The future of Britain's electricity networks: Government Response to the Committee's Second Report of Session 2009-10 - Energy and Climate Change Contents

Appendix: Government Response


The Government welcomes the Select Committee's report on "The future of Britain's electricity networks". The report identifies the vital role of the underlying electricity network infrastructure in delivering our energy and climate change targets, and the importance of greater and more strategic investment and the transition towards a smarter grid.

We have made significant progress to ensure that our electricity networks can best support new low carbon generation. The Secretary of State for Energy and Climate Change announced in the July Annual Energy Statement a comprehensive package of actions around the electricity grid. The Committee's report helped inform the development of this package of actions.

Getting connection to the grid has historically been a major barrier to the new renewable and other generation the UK needs to meet its climate change targets and deliver energy security. To help address this, we announced as part of the Annual Energy Statement the implementation of a new enduring "Connect and Manage" regime for grid access, enabling new generation to connect to the network quickly and removing a key barrier to new renewables. We implemented this regime in August 2010. This provides greater certainty for all new generators about the rules for access to the grid over the long term.

As the Committee notes, investment in new network is the real solution to connecting the new generation required to meet our energy and climate change targets. The March 2009 Electricity Networks Strategy Group 2020 Vision sets out the potential transmission investments needed to connect the significant changes in the generation mix to 2020. The report estimates that upgrading the onshore grid could require up to £4.7bn of new investment over the next decade. Ofgem is currently working with transmission companies on the required regulatory approvals for this investment. Good progress is being made.  In April Ofgem made changes to Transmission Owner licences to implement its final proposals for £319m of priority investments within the current transmission price control period (2007-2012). Ofgem is now considering further priority investment proposals from the transmission companies for a decision by April 2011.

Offshore wind will be crucial to delivering our renewable and low carbon targets. Under current plans, up to 50 GW of offshore wind generation and other marine technologies is expected to be developed over the next 10-15 years, which could require up to £20 billion of transmission assets to connect offshore wind farms to the onshore grid. The Government has therefore been working to put in place the most effective regulatory regime so that these connections can be delivered in a cost effective, timely and co-ordinated manner.

The Annual Energy Statement stated DECC's decision to consult further with Ofgem on the enduring regime for offshore transmission. This consultation proposed that offshore windfarm developers be allowed to construct transmission assets, before transferring them to an Offshore Transmission Owner, to give them more flexibility and to address project delivery. DECC and Ofgem announced in an Open Letter on 21 October 2010 our intention to implement the changes necessary to deliver this option.

The Annual Energy Statement also pre-announced Ofgem's independent review of the transmission charging regime. Project TransmiT, which was subsequently launched on 22 September with a call for evidence, aims to ensure that arrangements are in place that facilitate the timely move to a low carbon energy sector whilst continuing to provide security of supply at value for money for existing and future consumers.

We are also considering future electricity network policy and the steps towards a smarter grid. Ofgem is providing £500m funding over the next five year through the Low Carbon Networks Fund to support smart grid trials, and DECC is providing £2.8m towards eight smaller smart grid demonstration projects. DECC is rolling out smart meters to every UK home by 2020 - giving consumers more information about the energy they are using and putting in place the first steps towards a smarter grid. We are working with industry to develop a framework for smart grid standards, focussed on cyber security issues, to be published by the end of the year. Building on this, as part of our work on Electricity Market Reform, we are considering the future challenges for the electricity networks, the options for balancing the future electricity system, and the development of smarter grids.

Responses to the conclusions/recommendations of the Select Committee

1. The transition to a low-carbon economy will transform the role of our electricity networks over the next 40 years. Whereas today the networks are seen as a means to an end in the transportation of electricity from generators to consumers, in the future they will play an integral and active role, enabling supply and demand to be managed in a much more complex and decentralised energy system. The market alone will not be able to deliver these changes—it requires strategic leadership from Government delivering a vision for the future that engages actively both consumers and the energy sector. (Paragraph 13)

The Government recognises that networks will be vital to enabling the transition to a low carbon economy and that Government will need to be proactive in grid development and provide strategic leadership so that we are prepared for the future changes expected to Britain's electricity system. In line with DECC's 2050 pathways work and the Electricity Market Reform project, work is also underway to fully understand the future implications for networks of the move to a low-carbon economy.

2. Although we know with some confidence how the electricity mix will evolve in the run up to 2020, there is much less certainty over what a completely decarbonised energy system might look like in the long run. The Government's vision for the future of our electricity networks must take account of the range of possible scenarios for the evolution of the energy mix, ensuring it does not lock Britain into a particular outcome at an early stage. (Paragraph 19)

DECC has carried out work to identify the electricity supply and demand pathways to 2050, which was published for views in July. These pathways provide the basis for understanding what the challenges will be for networks from both a generation and demand perspective. The Government will take account of these future uncertainties when developing network policy, both with regard to types of technologies and behaviours that are likely, as well as the timing and trajectory of future developments. However, it should also be recognised that there is a trade-off between ensuring flexibility for the future and the need to take decisions early enough so that the network is prepared to enable future changes to the energy system and not be a barrier to it. This is especially important given the long lead times associated with network development. The Government will seek to balance avoidance of lock in against the need for early investment.

3. Whatever the scenarios for the future development of the electricity mix, it is likely that they will include a much higher proportion of generating capacity that is not able to respond easily to demand. The only cost-effective response is for demand itself to be more flexible and play a more active role in the management of our energy system. This should sit at the core of the Government's vision for Britain's electricity networks. (Paragraph 27)

To deal with greater levels of inflexible and intermittent generation at the same time as increasing levels of demand, there are a number of potential solutions available to enable effective balancing of demand and supply whilst maximising asset utilisation. These include demand management but also others such as more storage and greater interconnection. Increasing demand management is potentially a very attractive option, especially given the expected electrification of the transport and heating sectors, and should play an active role in the management of our energy system.

