Select Committee on Environmental Audit Minutes of Evidence

Memorandum from the Office of Gas and Electricity Markets (OFGEM)

  The Environmental Audit Committee, in requesting a memorandum from OFGEM, posed the following questions:


  1.   To what extent does Ofgem have a duty to help the Government meet the sustainable development and environmental targets it sets (eg for renewable energy)?

  2.   Ofgem's primary duty is to safeguard the interests of customers, including future generations of customers. To what extent is the concept of sustainable development intrinsic to this duty? Is there scope for interpreting it in a manner which gives increased weight to environmental objectives?

  3.   A key recommendation of the PIU Energy Review is that, where trade-offs have to be made, priority should be given to environmental objectives, and that the DTI's energy objective should be redrafted to reflect this priority. How does Ofgem see its future role in the light of these recommendations? What impact, if any, would such a change in emphasis have on Ofgem?

  4.   Are there any practical steps which Ofgem can take now—within the context of its existing statutory duties—to give effect to the changed balance recommended by the PIU report?

  5.   The PIU Energy Review suggested that the draft environmental guidance to Ofgem should be strengthened. Are there any specific functional areas where Ofgem would find it helpful to have more specific guidance?


  6.   Has Ofgem updated its analysis of the effects of NETA on smaller and intermittent generators since the publication of its August 2001 report? If so, what are the results of this work?

  7.   What changes have been made in NETA since its introduction in March 2001 in order to ameliorate its impact on smaller and intermittent generators? [A brief and simple explanation of the nature and objective of each change would be helpful.]

  8.   What is Ofgem's latest assessment of the extent to which consolidation services for smaller generators are available? Does Ofgem still believe that consolidation can provide a significant contribution?

  9.   The PIU report states: "There are sufficient grounds to recommend that Ofgem develops transitional arrangements which by-pass the particular difficulties imposed by the current electricity trading arrangements. Measures are underway which may help small generators. Transitional arrangements should be developed in parallel to be ready to be implemented by January 2003 in case the current measures are unsuccessful in helping small generators." Given the deadline suggested, what action is Ofgem taking in response to this recommendation?


  10.   The PIU report stated: "A joint DTI/DETR/Ofgem Report of the Embedded Generation Working Group (EGWG) looked at this problem and explained why the DNOs do not have an economic interest in connecting embedded generation. It made a number of recommendations about how to develop a new approach to designing and operating the network. These recommendations should be implemented as soon as possible. Unless this occurs, distributed generation will continue to have problems in connecting to the grid. Changes may, however, have to wait until the 2005 Distribution Price Control Review. But any further delay would put the 2010 renewables and CHP targets in jeopardy." In the light of the urgency accorded to this issue by the PIU, what progress has there been against the timetable set out in the Embedded Generation Working Group report?

  11.   What scope is there for implementing some changes immediately in order to encourage the connection of embedded generation? To what extent have you already taken action in this area?

  12.   What are the main barriers which currently prevent the connection of micro-CHP and PV systems to local networks? What steps are you taking to address these?


  13.   Have you carried out any monitoring of the environmental impacts of the introduction of NETA in terms of fuel type (coal, gas, oil etc) and in terms of greenhouse gas emissions? If so, what do the results show?

Response from OFGEM



Statutory framework (Q1)

  1.  The main powers and duties of the Authority are contained in the Gas Act 1986 and the Electricity Act 1989, each as recently amended by the Utilities Act 2000. In this note, "The Authority" and "Ofgem" are used interchangeably. Ofgem is the executive arm, which acts under the direction of the Authority.

  2.  The Utilities Act introduced a new principal objective and new secondary duties into the Gas and Electricity Acts. Ofgem's duty is to carry out its functions in the manner best calculated to further the principal objective, which is to protect the interests of consumers, including future consumers, wherever appropriate by promoting effective competition.

  3.  In carrying out this objective Ofgem must also have regard to:

    —  the need to ensure that all reasonable demands for electricity are met and, so far as is economical, all reasonable demands for gas are met;

    —  the need to secure that licence holders are able to finance their obligations;

    —  the interests of individuals who are disabled or chronically sick, of pensionable age, living on low incomes, or residing in rural areas; and

    —  the interests of consumers in relation to gas (under the Electricity Act) or electricity (under the Gas Act) and any interests of consumers in relation to telecommunications, water or sewerage services which may be affected by the carrying out of Ofgem's functions.

