrospectively identified triad periods.

For consumers, there are 2 areas of consideration:

  1. Consumers with on-site generation who export part (or all) of their generated electricity to the grid are likely to see a reduction in revenues. The triad avoidance benefit can often form up to 50% of the revenue from exported electricity and as such will affect those generation assets which are reliant on exporting power. This is separate to any incentives a consumer may have for increasing generation for on-site use without exporting.
  2. A decrease in the benefits available to distribution connected generation may prompt more technology companies to incentivise “behind-the-meter” generation which is connected inside a consumers site and as such would be used to offset consumer demand as opposed to generate to grid. This may help push through further improvements in the cost and application of on-site generation technologies such as battery storage unless OFGEM tackle these projects as well

Should any consumers operate (or plan to) self-generation assets which are reliant on exporting to the grid then we would suggest an immediate review of the business case taking into account the changes detailed within this document.

Beond has the expertise and capability to help our clients manage the all areas of risk and opportunity and believes in helping our clients achieve a total energy solution over and above just a traditional procurement service.