Energy and Climate ChangeWritten evidence submitted by the Combined Heat and Power Association

1. The Combined Heat and Power Association (CHPA) welcomes the opportunity to provide evidence to the Energy and Climate Change Committee’s inquiry into Local Energy. The CHPA is a leading advocate of decentralised energy services, combined heat and power and district heating, and has over 100 members active across a range of technologies and markets. The CHPA and its members would welcome the opportunity to appear before the Committee to provide oral evidence.

Executive Summary

Local energy encompasses both the production and use of energy, typically at the smaller scale and in direct response to energy consumers’ needs. Local, or decentralised, energy is produced at or near the point of final use, rather than at large, centralised plant. It is vital to recognise the importance of both heat and electricity when discussing local energy.

Consumers, whether domestic, commercial or industrial, do not consider heat and electricity to be separate components, but as one entity to meet their needs for warmth, and hot water and light. Consumer-focussed energy policy must be systems based, considering energy needs rather than the type of energy carrier required (electricity, gas, hot water) to meet that need.

A key reason why decentralised energy is less prevalent here than in countries such as Denmark is that decentralised generators have significant difficulties achieving access and value in the electricity market. Any policy to improve market access should be accessible to all market participants in generation, supply and demand, and the Energy Bill should supply this assurance.

The Government has provided strong rhetorical support for decentralised and local energy, but the scale of the institutional inertia needed to be overcome is substantial, and crosses across a number of different government and non-government organisations. There needs to be a shift change in governmental and regulatory thinking, where policies are developed for the decentralised and local generator first, and then scaled up to ensure they work for the larger generator.

Combined Heat and Power (CHP) capacity makes up more than half of the entire decentralised energy sector, and faces many of the challenges which face the wider decentralised energy market, including access to market, policy and market complexity, and access to capital. DECC’s new CHP policy needs to be completed by early 2014 if the market uncertainty is to not damage investor confidence in the CHP industry.

What is local energy?

3. Local energy encompasses both the production and use of energy, typically at the smaller scale and frequently in direct response to energy consumers’ needs. Local, or decentralised, energy is produced at or near the point of final use, rather than at large, centralised plant. Some of the technologies include highly efficient combined heat and power (renewable, energy from waste and gas-fired), hydro, community wind and district heating infrastructure.

4. Decentralised energy1 encompasses a range of ownership types, including, third-party assets and energy management, utility companies, community-cooperatives schemes and commercial business having direct ownership of their plant. Local or decentralised energy is not limited to community schemes, but also consists of industrial and commercial organisations and can often reach sizes of greater than 50 MW. These non-traditional organisations make up 8.2% of UK electricity capacity and offer an opportunity to play an even greater role.2

5. It is vital to recognise the importance of both heat and electricity when discussing local energy. Decentralised electricity makes up approximately 11% of UK electrical generation capacity3 and can be located in industrial facilities, offices, or public sector buildings. For heat, the challenge of transporting it over long distances ensures that heat generation is, by its nature, decentralised. Where appropriate, community-wide heat networks can be a central feature of effective decentralised energy systems, connecting communities through energy provision and offering greater resilience, security and flexibility than stand-alone approaches.

Benefits of local energy to the UK

6. Local, or decentralised, energy provides four clear benefits to the UK economy, to its environmental efforts, and to local consumers.

Community and consumer engagement

Cost effectiveness and increased competitive pressure in the energy market

Security and diversity of supply

Industrial competitiveness

Community and consumer engagement

7. Through a combination of greater efficiency (such as capturing heat normally wasted in electricity generation by locating near to points of heat demand), and greater utilisation of alternative resources, decentralised energy can drive down consumer’s energy bills—alleviating fuel poverty in areas of deprivation and presenting consumers with a genuine, competitive alternative to the centralised model of energy supply.

8. Decentralised generation is used in hospitals, universities, offices, and small towns. These schemes are engaging consumers with the energy system as participants and beneficiaries rather than as passive users, bearing the cost and risk for investments of others. Such a greater understanding of energy is vital if public and political support for decarbonisation is to be maintained.

9. Local Authorities and other local public sector organisations can play a key role in delivering local energy projects through integrating with wider local policy, providing assurance to local organisations of the validity of a project and providing their own buildings as key heat and electricity users to facilitate initial scheme viability. For example, the shared enterprise in developing heat networks can be a vital element of regenerating neighbourhoods, re-connecting communities and restoring positive relationships between the community and the local governments that often sponsor the schemes.

Cost-effectiveness and market competitiveness

10. Ensuring that the reformed electricity market is open to a diversity of players and a wider scale of investments would create a more open and competitive market for consumers. Research demonstrates the increased flexibility and value of decentralised energy infrastructure to the energy system.4 As significant deployment of renewables has occurred at a decentralised level, indicating that decentralised energy can compete on cost with centralised generation.