  4.  Ofgem is also required to carry out its functions in the manner that it considers best calculated:

    —  to promote efficiency and economy;

    —  to protect the public from dangers; and

    —  to secure a diverse and viable long-term energy supply.

  5.  In carrying out its functions Ofgem must have regard to the effect on the environment of activities connected with the generation, transmission, distribution or supply of electricity, and the conveyance of gas through pipes.

  6.  Finally, Ofgem is required to have regard to social and environmental guidance to be issued from time to time by the Secretary of State. The Secretary of State is required under the legislation to consult Ofgem and others concerning this guidance. No such guidance has been issued, although the Secretary of State has consulted on a draft.

  7.  For each decision of the Authority, it is necessary to weigh each element of the general duties in the light of relevant circumstances, and then consider how best to fulfil the principal objective. This necessarily involves balancing secondary objectives.

Ofgem's role and duties in relation to environmental matters (Q2)

  8.  Ofgem's principal objective is to protect the interests of consumers, present and future. In carrying out its functions, therefore, achieving this objective must be the main consideration. There is no scope for altering this, since it is clearly set out in the Gas Act 1986 and the Electricity Act 1989 (the Acts), by which Ofgem is bound.

  9.  The Acts require Ofgem to carry out its functions in the manner best calculated to promote efficiency and economy, and to secure a diverse and viable long-term energy supply. These qualifications clearly have environmental relevance, and are taken into account—with other relevant factors—in deciding the best way to protect the interests of consumers. (The full set of duties is set out above, in paragraphs 2 to 6, and illustrated diagrammatically in a factsheet about Ofgem's Environmental Action Plan, which is attached as an annex to this memorandum.)

  10.  In addition, the Acts require Ofgem to have regard to the environmental impacts of its activities and of those it regulates, and to the contents of any social and environmental guidance which the Secretary of State may issue. Therefore it is important to stress that environmental considerations are taken into account in Ofgem's policy-making process. The current project approval process requires a series of hurdles to be satisfied before policies can be approved:

    —  consistency with Ofgem's statutory duties;

    —  compliance with Ofgem's plan and budget;

    —  value for money for consumers, including disabled and chronically sick, and those of pensionable age, those on low incomes and residing in rural areas;

    —  likely environmental impact; and

    —  likely impact on Ofgem's reputation.

  11.  Ofgem has also developed a set of environmental principles for taking forward its work within the context of its statutory duties. They cover environmental sensitivity, coherence, the role of Ministers and other regulators, and dealing with market imperfections. These are set out in full below, in paragraph 20.

  12.  Ofgem considers that its policy-making process correctly reflects the specific duties set out in the Acts. There is no flexibility for Ofgem to alter the hierarchy of duties by which it is bound.

  13.  Ofgem has executive responsibility to administer certain elements of the Government's Climate Change Programme relating to renewables, energy efficiency and CHP. In these areas, Ofgem seeks to administer the Government's programmes in the most effective and efficient manner so as to keep the costs to a minimum. Details of these are set out in full below, in paragraph 22.

Social and Environmental Guidance (Q5)

  14.  A draft of the social and environmental guidance was issued in May 2001 for consultation. No guidance has yet been issued. The aim of the guidance is to ensure that Ofgem takes into account the Government's wider social and environment goals in its decision-making process:

    "In this way, the Authority can make a contribution, appropriate to its functions and duties, towards the wider social and environmental objectives of the Government, without compromising the principle of arm's length regulation."

  15.  The guidance does not issue specific instructions to Ofgem. It is designed to remain current for the next five years or so. Although Ofgem has a responsibility to have regard to the guidance, the draft guidance makes it clear that:

    "Where the Government wishes to implement social or environmental measures which would have significant financial implications for consumers or for the regulated companies, these would be implemented by means of a specific legal provision".

  16.  The environmental policies specifically referred to in the guidance include energy efficiency, sustainable development and the particular targets for emissions reductions, renewables and CHP that are described in the UK's Climate Change Programme.

