Select Committee on Science and Technology Appendices to the Minutes of Evidence


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 technologies;

    —  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 work.

  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 below.


Distributed Generation

  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:

  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 generators.

  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 networks.

  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. These are:

    —  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 generators.

  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 customers.

  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;

    —  Biomass and biofuels;

    —  Marine energy; and

    —  Hydrogen technology.

  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

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