Ofgem will be reducing a specific payment that some small electricity generators receive for producing electricity at peak times.
The electricity comes from embedded generators which are power plants connected to the lower voltage distribution network. Smaller embedded generators (with less than 100MW capacity) can receive payments from suppliers for helping them to reduce their charges to use the transmission network. These payments are over and above the price these generators receive for selling their electricity.
Payouts to embedded generators cost consumers millions
The current level of this payment is around £47/kW (double the clearing price for the 2016 capacity market auction) and has cost consumers around £370m last year.
The payouts are predicted to rise over the next four years to £70/kW.
There is approximately 30GW of embedded generation capacity on the UK’s electricity distribution networks. Those most impacted by the reforms are generators that can control when they produce electricity including diesel and small gas, combined heat and power plants, and biomass generators, which together account for approximately one third of embedded generation.
Around two thirds of the total embedded generation capacity, mainly renewable generation (solar and wind farms), will not be affected to the same extent because generally they do not receive this payment.
Electricity payouts distorting markets
Ofgem’s view is that the level of the payment is distorting the wholesale and capacity markets and if no action is taken the distortion will escalate.
Ofgem has decided to accept an industry proposal to phase in a reduction in the payment to between £3/kW and £7/kW over three years from 2018-21. This is the estimated cost of investing in capacity at the grid supply points (the boundaries where the high voltage network meets the lower voltage distribution networks).
The payment that embedded generators would receive under the reforms reflects the avoided cost of investing in this capacity. This is because less electricity would have to flow across the boundaries as embedded generators are providing it to the lower voltage grids. National Grid estimates that this figure will be in the range of £3/kW-£7/kW when the proposals are implemented. The previous estimate was £2/kW.
Ofgem believes the reforms will make the energy system more efficient overall.
Ofgem chief executive Dermot Nolan said: “We are concerned that the current level of the payment is distorting the market and is set to increase further. Our role is to protect customers and make sure costs are kept as low as possible. That is why we are taking action by reducing this payment.”
The payment that some smaller embedded generators receive for producing electricity at peak times helps suppliers reduce the biggest element of electricity transmission charges.
Ofgem states: “There is a range of other benefits to embedded generators and these are unaffected by today’s decision. We have proposed a targeted charging review to consider these.
Ofgem ‘missing the point’
The Association for Decentralised Energy (ADE) believes the decision today “does not address the heart of the issue, which is Ofgem’s approval for the rapid rise in the cost of the transmission network from £943m in 2007 to £3.7bn in 2021”.
Director Tim Rotheray added: “We are disappointed that the much larger national benefits that small generators deliver by reducing use of transmission networks remain unexamined, and Ofgem’s new review must investigate how lowering use of the transmission network can save consumers money over the long term.”