  17.  The Acts make it clear that the guidance will be advisory in nature, and will not contain specific instructions for Ofgem. Ofgem must "have regard to" its contents, and weigh them up once it has weighed up each element in its general duties in the light of relevant circumstances and applied them to the principal objective. Therefore it would not seem appropriate for the guidance to contain detailed instructions, many of which Ofgem would not ultimately be in a position to implement. Rather than listing specific outcomes more narrowly, it might be possible for the guidance to define more precisely what is meant by "significant" financial implications.

The PIU Energy Review (Q3-4)

  18.  The PIU Energy Review, published in February, raises important issues for energy customers, with whom Ofgem is primarily concerned, as well as for wider environmental objectives. We intend to take a full and constructive part in the debate that will follow publication, in particular the Government's planned consultation and White Paper.

  19.  But it is important to recognise that, as the Prime Minister's foreword states, the PIU review is a report to Government. It is not Government policy. Clearly, Ofgem may need to adjust its approach in the future to take account of any new duties or guidance that the Government may introduce. The way in which its role might change in future is dependent on any specific changes that are made to its duties or to the guidance.

Ofgem's Environmental Action Plan (Q3)

  20.  Ofgem has set out its policies in relation to the environment in its Environmental Action Plan, published in August 2001. The principles which underpin the plan are:

    (i)   Environmental sensitivity

      Ofgem, while principally an economic regulator, is sensitive to the environmental effects of its actions and of the industries that it regulates.

    (ii)   Coherence

      Ofgem will treat environmental issues coherently across the range of its decision-making. Its policies will seek to maximise synergy between its economic, environmental and social objectives, and to ensure that its activities do not cause unintended environmental harm.

    (iii)  Role of Ministers and environmental regulators

      Ofgem will look to Ministers and other government bodies with direct environmental responsibilities to take the lead on environmental policies where action would have significant financial implications. When called on to do so, and where it is compatible with its statutory duties, Ofgem will implement these policies in the most efficient manner.

    (iv)  Market imperfections

      Ofgem will seek to identify market imperfections that cause environmental harm. It will work to reduce or eliminate those that lie within its sphere of influence, and alert those responsible for environmental regulation to those issues that fall outside Ofgem's scope.

  21.  In accordance with these principles, Ofgem then identified the following priorities for action:

    —  further work on the price controls of transmission and distribution systems to see whether additional incentives are justified to reduce gas and electricity losses;

    —  a review of the treatment of embedded generation, where Ofgem needs to ensure that the system costs to be met by embedded generators are appropriate, and also that system integrity is maintained if there is a substantial increase in embedded generators;

    —  an investigation of whether, within the structure of efficient energy trading which the New Electricity Trading Arrangements (NETA) promotes, there is a case for further facilitation of renewables or Combined Heat and Power (CHP), and if so what are the most effective mechanisms to achieve this; and

    —  further encouragement of a system of NOX emissions trading, as an efficient means of encouraging compliance with environmental standards.

  22.  Also in accordance with these principles, Ofgem said that it would continue to carry out its executive functions relating to the environment, including:

    —  the administration of the exemption for renewables from the Government's Climate Change Levy and the administration of the Government's Renewables Obligation;

    —  the administration of the Energy Efficiency Commitment, where the overall framework will be set by Government; and

    —  the continuing survey of the CHP generating sector, to assist Government in its policy of promoting CHP.

Present position

  23.  Ofgem believes that these principles, and the actions derived from them, represent an appropriate response to the duties and powers placed upon the Authority. This is something which the Authority continues to review in the light of comments made to it, for example in the course of the consultations which have taken place on Ofgem's plan for 2002-03 and beyond.

NETA (Q6-9)

Overview (Q6)

  24.  The first year of NETA has shown the benefits that result from the introduction of more efficient and competitive trading arrangements. The new trading arrangements, in combination with other factors, have led to significant reductions in wholesale prices to the benefit of all customers. Generators, including CHP and renewables, have received lower prices. The costs of balancing the system have also fallen as a result of the National Grid Company responding to its incentives as system operator and greater competition in the provision of balancing services. At the same time, emerging market players such as power exchanges, brokers, traders and price reporters have created liquidity and price transparency enabling market access for a wide range of generators and demand side participants.

