Embedded benefits set for reform

In the last week, Ofgem and National Grid have both published consultation documents that could potentially have enormous revenue implications for generators connected to distribution networks. These documents both concern “’embedded benefits’. National Grid’s consultation can be found on their website. Read Ofgem’s open letter here.

“‘Embedded benefits’ typically describes the costs avoided when generators connect to the distribution networks rather than the transmission network. There is no single definition, but it typically relates to Transmission Network Use of System charges (TNUoS), Balancing Service Use of System Charge (BSUoS) and costs of losses. This includes costs avoided by the generators themselves, as well as costs which are reduced for local suppliers.

The TNUoS demand charge is the biggest component of the embedded benefit. By entering into contracts with suppliers, embedded generators can help suppliers to reduce or avoid TNUoS demand charges by generating electricity during three “triad periods” each year. Suppliers will pay embedded generators for this service which is often known as Triad Avoidance.

The TNUoS demand charge is the focusof both National Grid and Ofgem’s recent publications. In particular, there is concern within the industry that part of this embedded benefit is not cost reflective, and could be distorting investment and operational decisions in the wider energy market. Part of the charge ““ the locational demand charge ““ is designed to reflect the cost of building new transmission capacity. The residual demand chargeis used by National Grid to recover revenue spent on things like depreciation, regulated return, direct and indirect operating costs and network rates. The residual demand charge is set to increase in the future, and the value of the embedded benefit will therefore increase alongside it.

Figure 1: The value of the embedded benefit is set to rise in the future as more generation connects to the distribution networks and the residual demand TNUoS tariff increase Projections from National Grid’s consultation document

However, National Grid and the other Transmission Owners (TOs) will still need to recover this revenue from other players. As well as distorting the market, this could give a significant unintended subsidyto embedded generation. Earlier this year, DECC set out their concern that embedded benefits were driving down prices in the Capacity Market, by giving small diesel and gas generators an artificial advantage, preventing more efficient transmission-connected capacity from being built.

CUSC modification proposalsCMP264 and CMP265 present two alternative options for addressing the embedded benefits issue. Both modifications would lead to a change to gross charging for some embedded generators, but there are differences (as set out in the table below):

In addition, the workgroup consultation document presents five alternative options, which could be progressed depending on consultation responses. Responses are required by 24th August 2016.

Ofgem’s open letter presents a higher level view of embedded benefits, but also targets the residual demand as an area of focus. Crucially, Ofgem has decided not to address these issues through a Significant Code Review, due to the urgent need to find a solution, although they do point to some other areas of work which they think will be important for targeted review. Ofgem’s view is that it may not be appropriate to grandfather current levels of embedded benefits for existing embedded generation. This could have potentially massive impacts on any generator that relies on triad avoidance revenue. Ofgem welcomes responses to their open letter by Friday 23rd September.

In the longer term, we expect further direction on charging from Ofgem, National Grid, and the new Department for Business, Energy and Industrial Strategy (BEIS) in the coming weeks and months. National Grid has recently started scoping out a wider review of transmission charging (as mentioned in this open letter from April), and held two industry events in Glasgow and London last month. A forthcoming joint Ofgem-BEIS call for evidence on a “‘Routemap to a Smart, Flexible Energy System’ should start to clarify some elements of network charging for energy storage, other elements of embedded benefit like BSUoS, and the allocation of sunk/fixed costs.

TNEI, in collaboration with Cambridge Economic Policy Associates, has been helping Ofgem to develop their thinking on a number of charging issues this year, including flexibility and embedded benefits. If you have any questions on network charging, please contact Gordon McFadzean.