11. In addition, some of the technologies that can deliver significant cost-effective gains towards the UK’s emission reductions and renewable energy commitments are most effectively deployed as decentralised plant. For example, CHP must be local as it is constrained by the presence of a location-specific heat demand.

12. Electricity demand side response, such as a temporary reduction in electricity demand at an industrial site, provides a decentralised solution to electricity system stress. Demand side response provides reliable and cost-effective capacity services in the United States’ largest wholesale electricity market, saving about $290 million or 15% of total cost in a single year.5

Security and diversity of supply

13. Analysis by Price Waterhouse Coopers in 2012 argued meeting the renewable targets in addition to business as usual will require an additional approximately £200bn of capital over the next decade, or an average of about £17bn per annum. This is double the annual capital expenditure programmes of the big utilities combined which, taking the six major suppliers and National Grid together, totalled £8.6bn in 2009.6

14. The UK would benefit, therefore, from ensuring a market for a wider range of options to access a more comprehensive and diverse set of investors and market participants. Decentralised energy’s relatively small capital costs, along with its steady growth, can provide investors lower risk proposition than traditional electricity plant. These options embrace supply and demand-side, smaller-scale investments, and new actors in the industrial, commercial, community and public sectors.

15. Many small investments can add up to significant amounts of generation. The CHPA has members who manufacture and install small-scale CHP units, often fewer than 2 MW. Together these units comprise hundreds of megawatts of capacity across the UK. These CHP units are monitored centrally and can also be operated both remotely and at the site. This scope to combine multiple small units to create virtual power plants can provide a large amount of highly flexible and resilient electricity capacity.

16. As understanding of the sector grows, this situation will only improve. Analysis by the consulting firm Verdantix forecasts that decentralised energy will save 426 million tonnes of CO₂ by 2030. This will translate to 30 million tonnes of CO₂ per year by 2030, or 11% of the UK’s national emissions reductions target.

Commercial and industrial competitiveness

17. Decentralised energy supports local economies, whether it is driving the international competitiveness and efficiency of a paper mill or aiding the expansion of new enterprises. One option for commercial and industrial players to access the energy sector is through professional energy management who work with the industrial, commercial and public sectors to provide guaranteed energy bill savings and carbon reductions for their client. Research forecasts that decentralised energy investments could deliver £25 billion in savings to UK business up to 2030.

18. Industrial competitiveness should not come at the expense of meeting low carbon energy commitments. Indeed, industrial products will be central to delivering the low carbon economy. The Committee on Climate Change has shown how onsite, decentralised generation (overwhelmingly consisting of CHP) has protected industrial energy users from price rises over the last four years and will continue to do so in the future. Whilst industrial electricity from the grid rose by 116% between 2004 and 2011, the costs of on-site industrial electricity rose by just over half that amount, a 64% increase.7

Denmark: Centralised generation in the 1980s, compared to decentralised production today. Each dot represents an electricity generation plant, the size of the dot is related to plant capacity.

Supporting an enduring role for local energy

19. Because local generators can often provide higher efficiency and a more targeted consumer focus, the role of Government policy should centre on addressing the wider, interconnected market and policy issues which hinder local energy growth. This is a complex proposition, but it is only by solving these interconnected issues that we can achieve an enduring, market-based environment that will allow decentralised generators to flourish.

Facilitating local energy requires:

A route to market local generators

Policy clarity, certainty and simplicity

A systems approach to energy policy

A clear policy for combined heat and power

Provide local generators a route to market

20. A key reason that decentralised energy is less prevalent than in countries such as Denmark is that decentralised generators have significant difficulties achieving access and value to the electricity market. Smaller generators must sell their electricity on to energy suppliers, and are often required to sell their electricity at a significant discount (20–30%), or may simply be unable to access the market at all, because of a lack of buyers on the forward market.

21. This lack of market liquidity creates uncertainty and discourages local energy investment, and contrasts with the simple methods which allow, for example, Danish local generators to access the market and achieve full market value for their power. DECC, in its recent Heat Strategy, acknowledged this as a problem for CHP operators on industrial sites as well as heat networks.8

22. The result of local generators’ difficulties in accessing the market is strong growth of non-exporting electricity generation. Hospitals, public sector and commercial facilities produce electricity simply for their own needs rather than generating and selling to the market. By not participating in the market, the wider UK electricity system does not derive maximum benefit from local generators’ low-carbon investments.

Energy Bill market access powers must be for all generators

23. In the Energy Bill, the Government is providing powers to introduce market-making measures to improve market liquidity and access, if it is deemed necessary. This is occurring in tandem with other market access work by Ofgem.