The Government is considering the potential trade-offs between these different solutions based on their associated costs and benefits and the implications of different demand and supply scenarios for networks and balancing policy.

4. The regulatory framework will need to adapt to meet the new challenges of facilitating the transition to a low-carbon economy, whilst ensuring security of supply. As such, we welcome Ofgem's current RPI-X@20 review. At the same time as ensuring flexibility in the potential outcome for how the networks might evolve, it is important that reforms arising from the review and the Government's vision for the electricity networks take account of the need for long-term regulatory and policy stability to give firms the confidence to make the investments required. (Paragraph 30)

The Government and Ofgem recognise the importance of long-term regulatory and policy stability for investment.

In line with DECC's 2050 pathways work and the Electricity Market Reform project, work is underway to fully understand the future implications for networks of the move to a low-carbon economy.

On 4th October 2010 Ofgem published its "RIIO: A new way to regulate energy networks Final Decision" document setting out the new regulatory framework for electricity and gas transmission and distribution. The RIIO (Revenue=Incentives+Innovation+Outputs) model incorporates the conclusions of the RPI-X@20 review. The document set out Ofgem's desired outcomes for networks playing a fuller role in a delivery of a sustainable energy sector and providing value for money for existing and future consumers. These outcomes are driving changes in the regulatory framework and are aligned with the views set out in the Committee's report. There are a number of aspects of the framework that are relevant to long-term regulatory stability, most notably a focus on delivering outputs related to sustainable energy sector (including security of supply and delivery of low carbon), a focus on efficiency over the longer term and, related to this, a need to consider how best to keep options open where appropriate and how to value flexibility in the assessment of delivery solutions, as well as strong rewards for delivering and strong penalties for not delivering.

The RIIO framework for electricity networks will be applied in the next Transmission Price Control ( 2013-2021) and Distribution Price Control ( 2015-2023). The Government recognises the need for the regulatory framework to adapt to incentivise and enable network companies meet the future challenges of a sustainable energy sector. We therefore welcome the outcome of the review and are engaging with Ofgem and other stakeholders in this area.

5. Britain's networks sector currently has a hybrid structure that is largely the result of the evolving regulatory framework since privatisation. Whilst it may be adequate for now, the transition to a low-carbon energy system may require a different organisation of the industry. The Government and the regulator should not be afraid to allow this to happen, whether through regulation or otherwise, so long as it provides transparent and fair access to natural monopoly network assets for both generators and consumers. In particular, we recommend Ofgem monitors closely the market behaviour of the two vertically integrated Scottish firms. These arrangements could be changed if they are found to be detrimental to consumers. (Paragraph 35)

Ofgem is responsible for ensuring that all licensed GB market participants comply with relevant licence requirements and it enforces competition law rules in the GB gas and electricity sectors. There are clear standards for non-discriminatory third party access to gas and electricity networks underpinned by the requirements of EU legislation. Ofgem keeps the market under review and can investigate complaints of discriminatory or anti-competitive practices.

The Government intends to consult shortly on the implementation of the Third Package of EU legislation relating to the internal energy market. This legislation, which includes new Gas and Electricity Market Directives, strengthens the requirements for the unbundling of transmission assets. Ofgem will be responsible for certifying whether transmission undertakings in Great Britain (including the Scottish electricity transmission businesses) meet the unbundling requirements of the Third Package.

6. We note the progress the Department has made in beginning to develop a strategic vision for how Britain's electricity networks will evolve over time. In preparing a road map for delivery of the smart grid, it should take account of the following principles:

  •   The need to avoid locking the UK into a particular outcome for the future energy mix at an early stage;

  •   Integration and management of energy demand within the energy system;

  •   Minimisation of regulatory and policy uncertainty for network companies who must invest in network assets; and

  •   The possibility of a new industrial structure emerging over time. (Paragraph 38)

The Committee raises some important principles for developing a smarter electricity grid.

We are considering the delivery of smart grids within the development of overall network policy to ensure an integrated, coordinated approach. Smartening of the grid should help to enable increased demand management, which will be important in managing the future energy system. Demand management needs to be considered alongside other solutions which will help manage inflexible generation.

We recognise that "lock-in" should be avoided where possible and uncertainty should be minimised, but there is also a balance that needs to be found between these two objectives. To achieve this balance the trade-offs between them need to be considered and the value of waiting understood.

We welcomed the publication of the Electricity Networks Strategy Group smart grids route map.This set out a high-level description of the way a UK smart grid could be delivered, outlining the need for a range of well targeted pilot projects to be delivered between 2010 and 2015, with a view to scaling up those that are technically and economically successful for UK-wide application from 2015 onwards. It identified a range of potential challenges from a technical, industry, customer and regulatory perspective and emphasised the need for cross-industry coordination and stakeholder engagement.

7. Reform of the planning process is vital if network improvements are to be delivered on time to connect new generating capacity in the future. We note the recent changes to the planning systems in England and Wales, and Scotland, and are pleased to be playing a role in scrutinising the draft National Policy Statement for Electricity Networks Infrastructure. We hope the new system will lead to a faster decision-making process, but one that nonetheless will take account of the environmental concerns associated with new proposals. For this, developers have a duty to ensure their initial applications take adequate account of alternative options. The Government should also look closely at the consenting process for applications in England and Wales that will not fall to the Infrastructure Planning Commission to see whether reform or improved guidance is necessary at this level as well. (Paragraph 48)

We would like to thank the Committee for the scrutiny it has undertaken to date on the draft National Policy Statements (NPSs). The Government has announced that it will reform the major infrastructure planning system by abolishing the Infrastructure Planning Commission (IPC) and replacing it with a Major Infrastructure Planning Unit (MIPU) based in the Planning Inspectorate. In the MIPU system decisions will be taken by Ministers in accordance with the policy framework provided in NPSs, and on the basis of recommendations by the MIPU.

