Low carbon network: Government Response to the Committee's First Report of Session 2016-17 Contents

Appendix: Government response

Introduction

1.The Government welcomes the Energy and Climate Change Committee’s (ECCC) inquiry and report into low carbon network infrastructure. As the Committee recognises, this is an exciting time in the evolution of our energy system. With changing patterns of generation and demand and the introduction of new, innovative technologies, the network needs to be reinforced, upgraded and extended. At the same time, we need to increase our level of interconnection with other markets and make the system smarter through enabling deployment of, for example, storage and demand side response, so that we can manage the system more flexibly and at least cost.

2.The Government is committed to ensuring we have a secure, clean and affordable energy system. A low carbon network infrastructure that provides an efficient and reliable source of energy to power people’s home and businesses is essential. Initial steps have been taken and the system is already changing. Sustained and concerted effort is needed by Government, Ofgem, the network industry and wider stakeholders to ensure the transition continues and that the network acts as an enabler for change rather than an obstacle to it.

3.Understanding the whole system costs and allocating them fairly will be central to ensuring an efficient and secure network. Maximising competition will help drive up performance, bring new players into the market and bear down on costs. The Government agrees that this evolution required us to re-think roles and responsibilities, to ensure they are fit for purpose and deliver the most cost-effective outcomes.

4.The Committee is right to stress the need to move swiftly. The pace of change in the energy landscape has accelerated in recent years with the significant deployment of distributed generation, falling costs of technologies such as storage, roll out of smart meters, greater interconnection, and innovative solutions being developed and deployed against a background of changing patterns of demand and generation. It is vital that the policy and regulatory framework enables and supports positive changes.

5.However, as the Committee itself warns, it is imperative that any changes are properly considered by stakeholders. Government and Ofgem continue to engage with stakeholders across the range of areas as we seek to understand the issues and develop the right frameworks to deliver the most cost-effective outcomes.

6.Government welcomes the Committee’s consideration of these important issues and has responded to each of the recommendations made, in detail below.

Government response to the Committee’s conclusions and recommendations

Distributed generation

We call on the Government to establish a cross-departmental working group to investigate and report on improving the integration of the connection and planning-consent processes in England. This investigation should include an assessment of mechanisms - such as heat maps and centralised, standardised connection applications - that could simplify these processes and better inform generators about them.

7.The Government recognises the importance of a transparent and effective connections process. As the Committee noted in its report, connections to the electricity distribution network have increased significantly in recent years. Distribution network operators (DNOs) connected over 340,000 generation projects from 2010-15, which equates to over 11GW of new generation.1

8.There has already been significant effort to help improve and streamline the connections process. Network companies have taken steps to ensure they meet their connection customer needs, for example, through the annual work plans produced under Ofgem’s RIIO Incentive on Connections Engagement2, which requires them to understand customer needs and take steps to address them. This has led to, for example, DNOs developing online facilities where smaller, routine connections can be requested, tracked and paid for and DNOs providing tailored guidance to support smaller, non-professional developers such as community projects. Ofgem is closely monitoring progress and will use stakeholder feedback to determine whether further action is required.

9.There is already an Energy Networks Association (ENA) Distributed Generation DNO Steering Group which considers connection issues. It comprises DNOs and representatives of the distributed generation community. The Group raises issues to be discussed at the Distributed Generation Fora held annually. These events are attended by Government, Ofgem, DNOs and developers. In addition Government and Ofgem attend ENA distribution transmission interface steering group which oversees work to improve coordination between the transmission and distribution networks.

10.Through its Quicker and More Efficient Connections3 project, Government, Ofgem and DNOs have been considering what more can be done. This has included work to improve the connections process, maximise the use of existing network capacity through, for example, the deployment of smart solutions, and provide better transparency on network capacity and heat maps. It has also specifically considered the case for greater investment in anticipation of need (see paragraphs 14 to 16 below).