  25.  Ofgem is currently preparing a review of the first year of NETA that will include a chapter considering the position of smaller and intermittent generators that follows on from the report produced in August 2001.

Smaller and intermittent generators, including consolidation services (Q7-8)

  26.  However, in advance of this report, there are a number of general comments that can be made concerning the evolving position of smaller and intermittent generators:

    (i)   there have been a number of general modifications to imbalance prices that have had the effect of reducing the spread between top-up and spill prices and hence have benefited smaller and intermittent generators along with all other market participants. The result of these modifications has been that the spread between imbalance prices, which averaged over 69 /MWh in April 2001, has fallen to under 14 /MWh during March 2002. In addition, a report on modification P12, which proposes that gate closure should be reduced to one hour with effect from 2 July 2002, was considered by the Balancing and Settlement Code Panel on 14 March 2002. Ofgem has already indicated publicly that a shorter gate closure should have a significant effect on helping all participants to manage the risk of exposure to imbalance prices under NETA and improve short term liquidity;

    (ii)   the Authority has approved two modifications that are considered particularly beneficial for smaller and intermittent generators. The first modification was concerned with the definition of a "Trading Unit". Supply and demand grouped together within a Trading Unit can effectively net off their metered volumes and thus capture embedded benefits. The modification expands the definition of Trading Units and makes it easier for smaller generators to contract in a way that can realise embedded benefits for their entire output. The second modification was directly concerned with consolidation options and sought to provide greater flexibility for embedded generators to sell their output. Specifically, it enables such generators to split their output into predictable and unpredictable portions and sell each portion separately without recourse to the rigours of the central notification system; and

    (iii)  Ofgem set up the Consolidation Working Group, which has produced a report setting out potential ways to enable smaller generators to sell the electricity they produce with greater flexibility. Ofgem believes that consolidation services are, and will continue to be, of significant assistance to smaller and intermittent generators. However, there are concerns over the competitiveness of some of the purchase contracts being offered in this specialised market. The DTI and Ofgem are working together to examine further the issues surrounding the arrangements for embedded benefits and whether it would be justified to separate them from the tradable energy.

PIU report and transitional arrangements

  27.  Ofgem's approach to transitional arrangements will be determined by its legal powers. Ofgem may not propose modifications to the Balancing and Settlement Code (BSC). Most of the seventy-six BSC modifications proposed to date have been put forward by parties to the BSC, and the remainder have been proposed by the BSC Panel. Where Ofgem considers that a proposal better facilitates the achievement of the applicable Code objectives, having regard to its duties under the Act, Ofgem directs the change to be made.


Note: Embedded Generation is now referred to as Distributed Generation.

Actions in response to EGWG report, including work on connections (Q10-11)

  28.  Ofgem recognises the importance of embedded generation to the achievement of the Government's environmental goals and the urgency with which the issues must be tackled if the targets are to be achieved. We have put significant resource into working with interested parties to progress the issues. Our objective is a fair and transparent regime for embedded generation.

  29.  Following the DTI's November 1999 consultation paper on Network Access Management Issues, a joint government/industry working group (the Embedded Generation Working Group—EGWG) was established to consider technical, charging and information issues relevant to the likely increase in distributed generation, as well as longer-term questions of distribution network design and active network management.

  30.  On 12 January 2001, DTI published EGWG's findings. Its two main recommendations were that:

    —  Ofgem should review the structure of regulatory incentives on Distribution Network Operators (DNO's) in light of the new statutory duty on DNO's to facilitate competition; and that

    —  a group should be established under Government leadership to co-ordinate and take forward the implementation of EGWG's recommendations for the longer term.

  In response to the first recommendation, Ofgem has established a distributed generation project. This is a major piece of work that will last initially for 4-5 years.

  31.  In September 2001, Ofgem issued a first consultation paper on the subject, entitled "Embedded Generation: Price Controls, Incentives and Connection Charging". There were over 40 responses.