The IPC's fast-track application and examination processes will be retained and the Government intends that the statutory timetable for decision-taking will be no longer than the current IPC regime. A more detailed implementation plan will be published later in the year. The Government published its response to Parliament (including the ECC committee recommendations) on 18 October 2010 alongside the revised draft NPSs, (including a revised draft NPS on electricity networks infrastructure). NPSs will play a central role in the new system as the primary documents used by the IPC and Ministers under MIPU when making decisions. They have been written to integrate environmental, social and economic objectives and provide clarity on the need for infrastructure, to enable the IPC to balance the benefits against the adverse impacts.

The Department for Communities and Local Government (CLG) have also been looking at planning at local authority level. The Killian Pretty Review undertaken in 2008 investigated opportunities for improving the planning process. It made 17 recommendations to Government on ways to make the planning application system faster and more responsive.

The majority of the recommendations in response to the Killian Pretty Review have been implemented. There are a number of outstanding recommendations in relation to development management, the use and discharge of planning conditions and statutory consultation. The Government intend to radically reform the planning system based on the principles set out in the Conservative Party publication "Open Source Planning". In this context, the new Government has yet to decide its approach or timetable in relation to the outstanding Killian Pretty Review recommendations.

8. To avoid delays in connecting new power stations a more strategic approach to investment in transmission capacity is necessary. We welcome the Electricity Networks Strategy Group's work to identify the reinforcements it believes are needed in the next ten years. We also note Ofgem's cautious approach in allowing funding to advance particular projects and we urge them to be more proactive in promoting ways of avoiding delays. (Paragraph 58)

The Government agrees that the Electricity Networks Strategy Group's work represents an important contribution to ensuring the grid infrastructure is in place to help meet our 2020 renewables and climate change targets. The investments identified by the ENSG need to be assessed and authorised by Ofgem to ensure that they are required and will be delivered cost effectively. As the Committee notes in paragraph 52 of its report, this process has already begun with investment proposals put forward for priority projects identified in the ENSG. In April 2010, Ofgem authorised £319 million for pre-construction and construction activities, representing the first tranche of up to an additional £1bn of funding for the period up to the end of March 2012. Ofgem is considering the approval of further investment based on information provided by the transmission companies.

The Government welcomes the progress made to date. We recognise the need to avoid delay to grid investment but also that the proposed costs of such investments require scrutiny . We note that Ofgem's proposals have received support throughout the industry, including from the transmission companies, and that it anticipates providing further funding for projects. We are mindful of the importance of progress in this area remaining on track and will continue to engage with Ofgem and the transmission companies.

9. Given the costs involved, the resulting impact on customers' bills, and the risks of delay, it is vital the case for investment is as robust as possible and preferable to any alternatives. There is some concern that the existing regulatory framework is driving the case for transmission investment presented by the industry at the expense of other more cost-effective options that seek better to utilise the existing network infrastructure. The current fundamental review of the Security and Quality of Supply Standards (SQSS) presents a major opportunity to address these issues. However, the review, which had aimed to publish detailed proposals in September 2009, has not yet reported. Therefore, we are concerned that some of the currently proposed strategic network investment that is based on the existing SQSS may prove unnecessary. Furthermore, reform of the SQSS will be vital for the development of a future smart grid. It would be totally unacceptable if Ofgem failed to fulfil its duties to consumers by not ensuring the timely completion of this review, especially as the regulator has already begun to grant funding for additional investment. We consider it essential that consideration of new investment in transmission has the benefit of the outcome of the SQSS review and strongly recommend that urgent measures are taken to complete and publish the review. (Paragraph 59)

The Government agrees that the fundamental review of the Security and Quality of Supply Standard being led by the three transmission licensees (National Grid, Scottish Power Transmission Limited and Scottish Hydro Electric Transmission Limited) is important given the need to maintain adequate levels of supply, while also determining how security of supply standards might best align with future generation profiles. The transmission licensees are seeking to prioritise the elements of the review, with first substantive outputs expected shortly, which will among other things address the optimum transmission capacity to support intermittent generation (e.g. wind and wave).

The Government looks forward to these outputs and anticipates that the review will establish a suitable technical framework for planning and operation of transmission infrastructure as the generation mix changes in favour of increasing levels of renewable generation.

10. Constraints occur on the transmission network when the system is unable to transmit the power supplied at a particular location to where demand for it is situated. National Grid's management of these constraints gives rise to costs, which are met by generators and consumers. The level of constraint costs are an important signal of investment needs. It is, therefore, vital that this signal is accurate. We are concerned that the nature of the British Electricity Trading and Transmission Arrangements (BETTA) appear to artificially inflate the level of constraint costs. We note the general review of the BETTA market announced by the Government in the Pre-Budget Report in December 2009. However, we recommend Ofgem conducts a specific review of the BETTA market with a view to addressing this issue. We also support the Government's intention to enhance Ofgem's powers to regulate against companies artificially inflating constraint costs. (Paragraph 69)

We note the Committee's concern that the nature of BETTA could artificially inflate the level of constraint costs.

In broader policy framework terms, DECC and HM Treasury are taking forward the Electricity Market Reform project, to ensure the electricity market framework can most effectively deliver a fair deal for the consumer and the low-carbon investment needed in the long term. This review will take account of the available analysis and evidence, such as Ofgem's recent Project Discovery work and the advice of the Committee on Climate Change.

Within this context and informed by DECC's work to establish generation and supply pathways to 2050, work is underway and will continue over the current months to fully understand the implications for networks of the move to a low-carbon economy.

In addition, as the Committee notes, in the Energy Act 2010 a new Market Power Licence Condition was introduced, with the aim of protecting the consumer from the potential exploitation of market power in the electricity balancing market. This measure will help ensure a fair deal for consumers while essential network investment is made. Investment in upgrading the transmission network will significantly reduce the constraint situations that may give rise to exploitation and provides the long-term solution to this form of market power.