11.As the Committee highlighted in its report, the planning consent process is an integral part of generation and connection projects. It ensures that the impacts of any project are properly considered and, where appropriate, mitigated. During the inquiry the Committee specifically raised concerns about the relationship between the consenting process for generation and connection projects. Wherever practicable, applications for new generating stations and connections should be contained in a single planning application or in separate applications submitted in tandem which have been prepared in an integrated way. This is set out in the National Policy Statements4, which are ratified by Parliament.

12.The National Policy Statements recognise, however, that this approach may not always be suitable or possible. For example, lead times for generation and connection elements may differ. In some cases, therefore, applicants may submit a planning application for one element only but contains some information on the second strand of the project. When this occurs, the decision-maker will need to be satisfied that there are no obvious reasons why the other element is likely to be refused. The Government believes that this approach helps ensure that projects can progress in a timely manner while safeguarding the interests of developers, local communities and other interested parties.

13.Government does not believe that a new working group is necessary at this stage as there are already a number of groups looking at these issues and the creation of a new body may duplicate existing effort and dilute focus. Instead, it will continue to engage with Ofgem, the network industry and developer stakeholders, through existing fora, to explore what further steps can be taken to improve the process and ensure progress is maintained.

Ofgem should carry out further impact assessment on systems of cost recovery for anticipatory investment; this should include analysis of who bears the costs of stranded assets, so that relevant decision-makers are properly incentivised to avoid them.

14.Government believes that anticipatory network investment can bring more timely and cost-effective connections, however, it also carries the risks of stranded or under-utilised assets.

15.As noted in the Committee’s report, Ofgem has invited network companies and stakeholders to bring forward proposed anticipatory investment projects with evidence of the need and what the regulatory obstacles are to their realisation. It is currently considering five such ‘trial projects’ put forward by DNOs and stakeholders. Some of these projects are at a very early stage and Ofgem has highlighted the additional information that it would like see - this includes the criteria that could apply to each scheme to demonstrate the necessary certainty to justify the need for early investment.

16.Government agrees that we must be mindful of the costs and risks of stranded assets. These considerations will form an integral part of Ofgem’s discussions with DNOs and stakeholders and any resultant decisions. Ofgem remains open to receiving further trial projects. Ofgem intends to publish an update document in the autumn outlining the learning from these trials and its proposed way forward.

Network charges and connection costs

Cost-reflective charging should account for the reality that many renewable-energy sources are location-specific and distant from demand sources, particularly as UK transmission charges remain high by EU standards. DECC should investigate the disadvantage UK generators may consequently face against other European generators as Great Britain becomes more interconnected, and the impact this may have on development of domestic renewable generation.

17.Government supports a diverse energy mix, where a range of technologies, including interconnectors, can compete in an open market. Interconnectors exporting into Great Britain do not pay GB transmission charges, however, they will be subject to a range of charges and taxes in their own country, which British generators are not when they benefit from accessing new export markets.

18.The Government acknowledges that transmission charges vary across Europe. However, a recent study published4 by the Agency for the Cooperation of Energy Regulators (ACER), the agency representing independent regulators across Europe, found no evidence that lack of harmonisation in transmission charges is creating investment inefficiencies. The report also noted that network charges were just one element that would be considered by generators when making investment decisions. For example, although interconnectors and generators are both able to participate in the GB Capacity Market, only generators are able to compete for 15 year contracts. Interconnectors can only participate on a rolling one-year basis.5

19.With respect to renewable energy, the primary policy support mechanism, Feed-in Tariff with Contract for Difference, removes price risk from generators and means they are unaffected by changes in the wholesale price that may be caused by increasing imports of lower cost energy. Further, the potential for interconnectors to export during times of high generation and low demand (for example a windy summer weekend afternoon), is expected to increase the load-factor of intermittent generation as they will be able to continue to access the market to sell their power at times when in the absence of interconnection they would otherwise be curtailed. As the UK increases investment in renewables, this flexibility will become increasingly important, not only to maximise the environmental benefits of renewable energy across the region, but also to ensure the system is as efficient as possible.

Ofgem should analyse the costs and benefits of levelling connection costs across Great Britain.

