Memorandum submitted by Ofgem
1. The Committee has invited Ofgem to submit
evidence for its inquiry and has asked in particular how our regulatory
activities are providing an environment that encourages innovation
in energy technologies and how our policies will develop in the
future. This memorandum explains the legal framework underpinning
Ofgem's role and gives examples of specific areas of work, which
contribute to these goals.
2. While Ofgem does not have an explicit
duty in relation to innovation there are a number of areas where,
in discharging its wider responsibilities, Ofgem plays an important
role in facilitating the development of new technologies. In Ofgem's
view the main areas where innovation in energy technology is and
will be important going forward are:
in the development of renewable generation
in the way that distributed generation
will impact on networks;
in improving customer service and
billing systems; and
in improving demand management and
the systems to support traded markets which will lead to more
efficient energy use in response to price signals.
Those areas where Ofgem has a particular role
to play in encouraging innovation are set out below.
3. The Utilities Act 2000 modified the Electricity
Act 1989 and the Gas Act 1986. It sets out a new principal objective
for Ofgem to protect the interests of consumers (both present
and future) wherever appropriate by promoting effective competition.
Ofgem does not have specific statutory objectives or general duties
in relation to research and development. These changes reflected
the Government's view, presented in the White Paper "Modernising
the Framework for the Utility Regulation", that it was no
longer sensible to put the energy regulator under a duty to exercise
functions so as to promote research and development in generation,
transmission and supply.
4. In those parts of the industry that are
subject to competition, as in other sectors of the economy, the
level of research and development expenditure will be determined
by companies involved and by government funded research bodies
and government incentives. Where monopoly networks are subject
to regulation there are incentive arrangements in place to promote
efficiency and protect the quality of service. To the extent that
research and development is effective it will promote these objectives
and so research and development expenditures are treated in the
same way as other operating and capital expenditures.
5. Where the government has wider objectives
for energy policy, for instance in relation to renewable electricity
generation, then it may choose to fund additional research and
development expenditure. If a regulated company is able to secure
additional funding from the DTI (or elsewhere in the government)
then this revenue is allowed for in addition to its base level
of price control revenue.
6. Ofgem's actions and those of the industry
it regulates have an important impact on the environment. Ofgem
is under a statutory duty to 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 and to have regard to the environmental and social
guidance issued by the Secretary of State, in carrying out its
functions, when this guidance is issued. Ofgem seeks to make an
effective contribution to meeting important environmental challenges
first through the exercise of its statutory duties, and second
by working with others who have environmental responsibilities.
7. Ofgem set out its Environmental Action
Plan in August 2001, and produced its first annual report on the
Plan in June 2002. The Plan recognises the increased prominence
of environmental issues on the public policy agenda and enables
Ofgem to play a fuller and more effective role in informing the
wider debate and decisions. A further step has been the setting
up of an Environmental Advisory Group to help guide Ofgem's environmental
8. Thus, while Ofgem no longer has a specific
statutory duty in relation to research and development, it has
a number of wider responsibilities, for example on security of
supply, in relation to future customers and on environmental issues,
where innovation in energy technology plays an important part.
In many cases Ofgem's role is as a facilitator or catalyst for
innovation, as is the case of distributed generation discussed
9. Non-carbon energy may in future be increasingly
derived from small-scale generation technologies that are likely
to connect to local distribution networks (so called distributed
generation). The conditions under which these stations connect
to and use the distribution systems have been identified as requiring
industry-wide action. The development of "active" distribution
networks so that they can accommodate distributed generation will
be important if the Government's long-term environmental targets
are to be met. Ofgem will be a key party in developing changes
that impact upon the connection and use of distributed generation,
although it is not within our statutory remit to seek to promote
particular types of generating technology above others.
10. Utilisation of distributed generation
services may also assist in providing security of supply for consumers
(eg for capacity support) and in addition provide more efficient
operation of the network and bring environmental benefits through
reduced network power losses.
