Implementation of Electricity Market Reform - Energy and Climate Change Committee Contents

3  Providing value-for-money for consumers

The role of National Grid

27. We have previously raised concerns about potential conflicts of interest between National Grid's existing role (as the System Operator and owner of the transmission network) and its newer role as EMR delivery body. Following our pre-legislative scrutiny, we called for National Grid to be removed from its EMR role and replaced by a new independent, not-for-profit company,[77] a recommendation which was not taken up by Government.

28. As National Grid recommends the amount of capacity to procure in the Capacity Market to the Secretary of State, there is a risk that it has an incentive to over-procure capacity.[78] Some stakeholders were satisfied that DECC had dealt with this potential conflict of interest effectively.[79] However, new conflict of interest issues have arisen following the Government's recent confirmation[80] that interconnectors would participate in the second four-year-ahead Capacity Market auction in 2015. While this was necessary in order to meet State Aid approval conditions that generation from other countries should be included, the inclusion of interconnectors raises additional issues.[81] Stakeholders have voiced their concern that this may prevent a level playing field because interconnectors represent transmission capacity rather than generation capacity and are exempt from certain charges faced by other Capacity Market entrants (such as a number of grid charges and the carbon price floor, which have to be paid by UK-based generators).[82] Additionally, National Grid is itself a shareholder in a number of interconnectors, and E.ON expressed concerns about "National Grid running the Capacity Market as the Delivery Body, advising the Secretary of State on security of supply assessments and the capacity demand curve, whilst also benefitting as a participant".[83]

29. A Panel of Technical Experts (PTE) was set up by DECC to impartially scrutinise and quality assure the analysis underpinning National Grid's recommendations for how much capacity to procure in the 2014 Capacity Market auction. Simon Moore, Infrastructure Policy Manager at Citizens Advice, told us:

    The Panel of Technical Experts raised some questions about how National Grid had come to certain conclusions when it was preparing its report on how much capacity DECC should procure. My concern is that the issues that were raised were not well responded to, either by DECC or by National Grid, in a particularly public or clear fashion.[84]

Professor David Newbery, Emeritus Professor at the University of Cambridge and member of the Panel of Technical Experts, expressed his view that the decision on how much capacity to procure had been "overhasty" and may have been better informed by waiting "to see how we get through this winter, what was the demand-side response and how we are going to deal with the interconnectors".[85]

30. Mark Ripley accepted that load connection to the network adds to National Grid's asset base[86] but he defended the analysis underpinning the capacity procurement recommendation, stating that the company was not "incentivised on that".[87] He added that there had been a "regular dialogue" with the PTE.[88] The Minister explained the difference between National Grid's execution role, and the policy decisions that remain in the hands of the Government.[89] He emphasised this difference in relation to the role of interconnectors within the Capacity Market:

    We will decide the policy framework within which interconnectors operate, along with Ofgem, who have a very important role. Grid have their statutory responsibilities in terms of connection, but the policy decisions will be taken by us and Ofgem.[90]

31. Ofgem, as regulator of the electricity market, is responsible for overseeing the performance of National Grid in its EMR delivery functions.[91] It will publish an annual report showing how well National Grid has performed, and where appropriate provide assessments in relation to key performance indicators.

32. Despite National Grid's delivery functions being set out in secondary legislation and enforceable by Ofgem,[92] we have heard that there is confusion and concern about how it will be held accountable in practice.[93] Mark Ripley explained that Ofgem had put in place "some operational incentives" and that National Grid was "subject to the same level of scrutiny from Ofgem in our EMR duties as we have for all of our other licensed duties, which is a well-known and established framework".[94] He added that National Grid had "a long history" of managing the potential conflict of interest between their core regulated businesses and their non-regulated businesses, and that risks were "well mitigated by both the arrangements [they] have in place as an organisation and the design of the qualification and auction process".[95] Dermot Nolan, CEO of Ofgem, told us that he would like Ofgem to be "very centrally involved" in DECC's review of EMR in the summer.[96]

33. We remain concerned about potential conflicts of interest between National Grid's executive and advisory role within EMR, and its commercial incentives-particularly given the move to include interconnectors in future Capacity Market auctions. The Panel of Technical Experts (PTE) and Ofgem have important roles in holding National Grid to account.

