Ofgem recently announced they will proceed with their plans to dramatically reduce ‘embedded benefits’ received by distributed generators from £45 per kW to £2 per kW, phased in over three years from 1 April 2018.

We wrote a blog on the decision when Ofgem announced this was what it was ‘minded to do’ back in March which considered some of the impacts of changes to the fiendishly complicated system of paying for use of the grid. Ofgem’s comments in their final decisions and detailed impact assessment provide some more revealing insight into the regulator’s views.

Big v little

The decision is a straightforward shift of value from smaller embedded generation to large centralised generation. Ofgem argues it is simply allocating system costs neutrally. However, at other times it acknowledges they are making “a principles based decision”. That principle seems to be that the regulator is more comfortable with large generation.

An example is the discussion of the impact on the companies planning to build ‘peaking’ generators that have Capacity Market contracts to provide reserve power when the system needs it. Several companies have complained the embedded benefits decision has undermined their business model and they may not proceed, choosing to default on their Capacity Market contract. Ofgem’s impact assessment accepts this will be the case and will have a significant price tag for the government (up to £625 million). The impact assessment then rather gives the game away when it makes hopeful references to the replacement to peaking plant being larger and more efficient generation. Such large generation is, of course, exactly what BEIS was aiming to incentivise with the Capacity Market.

Smoke filled rooms

This impression of favouring ‘big v little’ is reinforced by the strange process by which the proposals to change network charging come forward. Industry participants come up with proposals, which they then consider and vote on themselves, before making proposals to Ofgem. This process is dominated by large incumbents with obvious vested interests and is essentially impossible for anyone outside the inner sanctum to penetrate. In this case, the working group which reviewed the proposal, and at least represented a broader spectrum of industry views, was unable to reach a decision and so it was left to the CUSC Panel, dominated by large generators and their allies, to make the proposal to Ofgem.

Investor  beware

Perhaps the most significant impact on new players and new business models of the decision is that Ofgem is crystal clear that system costs can change at any time. In response to one complaint about the impact on existing projects Ofgem state bluntly this is a “potential investment risk that may have arisen from an over-reliance on revenue streams that are subject to change through an industry code change management process”. Talking to the market it seems clear Ofgem’s actions have, for example, dampened the level of interest in storage. If the rules of the game can be changed so easily that adds regulatory risk and puts up the cost of capital, leading ultimately to higher bills for the consumer. Already we have seen a cost increase in the 2016 Capacity Market, and the expectation is that the 2017 auction will be even more expensive.  

With all the talk of a shift to smart, flexible decentralised energy it is easy to forget that incumbents are not going to watch value being destroyed without putting up a fight and that policy makers and regulators tend to be influenced by large players they have worked with for many years. The decision to cut embedded benefits is a reminder that the empire still has weapons with which to fight back.

It is essential now that Ofgem and BEIS also consider the governance and transparency of energy regulations and policy making as part of a wider review of network charges.

Author: Merlin Hyman 

Contact: mhyman@regensw.co.uk