Ofgem Slashes Benefits for Embedded Generators

A major industry announcement this week has cast further uncertainty into the world of small-scale power producers, as Ofgem has announced it is “minded to” change the Triad methodology for generators. This change will have a profound impact on the UK energy market in the coming years, with the generation make-up set to alter and a prolonged period of uncertainty; strangely however, the impact for the end consumer should be a positive one.

Embedded generation is the name for smaller-scale power producers which are connected at the distribution level rather than to National Grid’s high voltage network. It includes a large proportion of the renewables market, but also smaller gas-fired generation. At present these producers are paid Generator Triads for the capacity they provide to the network during the three winter peak demand periods; this is the opposite of the Demand Triads paid by end users who pay for what they demand of the system.

Ofgem’s ruling effectively states that this payment places these generators at a competitive advantage over large-scale transmission connected generation – the traditional large gas and coal-fired power stations that have always played a large role in the supply makeup. This is because embedded generators do not actually use the transmission system for which Triads pay, with their connection only at local level. To counter this unfair payment, Ofgem plans to slash payments to embedded generators from current levels of around £47.30/kW to £1.62/kW (a 96% drop) over the course of the coming three years, putting a major dent in the economics of installing generation capacity at distribution level.

Furthermore, the proposal contains no “grandfathering clause”; therefore this cut applies equally to capacity already installed as to new generation yet to be built. This means that new embedded power producers, who may have factored this payment into the lifespan of their plant, will now have to reconsider the economics over the longer term.

Ofgem argues that embedded generation brings benefit to the national network only equal to the costs that National Grid would otherwise incur from reinforcing the network, a cost it calculates at around £1.62/kW nationally; therefore any payments over and above this represent an unfair advantage and an excess cost to National Grid. Clearly this could have a major impact on the growth of embedded generation, an area of innovation and development into which the UK system was expected to develop in the coming years. This ruling however potentially alters the landscape again, providing considerable uncertainty for potential investors and undoubtedly favouring large, centralised producers who have traditionally monopolised the generation makeup of the country. Ofgem, for its part, does not believe this will impact security of supply.

For end users however the development is (perhaps counter-intuitively) positive. Due to the way suppliers calculate and pass through Triad charges, the drop in payments to generators by National Grid will see this element fall for customers. Basically, lower payments to generators will allow National Grid to cut charges to demand customers; this is because National Grid’s income is fixed by Ofgem and therefore the benefit of lower outgoings must be passed through to customers as a reduction in costs. It is currently unclear how large this reduction in Triad charges will be; however it is unlikely to be large enough to dis-incentivise Triad avoidance, and customers therefore should continue to try to reduce their demand in peak winter period to manage this cost.

Concerns for investors will be raised further however by the announcement that Ofgem will also be carrying out a Targeted Charging Review in early 2017, looking at further benefits received by these embedded generators; this will consider charges such a balancing costs, as well as costs for storage and “behind the meter” installations. This could lead to a Significant Code Review (effectively a legislative overhaul), highlighting the uncertain landscape for the UK power sector at present.

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