24. The CHPA supports measures to ensure a robust and liquid market and believes that any necessary powers should be developed to meet that aim. However, too often proposals to improve market access are limited only to a subset of generator types (such as renewable) or to a given support mechanism such as the Contract for Difference Feed-in Tariff.

25. Whilst it is vital that small and medium-sized operators are able to secure market access, any policy to improve market access should be accessible to all market participants in generation, supply and demand, and the Energy Bill should supply this assurance. It is only by allowing the market to work for all participants, in all technologies, that we can address the market access challenges for local generators.

Access for local generators to the capacity mechanism

26. The Government is providing very broad legislation to create a capacity market, and significant work is ongoing between DECC and industry stakeholders to develop the mechanism and its implementation. We welcome the clear interest from DECC to include demand side activity within the mechanism. It is vital that non-traditional sources of capacity, such as demand-side response (DSR), are included in the mechanism.

27. The inclusion of DSR capacity in the New England system operator forward capacity auction has been credited with saving consumers around $280 million.9 In addition, demand-side resources in capacity auctions can introduce more competitors into the capacity market, driving down costs further. Finally, demand side response is recognised as a potentially low-carbon way for the UK’s electricity grid to meet its capacity needs, substituting for generating capacity with a higher carbon footprint.

28. Despite positive efforts by Government, there remains a real risk that the mechanism’s design is based around traditional larger scale capacity plant and that this will effectively limit or even exclude demand side response, including local generation. Further details on these risks can be provided to the Committee.

Introduce policy clarity, certainty and simplicity

29. The electricity market is highly complex, involving a range of government and regulatory policies which can affect a local energy generator. These include the energy and environmental policies, such as Feed-in Tariffs and carbon taxation, as well as regulatory requirements, and can come from DECC, Ofgem or National Grid.

30. Too often, policies and regulations are designed from the perspective of large, centralised plant in with limited consideration of the impacts for smaller, decentralised generators. The higher transaction costs which smaller generators pay to address policy and market complexity holds back the local energy agenda.

31. The Government has provided strong rhetorical support for decentralised and local energy, but the scale of the institutional inertia needed to be overcome is enormous, and crosses across a number of different government and non-government organisations. To address this challenge, there needs to be a shift change in government and regulatory thinking, where policies are developed for the decentralised and local generator first, and then scaled up to ensure they work for the larger generator.

Develop energy policy using a systems approach

32. Heat, which makes up nearly half of all energy use is, by its nature, consumer-led and decentralised due to the challenges of transporting heat over long distances These attributes make heat ideally suited to provide a leading role in the local energy revolution.

33. Consumers, whether domestic, commercial or industrial, do not consider heat and electricity as separate components, but consider them together as their “energy” costs to meet their needs, such as warmth, and hot water and mobility. If Government policy is to effectively engage with energy policy at a local level, there is a need to examine energy policy as it is viewed by the consumer, which means examining both heat and electricity as a whole. By doing so, we can more effectively engage with local consumers by meeting their needs most efficiently.

34. Unfortunately, Government policymaking can too often divide policy between heat and electricity, preventing a truly consumer-led and efficient approach in delivering UK energy needs. Policies like the Electricity Demand Reduction proposals examine reducing electricity use, but exclude non-electrically generated heat. Consumer focussed energy policy must be systems based, considering energy needs rather than the type of energy carrier required (electricity, gas, hot water) to meet that need.

Support for combined heat and power

35. A central part of the decentralised energy mix is combined heat and power (CHP). CHP capacity makes up more than half of the entire decentralised energy sector, and 7% of UK electricity capacity.10 CHP and heat networks face many of the challenges which face the wider decentralised energy market, including access to market, policy and market complexity, and access to capital.

36. DECC proposed in their recently published Heat Strategy document, The Future of Heating, it would develop a bespoke CHP policy to support new gas CHP capacity. DECC’s CHP policy needs to be completed by early 2014 and provide a clear mechanism to ensure the deployment of new CHP capacity.

Feed-in Tariff support

37. It is by addressing the wider market and government obstacles to decentralised generators achieving market access and fair value for their energy that the decentralised energy sector will thrive. However, many of these problems are substantial and persistent, and may require many years of reform to fully address.

38. One medium-term option to ensure we are supporting and not hindering the decentralised energy agenda is through specific feed-in tariffs which can help decentralised generators access the market and achieve enough value to compete with the larger energy companies. But such support must be simple as possible to encourage take up by decentralised and local generators.

39. As the Committee is aware, the complex design of the CfD lends itself particularly to larger investments and participation by experienced market players and is widely viewed as too complex for non-expert market participants, small scale market entrants, and decentralised generators. The CHPA therefore continues to support any proposals for a simpler support mechanism where communities, commercial and industrial users can benefit. Because of its environmental benefits and wide cross-sector support, such a mechanism should also recognise the energy and carbon savings of gas CHP.

April 2013