11. Whilst we agree in principle with the current proposals to implement locational pricing for the Balancing Services Use of System charges as a means of reducing constraint costs in the short run, we question whether Ofgem should continue to pursue the modification brought forward by National Grid, given it could be replaced by another set of charging arrangements in the short to medium term when DECC implements a new regime for determining transmission access. (Paragraph 70)

On 1 March 2010, Ofgem vetoed the locational Balancing Services Use of System (BSUoS) modification that had been brought forward by National Grid and considered through the normal governance process. Ofgem concluded that on balance implementation of the modification, GB ECM-18 Locational BSUoS, would not better facilitate the achievement of the relevant objectives specified in National Grid's licence and the Authority's principal objective and statutory duties.

The Government's enduring grid access regime, which was implemented in August 2010, requires the continuing socialisation of constraint costs. This means that locational BSUoS does not make up part of the enduring arrangements.

The Redpoint analysis commissioned by DECC to inform the consultation on grid access reform suggested that the locational BSUoS model had the potential to reduce overall costs by altering the dispatch behaviour of conventional generation in constrained parts of the network. However, this reduction is only of significance if constraint costs are at the upper limit of expectations, and if generators are able to perfectly forecast the likely BSUoS charge and decide to alter their behaviour accordingly. In determining the enduring grid access reforms, we concluded that the introduction of a complex ex-post charge could adversely impact parts of the network (particularly Scotland) where good renewable energy resource needs to be harnessed, would not send the best signal for investor confidence, and would not be justified by the expected impact on costs.

12. We are concerned that the current system appears to charge wind generators disproportionately more than conventional generators for grid usage. We believe that it is imperative that transmission charges should not discriminate against renewable energy wherever it is located in Britain. Whilst we received conflicting evidence on this matter and acknowledge that other factors such as the planning system, grid access and financing play an important role in determining the investment case for new renewable generation, we believe it is vital that this issue be fully investigated as soon as possible. We note Ofgem's long-term commitment to the model of locational charging, but given the evidence we have received we recommend the Department establishes an independent review to develop an appropriate transmission charging methodology. (Paragraph 80)

We are grateful for the Committee's contribution to the debate on transmission charging. We announced in the Annual Energy Statement in July that Ofgem would launch an open and independent review of the transmission charging regime.

Ofgem published a call for evidence on 22 September launching Project TransmiT.

Transmission charging arrangements are an important matter for Ofgem and the EU Third Energy Package imposes a duty on the independent regulator in relation to the fixing or approving of transmission tariffs or their methodologies. It is therefore appropriate that this review is being undertaken by Ofgem. At the same time, the European Commission's Interpretative Note on the Third Energy Package recognises that Government has a role in setting the high-level policy framework. The Government has a strong interest in seeing a transmission charging regime that supports overall low-carbon generation and security of supply policy goals. Putting in place transmission charging arrangements that facilitate meeting these goals is explicitly set out as Ofgem's stated objective for Project TransmiT.

13. The old arrangements for gaining access to the transmission network gave rise to a queue of at least 60 GW of projects at various stages of development, a large proportion of which are renewables, some of which have potential connection dates as late as 2023. A new regime is vital if the Government is to meet its targets for renewable energy and emissions reductions. We welcome the 'interim connect and manage' arrangements, which should facilitate the earlier connection of 900 MW of renewable capacity in Scotland. We are, however, concerned by the lack of progress in developing a long-term access regime. It is extremely disappointing the industry has not been able to agree reforms and the Government has had to intervene. As far as possible, it is important an enduring regime is based on consensus between all parties—the Government, the regulator and the industry. (Paragraph 99)

14. We believe that to facilitate cost-effectively the formation of a smart grid and the delivery of the Government's strategic objectives, a long-term regime must contain four key features:

  •   Greater sharing of network access, particularly between renewable and conventional generators. This will reduce the need for investment in grid capacity, and the likelihood of large constraint costs, although it may need to be supported by additional market arrangements that guarantee spare generating capacity on the system;

  •   Prioritisation of renewables in electricity dispatch to maximise their contribution to decarbonising the energy system;

  •   An equal role for the demand-side in managing network access; and

  •   Arrangements that provide a degree of stability and regulatory certainty for generators to have the confidence to make investments. We urge the Department to move quickly to ensure an enduring regime is in place as early as possible in 2010. (Paragraph 100)
In determining the way forward on grid access, the Government took full account of the Committee's view that timely, effective and enduring reforms were vital in supporting the UK's climate change targets and ensure energy security. That is why we announced in the Annual Energy Statement that we were implementing an enduring grid access regime in August 2010.

This enduring regime is based on a 'Connect and Manage' Socialised Cost model, which enables new generation to connect to the grid without waiting for wider network reinforcement to be completed. The costs of managing this additional generation on the network are socialised across all generators connected to the grid. The analysis commissioned from our consultants Redpoint indicates that the costs will not be excessive - around 20 pence per household per year to 2020 - and that the model will not have a significant impact on existing generators. We expect this to be the best model for investment, whilst other potential reform models would have been considerably more complex to design, implement and administer.

The Government agrees with the Committee's assessment of the Interim Connect and Manage regime that was approved by Ofgem in May 2009. This has already enabled National Grid to advance the connection dates of around 13 GW of generation projects by an average of 4-5 years. Our grid access reform puts the successful Interim Connect and Manage arrangements in place on an enduring basis and therefore involves minimal disruption to industry.

Our approach of embedding the key features of the new regime in transmission licences will provide a stable access regime. We understand that uncertainty for industry could deter or delay investment and thereby undermine the objectives of our grid access reforms.

Other possible reforms, such as the potential for greater sharing of network access, are a matter for the existing industry governance process to take forward.