34. The questions raised by the PTE in its scrutiny of National Grid must be responded to publicly so that there is a clear line of sight between National Grid's original analysis, scrutiny by the PTE, and subsequent policy decisions by DECC and Ofgem. We recommend that DECC's upcoming review of EMR should include a point-by-point response to the issues raised by the PTE. The review should look again at how conflicts of interest are dealt with. We also expect DECC to set out what steps will be taken to ensure that National Grid does not have an unfair commercial advantage when interconnectors participate in future Capacity Market auctions.

Demand-side response

35. Demand-side response (DSR) could provide an important contribution to managing security of supply and cutting energy consumption. It offers a cheaper and greener alternative to building new generating capacity and could make a meaningful contribution towards security of supply.

36. There remains some lack of clarity as to the exact definition of what technologies are considered by DECC to be included within demand-side response measures. For example, back-up diesel generation is in our view not genuine demand reduction but localised generation. While Mark Ripley, from National Grid, categorically stated that diesel farms were not included in the definition,[97] the Minister acknowledged that "demand-side response is defined in the system as reduction in demand from behind the point of the consumer's connection. It is hard for the Grid to be able to differentiate between different types".[98] Baroness Verma also wrote to us that:

    Demand-side response (DSR) is the active voluntary reduction in the amount of electricity a user is taking from the grid at a given moment in time. This can be achieved through the use of on-site (back-up) generators; shifting a business operation to another time of day; or reducing demand by switching off or turning down electricity use. […]

    These providers-whether generation or load reduction services-can be referred to as "demand side" providers.[99]

37. We recommend that the definition of demand-side response should exclude consumers turning on their own generation assets such as diesel generators. This agreed definition should be consistently and immediately applied by DECC, Ofgem and National Grid.

38. We have regularly outlined our concerns about the unfair treatment of DSR in the Capacity Market,[100] and contributors to this inquiry outlined similar concerns that demand-side response had not received sufficient attention and was disadvantaged compared to generation capacity.[101] In particular, DSR providers can only bid for one-year contracts, whereas new generation can receive capacity agreements of up to 15 years.[102] Tilting the playing field against a nascent technology like DSR is exactly the opposite of the approach usually followed by DECC.

39. The restriction of DSR contracts to one-year was described as a clear barrier to the development of the industry, as the timeframe is simply not long enough to incentivise businesses to change their practices.[103] Citizens Advice explained that the current approach ran the risk of locking Britain into long-term contracts with new-build power stations that may not be needed and that "some DSR may be blocked from coming forward, even if it turns out cheaper on a year-by-year basis".[104] Evidence from markets in other countries, where equal contract lengths are awarded to both generation and demand capacity, suggests that DSR can make significant contributions, without being at the expense of new generation.[105] Sara Bell, CEO of Tempus Energy, explained that:

    To ask different resources to compete on uneven grounds does not make a level playing field. The reason why the contract length is the same in other markets is to create that level playing field. Demand-side customers, when they become flexible, need technology. They need to make that investment but, much more importantly, they need to, as a company, buy into the value of being flexible.[106]

40. Less than 0.4% of the capacity procured in the 2014 auction was awarded to DSR.[107] DECC expects DSR to primarily bid into the first one-year-ahead Capacity Market auction in 2017, for which a small amount of capacity has provisionally been set aside.[108] However, concerns were raised that the capacity procured during the 2017 auction runs the risk of being reduced in the event that it transpires that too much capacity was procured in December 2014.[109] Professor Newbery warned that:

    We might then find that because we have procured so much, there is not much space left and the price at which we could have got [capacity] will be substantially lower. Then we will say, "What a pity. It would have been a good idea to wait until we got these cheaper options on the table".[110]

Jonathan Mills, Director of EMR at DECC, acknowledged that the amount of capacity to be procured in the 2017 auction could be reduced:

    I think the main way in which we are managing the risks of procuring too much or too little are the T-1 auction. We have not bought everything that National Grid say they think we will need in the delivery year at this stage. We left some open to be bought in T-1. Should we find that demand forecasts have lowered or there is more other plant on the system outside the capacity market, then we have the option of reducing the amount that we procure at that stage.[111]