20.Government believes that it is important that customers pay a fair price for connecting to the electricity network. There are a number of locational factors which affect connection costs such as available network capacity, whether undergrounding is required (e.g. in urban areas), and distance of the customer from the network. These are more pronounced for larger connections than smaller connections.

21.Ofgem recently looked into the variation in DNO connection costs (for smaller connections) and found that there was regional variation. This was due to regional differences in the average amount of work needed to connect in each region, regional differences in cost and differences in the amount of work that the DNO assumes that the customer will want them to complete. Ofgem did not identify any evidence to suggest that DNOs were overcharging customers, but it has required the DNOs to review and improve the quality of information provided to prospective customers about the cost of getting connected.6

22.Given the locational variation in connection costs, introducing a level national connection cost would mean customers in some areas picking up a share of the connection costs of other customers. The current cost reflective approach to connections helps to ensure the efficient use of the network. It sends important price signals to customers and helps utilise existing network assets more effectively. Removing such a price signal could increase overall connection costs as it may encourage developers to connect in areas with higher connection costs as they would not be exposed to the full cost. The price signal also incentivises connecting customers to engage with smart grid solutions, which can reduce connection costs.

Smart Meters

We are concerned that the roll-out of smart meters is not progressing quickly enough to achieve the necessary mass to truly create a smart energy network.

23.The Government plans for every home and small business to be offered smart meters by the end of 2020 as they will help households and businesses take control of their energy use, bring an end to estimated bills, make switching supplier faster, and help bill-payers become more energy efficient. The Programme is building momentum - there are now over 3.6 million smart and advanced meters operating across homes and businesses in Great Britain in the Foundation stage of the Programme, ahead of the nationwide roll-out.

24.The central data and communications infrastructure that will be used by all energy suppliers to operate their smart meters has begun final testing. Government assesses all nine large energy suppliers as being adequately or well prepared to start using the Data Communications Company.

Gas and heat networks

Ofgem should build on the promise of green gases by continuing to investigate and clarify safe levels for their injection. Both the Government and Ofgem should set indicative targets for biomethane and hydrogen deployment, and consider what support might be needed to deliver consequential changes to network infrastructure.

25.Decarbonising how we heat our homes and businesses, including heating used in industrial processes, is an essential part of meeting the UK’s 2050 carbon reduction target under the Climate Change Act. As the Committee highlighted during the inquiry, a transformation will be required to deliver this with significant implications for the UK’s energy infrastructure.

26.There are a number of technologies with potential to support this transformation, including low carbon gases such as hydrogen and biomethane, as well as heat networks and heat pumps. However, it is not yet clear which of these will work best at scale and in keeping costs down for consumers. Different approaches need to be tested. The Government plans to set out our approach to addressing the long term questions on heat decarbonisation as part of the strategy to meet our carbon budgets.

27.Over the long-term it is likely that a mix of different technologies will deliver the best outcome for consumers and decarbonisation. This is why Government is already supporting low carbon heat deployment through the Renewable Heat Incentive (RHI) and have allocated £330m to support development of heat networks. The Government also announced a doubling of DECC’s spend on Innovation to £500 million over the next five years and we expect to have schemes aimed at cost reduction and accelerating the uptake of low carbon heat technologies.

28.The regulatory framework also provides network operators with opportunities to undertake innovation projects to better understand hydrogen and other decarbonisation options whilst controlling costs to consumers. Through the RIIO-GD1 price control7, Ofgem encourages the gas distribution networks to connect biomethane production facilities to the gas network and has secured a voluntary standard of service for these connections. Through work funded via the Network Innovation Competition, the networks are developing new sources of biomethane, as well as investigating the possibility of injecting hydrogen in to the existing gas network. The composition of gas flowing through the network is governed by the Gas Safety (Management) Regulations which is the responsibility of the Health and Safety Executive.

The Government has rightly set an ambitious target for district heating—one which requires significant private-sector investment. A regulatory investment framework for district heating, similar to those for other networks, would aid this. It would also complement existing voluntary schemes in providing independent safeguarding for consumers. Ofgem should be required by the Government to regulate district heating networks, and the Government should seek to make whatever legislative changes are necessary to enable this.