On the matter of priority dispatch for renewable generation, the Government notes that, unlike many European markets, the UK does not have a centralised dispatch system. Instead, the UK provides guaranteed access, with every connected generator having a guarantee of being able to use the electricity network. The only reason generators may not be able to generate is to ensure the reliability and safety of the grid system. On such occasions, the UK's market arrangements determine which generator reduces its output, with compensation provided. This type of arrangement is specifically recognised in the Directive 2009/28/EC on the promotion of the use of energy from renewable sources. Renewable generation sources such as wind benefit from these arrangements as zero-marginal fuel cost generators will be higher in the merit order, and will therefore run ahead of other generation types.

15. We welcome Ofgem's decision to review the industry's rule-making process. The existing system, under which only network owners can propose changes to the grid codes and charging methodologies, has for far too long forestalled reform in areas such as transmission access. The regulator's proposal that it take powers to implement code amendments arising from major policy reviews, whilst conceding power in areas of less significance to consumers or competition, is a sensible approach. So too is the proposal to make governance of the charging methodologies more inclusive. Changes in both these areas will facilitate the delivery of the Government's climate change and security of supply objectives. (Paragraph 103)

Ofgem has now made the necessary licence changes that will lead to the implementation of its proposals by the end of the year. This includes reforms that will allow more parties to propose changes to codes and charging methodologies, allow Ofgem to undertake significant code reviews and also allow Ofgem to step back from less material areas of the codes. These changes should speed up the code modification process and contribute towards meeting the Government's energy goals on tackling climate change and ensuring security of supply.

16. There are many challenges associated with the expansion of the electricity network offshore. It is important the regulatory framework reflects these difficulties and treats generators connecting offshore equitably vis-à-vis their onshore counterparts. The offshore wind industry presents a significant commercial opportunity for British industry, which requires a regulatory regime that will stimulate domestic investment in cabling and associated equipment manufacture. (Paragraph 111)

The Government agrees that the new offshore transmission regime represents a valuable commercial opportunity for domestic industry and investors. A key element of the enduring regime for offshore transmission Is the competitive tender process for appointing Offshore Transmission Owners (OFTOs) to own and maintain (and also construct, where this option is selected by a generator) the offshore transmission assets. This is intended to encourage innovation and enable new entrants to compete in the market, as well as deliver best value to the consumer. The first tender round, commenced in July 2009, has attracted very strong interest and preferred OFTO bidders were selected in August 2010 to own and operate the first £700 million worth of transmission links to seven of the nine projects in this round. The preferred bidders are new entrants to the market.

The flexibility for offshore generators to decide whether to construct onshore themselves or for a third party appointed on the basis of a competitive tender process acknowledges the challenges faced offshore.

17. Connecting the first three rounds of licences for offshore wind farms will require a capital investment of £15 billion—twice the value of the existing onshore transmission network. We therefore support the auctioning approach for the delivery of future offshore transmission links to ensure costs are minimised for the consumer. In the short to medium term this will lead to the direct 'point-to-point' connection of Round 1 and 2 wind farms as the most cost-effective and technically feasible way forward, which also militates against the possibility of delays. However, risks remain, particularly if companies underestimate the cost of the work for which they have tendered. This means the Department and Ofgem must keep its approach under review. Moreover, it is not yet clear how the present framework will deliver the most efficient network solution to connect the 33 GW of offshore wind that is possible under Round 3. There remains a risk that the current approach could lead to the piecemeal development of the offshore network that is less cost-effective in the long run. We note that the Department merely believes that zone-based approaches to connecting wind farms onshore will develop. We do not consider this is a sufficiently robust approach, and recommend the regulator conducts more analysis to develop a route-map of how it expects the competitive tendering regime to evolve to meet this long-term challenge. (Paragraph 120)

The Government welcomes the Committee's support for the competitive approach to offshore transmission to deliver cost-effective connections to the onshore grid. We also recognise the importance of coordination of grid connections. As part of the new offshore transmission regime, National Grid's role as onshore GB System Operator has been extended offshore to become the National Electricity Transmission System Operator (NETSO). This should help ensure coordination and efficient operation of the network.

An obligation was also placed on National Grid to produce an annual Offshore Development Information Statement (ODIS). This statement sets out a range of future scenarios for the development of the offshore transmission system, with the purpose of providing information about the likely impact of possible future scenarios on the development of the national electricity transmission system. It also highlights opportunities for developers to develop co-ordinated transmission connections together. The ODIS was published on 30 September 2010 and will be updated annually.

The recent consultation on the enduring regime for offshore transmission, launched in August, sought further views on how the regime can deliver co-ordinated development. Following analysis of the responses, the Government and Ofgem announced in an Open Letter on 21 October 2010 that we will undertake further work to consider whether additional measures will be required to deliver co-ordinated networks through the offshore transmission regime and, if so, what these measures might look like in practice. We will continue to engage with National Grid, the Crown Estate, developers, OFTOs and other stakeholders to ensure the regime remains fit for purpose for Round 3 projects. We envisage launching a specific consultation on the strategic development of offshore transmission in 2011, on the back of this further analysis.

The Committee has expressed a concern that companies might underestimate the cost of the work for which they have tendered. Ofgem has designed a robust competitive tender process which will ensure that bidders are fully informed of the costs and risks involved with tendered projects and that the bidders are properly assessed to ensure they have the capabilities to meet the requirements of the tender, and is monitoring the process.