41. While acknowledging the cost-reduction potential of demand-side reduction and being "pleased to see that there was some demand-side reduction successful in the auction," the Minister warned that "we have to be very careful what we mean by demand-side reduction, because often it is localised generation that is not in major plant".[112] He added that DECC "had extensive discussions with the DSR fraternity" and that "some of the concerns that they had will be part of the review over the summer".[113]

42. DECC is still failing to ensure that demand-side response (DSR) measures are on a level playing field in the Capacity Market. If we do not invest in DSR today, we may be forced to pay for more expensive generation capacity that we do not need in the future, thereby locking ourselves into a pattern of higher costs and, potentially, higher emissions.

43. We recommend that DECC's review of EMR makes it easier for DSR to have a much bigger role in future Capacity Market auctions. DECC should consider increasing the contract length of DSR capacity agreements in the next Capacity Market auction. We also recommend that DECC set out a more detailed strategy on how to help the DSR market grow to reach its full potential, in line with its proclaimed approach of supporting early stage technologies.

77   Energy and Climate Change Committee, First Report of Session 2012-2013, Draft Energy Bill: Pre-legislative Scrutiny, HC 271-I, para 198 Back

78   Citizens Advice (IEM 005) para 3, 5 Back

79   Q69 [Andrew Buglass], Q138 [Sara Vaughan] Back

80   Department of Energy and Climate Change, 'Interconnectors to participate in the Capacity Market from 2015,' accessed 3 February 2015 Back

81   Q109 [Sara Vaughan, Rupert Steele] Back

82   Q137 [Sara Vaughan], Q153 [Rupert Steele] Back

83   E.ON (IEM 017) para 23 Back

84   Q69 [Simon Moore] Back

85   Q68 [Professor David Newbery] Back

86   Q228 [Mark Ripley] Back

87   Q216 [Mark Ripley] Back

88   Q219 [Mark Ripley] Back

89   Qq246,248 [Rt Hon Matthew Hancock] Back

90   Q291 [Rt Hon Matthew Hancock] Back

91   Ofgem (IEM 006) Back

92   Department of Energy and Climate Change (IEM 023) para 52 Back

93   RenewableUK (IEM 040) para 15, Q109 [Chris Elder] Back

94   Q175 [Mark Ripley] Back

95   Q217 [Mark Ripley] Back

96   Oral evidence taken on 27 January 2015, Q14 [Dermot Nolan] Back

97   Q226 [Mark Ripley] Back

98   Q295 [Rt Hon Matthew Hancock] Back

99   Letter from Baroness Verma to the Energy and Climate Change Select Committee (January 2015) Back

100   Letter from the Energy and Climate Change Committee to the Rt Hon Matthew Hancock MP (September 2014), Energy and Climate Change Committee, First Report of Session 2012-2013, Draft Energy Bill: Pre-legislative Scrutiny, HC 271-I, para 50, Energy and Climate Change Committee, Fourth Report of Session 2010-2012, HC 742, Electricity Market Reform, para 59 Back

101   Citizens Advice (IEM 005) para 18, Tempus Energy (IEM 015) para 22, Q122 [Sara Vaughan], Q146 [Sara Bell] Back

102   Department of Energy and Climate Change, Implementing Electricity Market Reform (EMR) (June 2014), p 103, Citizens Advice (IEM 005) para 18, Tempus Energy (IEM 015) para 22 Back

103   Q122 [Jeremy Nicholson], Q146 [Sara Bell] Back

104   Citizens Advice (IEM 005) para 18 Back

105   Q90 [Professor David Newbery], Q141 [Sara Bell] Back

106   Q146 [Sara Bell] Back

107   National Grid, Final Auction Results (January 2015) p 7 Back

108   Department of Energy and Climate Change (IEM 023) para 48 Back

109   Citizens Advice (IEM 005)  Back

110   Q87 [David Newbery] Back

111   Q301 [Jonathan Mills] Back

112   Q289 [Rt Hon Matthew Hancock] Back

113   Q289 [Rt Hon Matthew Hancock] Back

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Prepared 4 March 2015