  32.  On 26 March 2002, Ofgem published a document reviewing these responses. The document also makes a number of proposals that can be implemented ahead of the next distribution price control period (from April 2005) and suggests further work that can be undertaken now. In summary, Ofgem's proposals are:

    —  giving distributed generators the choice of paying connections charges up-front, or of spreading some of the payments;

    —  reducing the time and cost of network studies for individual generation proposals;

    —  reimbursing "initial contributors" when other connections subsequently share connection assets for which they have paid;

    —  reducing connection charges where the new connection helps the DNO to avoid asset replacement or reinforcement costs;

    —  new standards for quotations for connection of distributed generators;

    —  ensuring that householders who purchase DCHP equipment will not be faced with burdensome procedures or unreasonable charges;

    —  appropriately metering imports and exports of active power, to ensure fair, cost-reflective charging;

    —  protecting the interests of existing distributed generators; and

    —  ensuring that accurate, comprehensible information is available to anyone interested in connecting distributed generation.

  33.  To implement the second recommendation, the Distributed Generation Co-ordinating Group (DGCG) has been established, under joint DTI/Ofgem chairmanship. The DGCG has met twice, and the next meeting is scheduled for 26 April. To support the DGCG's work, a Technical Steering Group (TSG) has been established. A work programme has been agreed for the TSG, consisting initially of six workstreams. The workstreams cover:

    —  distributed generation status and projections;

    —  standardisation of information and solutions;

    —  short-term network solutions;

    —  long-term network concepts and options;

    —  micro-generation solutions; and

    —  industry skills and resource.

  34.  The DGCG has appointed a Programme Manager to ensure that the work programme keeps to schedule and is successfully addressing the recommendations of the EGWG. The DGCG will report annually to Ofgem and DTI.

  35.  The timetable for the TSG's work will depend on prioritisation of the various projects under each workstream, but current priorities include:

    —  monitoring and forecasting the development of distributed generation;

    —  developing straightforward and workable procedures for the connection of DCHP and micro-generation;

    —  revision of relevant industry codes and standards for network design and management; and

    —  developing an appropriate system for classification of the various sizes and types of distributed generation.

Barriers to connection of micro-CHP and PV systems (Q12)

  36.  The EAC asked specifically about the main barriers to the connection of micro-CHP and PV systems to local networks. The following table indicates what those barriers presently are, and the action that is being taken to address them.



Perceived barrier



Lack of technical guidance on connection requirements for DCHP and micro-generation.

The Electricity Association's work on developing Engineering Recommendation G83 is well advanced and should be completed by late 2002.


Requirement for simple, standard connection agreements.

Under consideration by the TSG workstream on DCHP and micro-generation.


Need for profiles to underpin new `DCHP tariffs'.

Early DCHP trials will yield profiling data. Metering of imported and exported active power volumes will facilitate development of cost-reflective tariffs.


Requirement to secure DNO's approval for connection of any source of energy in parallel to the DNO's system.

Under consideration by DTI's Engineering Inspectorate for new Electricity Safety, Quality and Continuity Regulations 2002.


Lack of installers trained to work on electricity, gas and metering systems.

Being addressed by prospective DCHP manufacturers and monitored by the TSG workstream.


The requirement of the Balancing and Settlement Code that all generation should have half-hourly export metering.

Under consideration by the TSG workstream on DCHP and micro-generation.


Although engineering recommendation G77 makes specific provision for connection of PV systems, "pay back" time is a problem.

Financial support for PV systems is a matter for Government, but we shall look with interest at the effects of the recently announced subsidy scheme, against a background of Ofgem's interest in distributed generation.


  37.  As micro-generation and DCHP units are installed in increasing numbers, further issues will have to be addressed if they are not to hinder the development of these generation technologies. They include:

    —  modification and management of networks to accept export from large concentrations of micro-generation and DCHP units; and

    —  settlement of consolidated exports from DCHP and micro-generation under NETA.


  38.  It is not Ofgem's role to monitor environmental impacts since this is the function of the Environment Agency. Although some commentators have attempted to assess the impacts of NETA on emissions, it is extremely difficult to separate out the impact of the introduction of NETA from other drivers, such as movements in the relative prices of coal, gas and oil; supply and demand conditions; and weather effects.

April 2002


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