18. As the level of wind generation in the electricity mix increases over the next decade, its intermittency and unpredictability will make it increasingly difficult for the system operator to balance supply and demand. A potential solution may be greater interconnection with European networks. However, the lack of progress in liberalising the European energy sector, means Britain risks tying itself closer to markets that lack competition and transparency, as has already happened, many would argue to its detriment, in the gas sector. The Government should continue its efforts to ensure the European Union makes rapid progress on implementing full transparency of Member States' energy sectors so that the UK is not further disadvantaged. In addition, it is not yet clear to what extent the GB system would be able to rely on other countries to provide balancing services, given weather systems rarely conform to national boundaries. The regulator should, therefore, proceed with caution in licensing future interconnection. Moreover, the electrification of the transport and heating sectors combined with active management of demand through smart grid technologies could provide a means of managing wind intermittency in the future. We believe it will be necessary to attain a clear view of the cost/benefits of interconnection in the context of UK energy security and the balancing of services, and recommend Ofgem conducts research to better establish this view. (Paragraph 127)

The Government agrees that greater interconnection with other European markets should help manage intermittency as more wind generation connects to the GB system in the coming years. While we are continuing to press for full and timely implementation of the EU Third Package of internal energy market legislation, we are encouraged by the progress that has already been made in liberalising the European energy sector. Both the Government and Ofgem have been particularly proactive in pursuing improvements in transparency. The electricity sector has led the way in releasing information to the market but, even on gas, the level of information provision has improved markedly with the release of daily information on the use and availability of gas networks in North West Europe and on daily gas storage levels throughout Europe.

Greater interconnection will also provide trading opportunities which should have a positive impact on market liquidity in GB, and thereby lower costs to consumers. This is why one of the goals of the Third Package is to foster greater integration of national energy markets by identifying where cross-border investment may be needed, ensuring that interconnector capacity is used efficiently and imposing new duties on national regulators to eliminate the barriers to cross-border trade and ensure compliance with the Third Package more generally. Ofgem will therefore need to provide a regulatory framework for future electricity interconnection. In this context, Ofgem issued from January to March a consultation seeking views on how policy on the regulation of interconnectors should be developed. Ofgem is developing an approach following the consultation, with a proposal for a pilot project by the end of the year.

19. The 'super-grid' could make a significant contribution to a low-carbon economy. However, there are major technical and regulatory challenges, while the necessary funding would likely require the redirecting of capital from domestic investment in network and renewable energy infrastructure. The super-grid would have some energy security benefits such as reducing Britain's exposure to fossil fuel price volatility, but would also bring with it new energy security risks, for example, through a new energy dependency on North African countries. We recommend the Government remains engaged at a European level in exploring the super-grid's potential. Any future decision to invest would require a robust analysis of the scheme's cost-effectiveness relative to other means of securing electricity supplies, such as greater demand flexibility. (Paragraph 132)

The Government agrees that greater interconnection with other European grids has the potential to make a useful contribution to a low-carbon economy. For example a grid linking offshore wind farms on the North and Baltic Seas (with each other and to the nearest mainland grid(s)) could potentially have benefits in addressing the intermittency and variability of wind generation.

However, as the Committee notes, connecting offshore wind farms across Member Statesf borders would raise many difficult regulatory, legal and technical issues. Member States will therefore need to cooperate closely to ensure that regulation and legal frameworks do not act as a barrier where it makes sense to connect across in this way.

DECC is fully engaged in discussions within Europe on these issues. The European Commission will publish a Communication on Energy Infrastructure in November 2010 which will propose ways in which priority infrastructure projects, for example offshore grids in the Northern Seas and the connection of renewables in South West Europe, can be taken forward. At the Energy Council in December 2010, the Government plans to sign a Memorandum of Understanding with the Energy Ministers of Germany, France, Belgium, Netherlands, Luxembourg, Denmark, Sweden, the Republic of Ireland and Norway, committing to cooperate on developing an offshore grid to support renewables projects. This initiative promises to be an effective way of progressing this work to our mutual benefit. In particular, it will provide an opportunity for us to feed in the experience we have gained in developing our offshore regime and play a full part in developing wider EU arrangements which support our political objectives.

However, to develop a more extensive North Sea grid than is currently envisaged would require the laying of more cables offshore, which would increase costs for offshore wind developers and, under current arrangements, would have to be paid for by electricity consumers. The Government therefore agrees that further work is needed to better understand the benefits and risks for the UK to support any additional costs.

The Government is supporting the initiatives to develop concentrated solar power and wind energy in North Africa and the Middle East, for example the Mediterranean Solar Plan. Such developments will be costly and involve complex cross-border regulatory issues but have the potential to be beneficial in terms of the energy security and low-carbon agendas. We agree that a robust cost-benefit analysis will be required to ensure that such initiatives provide a cost-effective way of meeting our political objectives. On the issue of energy security, the mutual dependence in the relationship (solar energy for the EU, payments for the producing North African states) should reduce the likelihood of supply interruptions. Added security would come from the fact that there would be diversity of supply, with several North African states being involved, none of which would be in a monopoly position. Our view is that the issues of investment costs (in production and cables), investment regimes in the producer countries and cross-border regulation seem of far greater significance than those of security and EU dependence on one region.

20. In the future there could be potentially thousands of generators connected to the distribution networks at scales varying from domestic solar panels to large wind farms. Energy demand could also evolve and increase through the electrification of the transport and heating sectors. The deployment of smart grid technologies, such as smart meters, will therefore be crucial to the effective and economically efficient management of an increasingly complex energy system. This necessitates a fundamental rethink of the role of distribution companies who in the future will need to play a more active role in balancing demand and supply across their networks, potentially taking on a local system operator role. (Paragraph 144)

As the committee recognises, the smart grid could enable the use of demand side and distributed energy resources more broadly, in a manner that would help integrate inflexible generation, reduce network reinforcement and maintain network stability and energy security. Heating and transport electrification present the challenge of higher demand and different demand profiles but will also offer a higher degree of flexible demand. This will need to be integrated with both generation and the network (with smart grid likely to provide the enabling underlying infrastructure) as well as in the home through smart meters. Ultimately the smart grid will allow integrated optimisation of transmission and distribution connected generation dispatch, storage and demand response to reduce the total UK system costs (across generation, networks and consumers), and maintain system integrity.