11. during 2000 a joint government/industry
working group, the Embedded Generation Working Group (EGWG), was
established to consider network access issues arising from the
increase in distributed generation that would be needed to meet
the Government's targets for sourcing electricity from renewables.
The group published their final report in 2001 and it recommended
that Ofgem should review the structure of regulatory incentives
on distribution network operators (DNOs) in light of the new statutory
duty placed by the Utilities Act 2000) on DNOs to develop and
maintain efficient, co-ordinated and economical systems of electricity
distribution and to facilitate competition in generation and supply
of electricity. It also recommended 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.
12. In response to the EGWG's first recommendation
Ofgem established a distributed generation project. Following
consultation in September 2001, Ofgem issued a paper in March
2002 outlining a number of interim proposals that could be put
in place prior to the next Distribution Price Control, which comes
into force in April 2005. These interim proposals include:
giving distributed generators the
choice of paying connections charges up-front, or spreading some
of the payments;
reducing the time and cost of network
studies for individual generation proposals and ensuring that
accurate, comprehensible information is available to anyone interested
in connecting to distributed generation;
reimbursing "initial contributors"
when other connections subsequently share connection assets for
which they have paid;
ensuring that householders who purchase
DCHP equipment will not be faced with burdensome procedures or
unreasonable charges; and
appropriately metering imports and
exports of active power, to ensure fair, cost-reflective charging.
13. In response to the EGWG's second recommendation
the Distributed Generation Co-ordinating Group (DGCG) was established.
The group has met four times and is jointly chaired by Ofgem and
the DTI. Further details, including notes of meetings, can be
found on the DGCG website at: www.distributed-generation.org.uk
14. In the next few years, Ofgem will wish
to see DNOs develop a carefully considered and proactive approach
to the development of their networks from passive to active operation,
not only addressing the commercial and technical factors, but
also promoting the utilisation as well as connection of distributed
15. As part of the forthcoming Distribution
price control. Ofgem is giving consideration to a range of possible
incentives to ensure that DNOs are suitably rewarded and incentivised
both to connect distributed generation and to utilize it on their
16. Ofgem recognises that, if government
targets for renewables and CHP are to be met, it is likely that
considerable investment will be needed in the distribution networks.
As these networks are not at present designed for "active"
operation, innovation will be needed to adapt them in an efficient
and effective way to meet their new role.
17. Ofgem has been active in stimulating
consideration of two topic areas that will be key to developing
and implementing successful solutions for distributed generation.
the management of innovation by the
regulated network companies; and
the availability of the necessary
skills and resources in the sector.
18. The former has implications for regulatory
policy and this is being addressed in Ofgem's project to review
the setting of price controls; it also has important considerations
for the distribution companies and they are now starting to address
this through the Distributed Generation Co-ordinating Group. The
latter item concerning skills is the subject of a workstream under
the DGCG which has Ofgem's interest and support but is primarily
a matter for the companies and their suppliers.
19. Ofgem has noted the evident decline
in recent years of powers system engineering capability in UK
universities which is reflected in the number and quality of available
graduates; we also believe that this is part of an international
skills shortfall and it is therefore unlikely that future needs
can be met simply by calling on imported resources. Ofgem does
not have a direct locus in this area but is proactive in stimulating
the debate both through the DGCG and by working proactively with
the Institution of Electrical Engineers (IEE), providing opportunities
for the UK universities to take a high profile in sector activities,
and encouraging dialogue with the manufacturers of power system
plant and equipment.
20. Looking to the future, Ofgem considers
that there is potential for greater demand side participation
in the Balancing Mechanism which would result in lower balancing
costs. The Demand Side Working Group was established last year
with the aim of assessing and understanding obstacles to demand
side participation. Wider participation is likely to require technological
advances in control systems. Work is being undertaken by Ofgem,
Elexon and the industry via the New Metering Technology Working
Group to develop this market.