29.Government is keen to accelerate the deployment of heat networks in the UK, as a cost-effective way of cutting carbon emissions and providing reliable and affordable heat to customers. Government therefore welcome the Committee’s interest in this area.

30.In June 2016, Government published a consultation seeking views to inform the design and management of the Heat Network Investment Project, which aims to provide £320m of capital support to increase the volume of heat networks being built, deliver carbon savings, and help create the conditions necessary for a self-sustaining heat network market to develop. Government has also been working closely with the heat network industry and trade association to establish the ‘Heat Trust’, a voluntary consumer protection scheme for heat network customers and on the development of the voluntary Heat Network Code of Practice, which establishes minimum standards for the design, installation and operation of heat networks.

31.An important element of our overall heat networks strategy is creating a sustainable and enduring market framework to ensure that current public funding is a time-limited catalyst to support the move to a permanent, market-based industry, which continues to expand.

32.As the Committee has recommended, one option for creating a sustainable market is the development of a regulatory framework, and working with Ofgem, relevant trade bodies and wider industry to consider this, alongside a range of other approaches. As part of this Government will look to address questions about the cost of heat networks, their quality, how to improve rates of return and certainty of revenue generation for investors, and how to ensure that consumer protections are effective. Government look forward to working with Ofgem, consumer bodies and the sector itself as we take this work forward.

Storage

Further large-scale storage, such as Pumped Hydro and Compressed Air Energy Storage, could be of great value in managing variable generation, but there is uncertainty as to the potential for future deployment. We recommend that the Government commissions a study on the future of large-scale storage in the UK which includes consideration of potential sites and what support such projects would need to be viable.

33.Government recognises the potential role that cost effective energy storage, alongside other forms of flexibility, could play in contributing to a resilient, affordable and low carbon energy system in the UK. Government has already provided funding to identify potential sites for pumped storage across the UK. The study produced by Quarry Battery Company, identified around 1GW of viable pump storage sites (e.g. repurposing existing quarries) and up to 15GW of more novel storage applications (e.g. low head storage solutions). Other storage developers (e.g. SSE and Scottish Power) are also considering large pumped hydro sites in Scotland. Compressed air and liquid air technologies also show promise as cost-effective alternatives to pumped hydro, with fewer geographical constraints. However, these technologies are still at the innovation stage in the UK, and have not been demonstrated yet at large scale here

34.As part of its work on a smart, flexible, energy system, Government will continue to assess the case for flexibility at all scales, including large scale storage, in delivering benefits for the UK’s electricity system.

The current regulatory conditions for storage are hindering its development. We welcome the Government’s consultative approach to this matter, but hope it will proceed with a sense of urgency. We urge the Government to publish its plans, as soon as possible, for exempting storage installations from balancing charges, and from all double-charging of network charges.

35.As the Committee recognises, Government and Ofgem have been working with stakeholders to ensure we develop the right regulatory framework for storage. We will set out the barriers (such as, how storage is treated under the current network charging regime) and any initial options to address them soon.

36.As part of this work, we will identify some simple changes to the network charging regime that could be taken forward immediately (e.g. development of guidance on the classification of storage in the current charging methodologies and making sure network operators offer storage devices flexible connections). Ofgem will also seek views on whether, and which, further elements of the charging regime should apply differently to storage operators in future.

Storage technologies should be deployed at scale as soon as possible. We support network utilisation of storage: this helps balance the system, and provides storage operators with a revenue stream that encourages its development. Allowing networks to operate and procure storage, especially in the short run, could also facilitate these benefits. However, we have concerns about network ownership of storage. In the long run, we do not want networks to have vested interests in particular technologies that discourage them from switching where more cost-effective solutions emerge; we are also concerned about any expansion of networks’ monopoly power more generally. DECC and Ofgem should analyse the long-term risks of network ownership, operation and procurement in their work on storage.