The Committee's report raises some interesting points about the future changes to the role of distribution companies. This will result in a more complex system at the distribution level that may lead to changes in the market framework to enable efficient system operation. Distribution companies taking on a local system operator role is one way that the future system might be managed, however there are a range of options that we will be considering.

21. Creating smarter distribution poses significant challenges. Although many of the technical aspects are well-understood there is relatively little experience of their application to the smart grid. Furthermore, the regulatory framework does not at present provide a level playing field for the adoption of smart grid solutions, such as active demand management. Ofgem must address these issues in the coming years. One area in which we believe it could make an immediate difference is to work with Ofcom to ensure the allocation of suitable spectrum for smart grid use as soon as possible, thus enabling the full range of smart grid technologies to be considered for deployment in Britain. (Paragraph 145)

DECC and Ofgem are in discussions with Ofcom regarding suitable spectrum for Smart Grids.

22. We welcome the outcome of Ofgem's fifth distribution price control review (DPCR), which seems to balance the requirement for network renewal on the one hand, with the need to minimise the resulting impact on consumers' bills on the other. However, the success or otherwise of the DPCR will need to be assessed against whether it encourages a significantly greater role for distributed generation and demand-side management within the energy system over the review period, and the extent to which it leads to the deployment of smart grid technologies. (Paragraph 149)

The Government also welcomes the outcome of Ofgem's DPCR5, which was preceded by a five-year period of record increases in capital investment in the distribution network. Ofgem's final decision on total expenditure implies an average cut to DNOs' proposals but a record increase of almost 50% with respect to the previous price control review. We believe the introduction of the £500 million Low Carbon Networks Fund will encourage investment in smart grid technologies which will help with increased distributed generation and demand-side management.

23. The level of research and development conducted by the networks sector has risen significantly over the last five years, though still represents just 0.33% of firms' income. If Britain is to be one of the first to deploy smart grid technologies on a wide scale, the industry must invest sufficiently to turn what is at present a vision into a reality. To the extent that the lack of R&D is a result of the rules governing companies' expenditure under the Innovation Funding Incentive, Ofgem should look again at this matter. To the extent that the underspend is the result of the absence of a "culture of innovation", the industry must accept that it has failed in its responsibilities and that it needs to show significant improvement not just in the interests of both the nation and the consumer, but also to grasp the huge opportunities that the global market offers. (Paragraph 157)

We believe the introduction of Ofgem's Low Carbon Networks Fund will encourage further innovation within the industry which will help UK companies grasp the huge opportunities that the global market will offer. We believe the opportunity offered under the fund for end-to-end trials will ensure the UK is a first mover in developing smart grids.

24. We welcome the introduction of the Low Carbon Networks Fund and the continuation of the Innovation Funding Incentive. We recommend Ofgem keeps both these mechanisms under review with the aim of increasing the available funding for both within the current distribution price control period if there is demand. We welcome also new public sector funding for smart grid demonstrations, and hope the Government will continue to support this area despite the current fiscal constraints. (Paragraph 158)

The Government is supporting the demonstration of smart grid technologies through DECC's Smart Grid Demonstration Fund. DECC have made £2.8 million available to SMEs and large organisations over 2009/10 and 2010/11 to promote smart grid development to support storage, balancing and automation load control measures on the distribution network. The Government continues to explore opportunities to fund smart grid development by collaborating across Departments and ensuring funding programmes are complementary. A particular focus for the future will be to pursue integrated demonstration of smart grid technologies. Ofgem through the RIIO package are further developing funding mechanisms for innovation on the networks.

25. Generators connected to the distribution networks do not currently pay transmission network use of system charges because it is assumed their output is absorbed by local demand and therefore reduces the need for transmission capacity—a concept known as 'embedded benefits'. The level of distributed generation, particularly renewables, could increase significantly in the next decade, to the extent that local supply will at times exceed local demand, resulting in spillovers back into the transmission system. Moreover, where renewable generation is intermittent, transmission capacity will still be necessary to respond to shortfalls in supply. For this reason, the current treatment of embedded generation is not sustainable in the long run. (Paragraph 163)

26. Because the proportion of distributed generation in the electricity mix is still very low, there is no need for Ofgem and the industry to reach an immediate decision on an enduring set of arrangements. Instead, it should wait until it can be shown clearly that distributed generation is impacting on the transmission system. We recommend the regulator develops a set of criteria to determine when it would be appropriate to reconsider this issue as the risk of change too soon is that it may exacerbate the 'lock-in' of a centralised energy system. Central to the debate over the two options proposed by National Grid is the question of whether in the future there should be separate regulatory frameworks for the distribution and transmission networks, or if there is a case for regulating the whole system as a single entity. The regulator must resolve this question first, which forms part of its RPI-X@20 review, before it can conclude on an enduring set of charging arrangements for distributed generation. (Paragraph 164)

The Government recognises the important role that distributed generation (DG) has to play in our transition to a low carbon economy. The expected increase in DG will require an appropriate charging regime to connect to, and use, the network.

Responsibility for the charging regime lies with Ofgem, as the independent regulator, and National Grid, in its role as National Electricity Transmission System Operator.

The Government agrees with the Committee's point that the treatment of distributed generation is an issue requiring industry and Ofgem consideration. Generators connected to the distribution networks ('embedded' generators) are currently paid the equivalent of demand Transmission Network Use of System (TNUoS) charges, leading to a benefit of around £18/kW compared with those generators directly connected to the transmission network. National Grid's preliminary analysis suggests that the benefit of embedding, in terms of avoiding transmission investment, may be nearer to £6.50/kW, but there are conflicting industry views on the justification for varying the level of embedded benefit on that account.