21. As part of the one-year review of NETA,
Ofgem surveyed all smaller generators. The response from the smaller
generators who responded was that they are producing about the
same quantity of electricity in the first year of NETA compared
to the year before NETA. This differs from the two month review,
published by Ofgem in August 2001, where smaller generators have
fallen, this has generally been in line with prices for other
22. Following a joint Ofgem/DTI working
group, Ofgem approved a number of proposals by participants to
encourage the development of consolidation services. These services
enable generators, including smaller generators, to combine their
output and negotiate better terms for selling it. Another important
change has been made in respect of the Balancing and Settlement
Code, whereby gate closure has been reduced from three and a half
hours to one hour. This gives unpredictable generators (including
wind generators) more flexibility to balance their positions before
Gate Closure and, therefore, reduce the risk of exposure to charges
for being out of balance.
23. Ofgem published a document in February
2002 which suggested a way forward for the development of charges
for transmission losses. There are clear environmental benefits
to be gained from reducing the amount of electricity lost in transmission.
This document suggested that the starting point for developing
revised arrangements should be the mechanism developed, but never
implemented, by the Electricity Pool, and that reform should be
progressed through the new governance arrangements created as
part of the New Electricity Trading Arrangements (NETA), which
replaced the Electricity Pool. Since this document was published,
industry members have proposed two Modification Proposals and
these are currently in a period of industry assessment. Both of
these proposals involve zonal charges, applying to both generation
and demand, which are designed to reflect the costs of losses
arising from the transmission of electricity to, and from, particular
areas of the transmission system. This would encourage efficient
use of the system. In each proposal the zonal losses charge on
generation would apply to all generation in that zone regardless
of its design of energy source. As such, these proposals do not
discriminate against any individual technology or fuel source.
24. Ofgem is seeking to promote greater
visibility of asset risk management in the transmission and distribution
of electricity and gas. The prupose of this is to both promote
best practices in the regulated companies and to gain assurance
that effective network stewardship is taking place in the interest
of longer term supply security and the quality of supply to future
25. To fulfil the aims of this initiative
Ofgem has initiated an Asset Risk Management Survey, which will
explore the level of development, extent of deployment and level
of integration of risk management processes across the networks.
Innovation and new technology that could impact on long-term network
performance is one of the areas being targeted by the survey.
26. In the first year, full company results
will be confidential to Ofgem and the individual companies involved,
with an anonymised industry summary produced for public reporting
in January 2003.
27. Some suppliers have expressed considerable
interest in the development of new energy efficiency products
to meet their energy efficiency targets under the Energy Efficiency
Commitment (EEC). Most of the focus has been on heating products
but there has also been some interest in consumer goods.
28. Several suppliers have committed to
promoting solar thermal heating. This carbon free technology generates
heat from the sun. At present the capital cost is high, but increased
volumes might reduce these costs. Other low carbon heating technologies
are being discussed especially those that would be suitable for
homes that are not connected to the gas grid. Consequently, in
the longer term, these measures could be beneficial in the fight
against fuel poverty.
29. The suppliers have maintained support
for a R&D group which looks at new technologies that are coming
to the market and aims to analyse how they might be fitted into
their EEC schemes. There is, for instance, considerable interest
in the development of micro-CHP.
30. There are a variety of sources from
which organisations can gain funding for research and development
projects. For example, Ofgem is aware that the Engineering and
Physical Sciences Research Council (EPSRC) has set up the Supergen
initiative, a research and development project on renewable energy
technology. From time to time, Ofgem has responded to requests
to be a named supporter of particular research applications under
this funding mechanism and has been party to review meetings.
Supergen is focusing on the following themes:
Electricity networks and grid connection;
31. Ofgem is also aware of the European
Commission's THERMIE, ALTENER and ALTENER II programmes, which
have the aim of promoting the development of renewable energy
technologies. There are also research projects being undertaking
by relevant trade associations; for example, the Society of British
Gas Industries is currently carrying out research projects in
connection with micro-combined heat and power technologies.
32. Ofgem's basic premise is that we should
do nothing that acts as barrier to companies seeking external
funds for research and development purposes.
20 September 2002