37.Under the current framework, network operators are able to procure flexibility services from third parties and we encourage them to do so when this is beneficial for consumers. Elements of the RIIO framework, including the Network Innovation Competition8, incentivise network companies to trial new technologies or ways of working and to adopt those which will benefit consumers. Ofgem has provided funding to a number of innovation projects where distribution network operators (DNOs) trialled the use of storage as an alternative to traditional network reinforcement.

38.The innovation funding, combined with the elements of the RIIO price control framework, such as the efficiency incentive and the Totex approach (which helps remove any bias towards capital expenditure over operational expenditure), provides an incentive to network operators to choose the most economic and efficient way of running their network, be that in the form of capital expenditure (investing in cables and wires) or operational expenditure (procuring services from third parties). This should ensure that network companies can procure services from storage providers (or other flexibility providers) to use flexibility efficiently to defer or avoid investments, support cheaper and timelier connections, or to better manage issues on their networks.

Demand side response

The promised review of Demand Side Response (DSR) by Ofgem is a sensible first step towards clarifying and unlocking the potential for DSR technologies and business models. However, we maintain the views of our predecessor Committee that the Government needs to set out a more detailed strategy for DSR. This strategy and any work on this issue by Ofgem must also pay close attention to the risks of DSR for vulnerable customers, and how best to mitigate these.

39.Government agrees that demand side response (DSR) has the potential to play an increasingly valuable role in system operation, helping to defer or avoid the need for costly network reinforcement.

40.Government and Ofgem are taking forward key changes in the operation of the system including rolling out smart meters and enabling half-hourly settlement for more consumers, both of which will make it easier for consumers to offer DSR. In addition, Government will seek views and evidence on consumer protection issues related to DSR (e.g. data privacy, social impacts, informing consumers, and preventing abuses) soon.

Interconnection

Significant interconnector expansion will help balance a low-carbon network, and we support it for that reason. We note that Great Britain is likely to be a net importer of electricity; development of interconnection should be accompanied by a strategy to develop sufficient low-carbon generation capacity for export.

41.Government is committed to increasing electricity interconnection with projects that support our energy objectives. Interconnection allows consumers to access cheaper power from overseas markets, drives greater competition amongst generators and improves price efficiency by creating larger markets. Ofgem’s analysis shows that the current round of interconnector projects are expected to deliver at least £11.8bn of consumer benefits over 25 years.9

42.The primary focus of our electricity policy is to provide a secure electricity supply which keeps consumer bills as low as possible and allows us to meet our low carbon commitments. Interconnectors contribute to all these objectives, providing additional flexibility to export low-carbon generation during periods of surplus, and this is to be welcomed.

Innovation

We strongly support Ofgem’s commitment to network innovation, but feel there is room for improvement. Ofgem must collect standardised trial data to optimise learning from projects. Furthermore, it should allocate proportionally more funding to later-stage development, and seek opportunities to leverage other sources of funding to achieve project commercialisation. A stronger role for non-network companies in using Network Innovation Stimulus could also balance DNOs’ propensity for risk aversion in the short term, while counteracting it in the long run.

43.Innovation enables businesses to develop new ideas, products and services, and create new jobs and export opportunities. The UK has a long and strong history in science and innovation and a well-earned reputation for the development and protection of intellectual property. Innovation will play a critical role in modernising our networks, ensuring an efficient means of balancing supply and demand and keeping costs down for consumers. Ofgem is currently conducting a review of its innovation schemes to make sure they deliver genuine innovation on the electricity and gas networks and continue to work in the consumer’s interest.

44.This review is considering a wide range of issues, from the governance of the schemes to the level of funding available. Government welcomes the Energy and Climate Change Committee findings and the themes noted, such as the role of non-network companies, are being considered as part of the Ofgem review. Ofgem is committed to working with stakeholders to ensure that the changes that result from its Innovation Review maximise the benefits and value for money for consumers. Ofgem aims to consult on the findings from its review in the autumn, with a decision expected in early 2017.

45.Innovation in energy storage, demand side response and network development has also been a focus of public sector funded and managed innovation support recently; for example, more than £80m public sector controlled support has been committed to energy storage research, development and demonstration activities since 2012.