This issue was extended into Scotland through the development of the British Electricity Trading and Transmission Arrangements (BETTA). In addition, due to the differences in transmission voltage levels, embedded generators in England and Wales connected at 132kV are treated differently to those in Scotland under BETTA. Ofgem introduced the 'small generator discount' as an interim measure to ameliorate the issue of differential treatment, and National Grid has been under an obligation to use 'best endeavours' to establish enduring arrangements for Scottish generators by April 2011.

National Grid was in the process of seeking an enduring solution to the 'small generator discount' which would predicate a resolution of their view that embedded benefit is over-stated. This process has been suspended as the issue is now being considered as part of Ofgem's wider review of the transmission charging arrangements.

The Government agrees that this issue needs further consideration by the industry and welcomes the opportunity now available for this to be considered within the context of the wider charging review. In considering revised arrangements for distributed generation, we expect Ofgem to take into account the possible impacts on both energy security and climate change policies and other benefits introduced by locally generated electricity.

The current industry review process referred to in paragraph 161 of the Committee's report is expected to provide a robust charging solution based on the application of fundamental economic principles of cost reflectivity, non-discrimination and competition, and will seek to provide efficient and coordinated allocation of access. The impact on the amount of investment in transmission capacity required to accommodate the growth in DG and the efficient allocation of this cost, recovered through electricity transmission charges, is being addressed by Ofgem and National Grid as a matter of urgency.

The Select Committee refers to Ofgem's RPI-X@20 review which looked at the four network sectors and the extent to which it is appropriate to regulate them in the same way. However, Ofgem will not be regulating the system as a 'single entity'. The structure of having four sectors regulated with their own price controls will remain. Ofgem is, however, considering with stakeholders what the outcomes and outputs are that would need to be delivered in each sector. This is likely to include outputs relating to connection conditions for DG at local grid level and there may be cases for considering arrangements at transmission level too.

27. The transition to a low-carbon economy will require trained people that have the skills to deliver the many challenges the networks face in the coming years. Yet an aging workforce and a lack of new recruits mean the industry currently faces an acute skills shortage. This problem has been exacerbated by a regulatory framework that has reduced firms' expenditure on skills over time. We welcome the establishment of the National Skills Academy for Power, but believe DECC and the Department for Business, Innovation and Skills need to do more to inspire young people and graduates to take up a career in the energy sector. Network companies too should face improved incentives through the price control reviews. Accordingly, this must form a key part of Ofgem's RPI-X@20 review. Looking forward, firms must also accept their role in ensuring employees have the opportunity to improve their skills. A skilled workforce will be crucial to the development of a cost-effective low-carbon energy system. As one witness put it: "Without the broad skills of all participants within the sector, the UK faces a dirtier, more expensive and less efficient future". (Paragraph 174)

The Government accepts that the skills position is challenging. But the electricity sector has the best analysis of its current and future workforce, probably in the world, and is developing a robust strategy for the ensuring that is has the skills it will need.

Currently 35,000 people work in the electricity sector and its immediate supply chain. This workforce is ageing and retirement rates are set to increase sharply. Around 28,000 will leave the industry by 2024. On top of this, at least 10,000 more need to be recruited and trained to deliver the new investment, including those required to integrate renewable energy and deliver smart networks and meters.

The Sector Skills Council, Energy & Utility Skills, has strategic responsibility for the electricity sector. The skills strategy for the sector has been developed by employers from the electricity industry and its supply chain through the Power Sector Skills Strategy Group (PSSG). This group initiated plans to develop a National Skills Academy to be the strategic manager of skills and training for the industry. The PSSG was reformed over the summer to form the sector strategy groups for the Academy.

Numerically, most vacancies will occur at craft and technician grades. The most immediate need for the sector is to increase both recruitment and the capacity to train these recruits (through apprenticeships and conversion training for mature entrants) to deliver skills at levels 3 to 4. This requires the training capacity to be increased by at least 75%. Graduate recruitment is also challenging, especially for power engineers.

The National Skills Academy for Power, which was launched in March 2010, will provide strategic leadership for the industry. It will work with EU Skills to ensure that occupational standards and qualifications are up to date, develop and quality control a network of accredited training providers, manage training programmes on behalf of employers and refine the labour market models to ensure that skill supply and demand are well matched. It will also, on behalf of employers, deliver a major programme on sector attractiveness, to promote the industry and its employment opportunities to both young people and mature entrants from other sectors.

The Power Academy is a collaboration between major electricity sector employers, the Institution of Engineering Technologies and seven UK universities to support up to 60 undergraduates per year through power engineering degrees.

Employer members of RenewableUK (formerly the BWEA) have developed an apprenticeship programme for wind turbine technicians, to fill an important gap in training provision. The first cadre of 18 students started their courses at Carnegie College in Fife in September, with roll out of the programme to England and Wales in the near future.

DECC has worked with EU Skills and an alliance of Sector Skills organisations in a review of skills for renewable energy. This has identified what exists in occupational standards, training and qualifications and has highlighted key gaps in provision for priority action by the SSCs and Academies.

Ofgem, in its draft settlement for Distribution Price Control Review 5, has allocated £220 million for training, in recognition of the need to address the workforce demographics and also for the industry to prepare for a steep increase in capital investment.

DECC and BIS launched a consultation on low-carbon skills in March. This set out what was being done and gave us feedback on both current activities and on what more needs to be done. In the summer, BIS launched a consultation on simplifying the skills support structures and making the system more flexible and responsive to employers' needs. These will inform both departments and enable us to better target our future strategy. We expect to publish the formal response to both consultations in November.

Higher education is seeing a real increase in STEM subjects and many engineering courses now offer elective modules, for example in renewable energy and nuclear power. Specialised Masters courses are also available. The Government, through EPSRC, is funding five doctoral training centres across the energy field, aimed at developing people with technical depth, coupled to a broader business and societal understanding, who will become future strategic leaders.

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