46.The Government has significantly increased its energy innovation support going forward, such that annual spend by 2021 will have doubled to over £400 million per annum. Ministers will make announcements in due course on the specific funding programmes under the energy innovation budget, but in the Budget 2016 announcement the Government confirmed that it would allocate at least £50 million to help innovation in energy storage, demand side response and other smart technologies over the next five years.

47.Funding for Innovate UK has risen from £315 million in 2009/10 to £567 million in 2016/17. Innovate UK helps to commercialise innovative ideas with direct research and development funding and also supports a network of 11 Catapult centres across the UK, that have already attracted over £1.6bn in investment in their first 5 years, including Catapults looking at energy systems, future cities, transport systems and digital transformation—all areas which are important to development and delivery of low carbon network infrastructure.

System operation

The benefits of Distribution System Operators (DSOs) seem near-universally acknowledged, yet there is no clear Government road map to their implementation. The Government should develop and publish a road map for DSO introduction, identifying future legislative and regulatory changes needed. The road map should include a plan to require small-scale generators to provide real-time information to DSOs. The relationships across DSOs and between DSOs and the Transmission System Operator must also be clarified.

We recommend creating an Independent System Operator (ISO). Despite strong efforts by National Grid itself and Ofgem to mitigate the potential for conflicts of interest, it seems intractable and growing. Unnecessary asset development, or giving interconnectors an unfair advantage over existing and emerging balancing tools, could dilute the impact of other efforts to develop low-carbon network infrastructure. We note these concerns may also arise for Distribution System Operators in future. The Government should set out its intentions regarding an ISO as soon as possible, and consult on a detailed, staged plan for their implementation, so as to avoid injecting uncertainty into the energy sector. In particular, it will be important to act in a fashion that retains National Grid’s considerable technical expertise.

48.Government agrees with the Committee that the changing energy system is leading to greater interaction between the electricity transmission and distribution networks, with two-way flows of power, and a greater role for active management of supply and demand on distribution networks than previously.

49.This evolution prompts a wider debate about whether the current system architecture is best placed to minimise costs for consumers, and we look forward to the Energy Systems Catapult and the Institution of Engineering and Technology progressing the recommendations of the Future Power Systems Architecture project and will provide support where necessary. The evolving challenges we face may require new roles to be taken on by different bodies, such as a wider remit for distribution network operators or the System Operator.

50.At the distribution level, the RIIO-ED1 price control10 recognises this and provides incentives to the distribution networks owners (DNOs) to initiate the transition to becoming distribution system operators. Government and Ofgem have also been working closely with the Smart Grid Forum11 and other industry partners to consider what additional changes to roles and responsibilities in the energy system may be needed, including what the DSO role could look like in the longer-term. Government will publish its thinking soon.

51.As the Committee notes, the changes also raise the question as to whether the current role and governance of the transmission system operator remain appropriate. There are a range of views here. The Committee concludes that the System Operator should be made independent, citing concerns about conflicts of interest.

52.In its report into delivering future proof energy infrastructure, ‘Smart Power’12, the National Infrastructure Commission13 considered whether Great Britain has the right framework in place to ensure the electricity grid is operated efficiently. It concluded that creation of an entirely independent System Operator should not be treated as an immediate priority, but should be kept under review in light of progress towards strengthening National Grid’s independence. There is also much to learn from the experience of other countries, such as the creation of local markets in New York and the success of Independent System Operators in driving competition and innovation in North America and elsewhere.

53.Government recognises the real strengths that National Grid brings as the electricity transmission system operator in terms of its track record and expertise. Government has been working with National Grid and Ofgem on the future role of the System Operator, and is now considering the case for changes to the status quo.


1 Ofgem data on DNO performance in 2010-2015

5 This is because the flows on the interconnectors are dictated by market forces, and may change over time. The one year nature allows Government to reflect the latest market projections in the de-rating factors, ensuring that we procure the right amount of capacity in the Capacity Market auction.




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11 October 2016