Memorandum by Ofgem
INTRODUCTION
1. Ofgem is the regulator of the gas and
electricity industries in Britain. Protecting consumers is our
first priority. We do this by promoting competition, wherever
appropriate, and regulating the monopoly companies which run the
gas and electricity networks. Other priorities and influences
include:
— helping to secure Britain's energy
supplies by promoting competitive gas and electricity markets—and
regulating them so that there is adequate investment in the networks;
— contributing to the drive to curb
climate change and other work aimed at sustainable development
by, for example:
— helping gas and electricity industries
to achieve environmental improvements as efficiently as possible;
and
— taking account of the needs of vulnerable
customers, particularly older people, those with disabilities
and those on low incomes.
SUMMARY
2. The target is achievable but very challenging
both for the UK and for the EU. It is likely to require unprecedented
levels of investment and technical innovation in a relatively
short space of time. This will be required in all areas of the
supply chain: the generation market, the transmission and distribution
networks and the retail market.
3. The electricity transmission networks—the
wires which carry electricity from generators to customers—do
not have enough capacity or appropriate access rules to meet the
target. New lines need to built in order to help connect more
renewables, and better use needs to be made of existing lines.
Ofgem is playing its part by allowing a 100% increase in investment
in the energy networks and by reviewing the arrangements for allowing
generators to gain access to the networks.
4. The biggest single obstacle faced by
renewable generators and transmission owners will remain planning
provisions—particularly for major electricity infrastructure.
It is estimated that there are currently 8 gigawatts (GW) of renewable
generation capacity delayed within the onshore planning system.
Whilst we recognise that the UK Government's Planning Bill aims
to improve the planning process for major infrastructure projects,
this legislation would apply only to England and Wales, where
planning delays are less acute at the moment.
5. Meeting the target will not be cheap.
It is vital that the policy instruments designed to meet it also
protect customers from facing excessive or inefficient costs.
This is particularly important given the context of rapidly rising
energy prices and increasing fuel poverty. The experience of other
EU Member States provides evidence on the cost-effectiveness of
different policies. However, their relative performance will be
influenced by other factors too, such as the lack of planning
constraints and the availability of spare transmission capacity.
Question 1—How achievable are both the EU's
general 20% and the UK's national 15% renewable energy targets?
6. The target is achievable but very challenging
both for the UK and for the EU. It is likely to require unprecedented
levels of investment and technical innovation in a relatively
short space of time. This will be required in all areas of the
supply chain: the generation market, the transmission and distribution
networks and the retail market as it responds to the pricing signals
likely to emerge from an electricity network with high penetration
of intermittent generation.[2]
7. We think it is vital that the policy
instruments designed to meet the target also protect customers
from facing excessive or inefficient costs. This is particularly
important given the level of investment required and the context
of rapidly rising energy prices and increasing fuel poverty. Lessons
can be learned from the existing support mechanism for renewable
energy—the Renewables Obligation (RO). The RO was designed
to sit alongside the competitive wholesale market and allow subsidies
to fall away as technologies became competitive. The proportion
of Britain's energy coming from renewables has increased since
the RO was introduced but by far less than is required to meet
the target and there are questions about its cost effectiveness.
The Government is now considering what form the RO should take
in the future. Given the risks and uncertainties in meeting the
very challenging EU target, any new policy instrument needs to
be robust to any future obstacles. There could be continued problems
with planning if Government's reforms take time to implement or
are unsuccessful. In addition, for the next few years there may
be bottlenecks in the renewable manufacturing supply chain (for
example for wind turbines) as EU and global demand surges and
manufacturers seek to increase their manufacturing capacity.
8. It is important to note that the 15%
target relates to energy. Much of Britain's energy use
is in transport, where the scope for renewable energy is more
limited, and in the use of natural gas in businesses and domestic
homes. This means that the proportion of electricity that
must be generated from renewable sources in order to meet the
UK's target is likely to be much higher than 15%. Many estimates
put it in the region of 35 to 40%. To see what this means in practice,
a renewable electricity target of 38% would equate to an
electrical output of around 135 terawatt hours (TWh) compared
to a total GB output of around 355TWh. Assuming a generous load
factor of 35% for renewable generators,[3]
this would require renewable generation capacity at around 44
gigawatts (GW), equivalent to 56% of existing installed generating
capacity in Britain (78GW). To achieve this target in the next
12 years is immensely challenging, given the number of potential
barriers to increases in renewable electricity capacity. These
include:
— obtaining planning consents (for
generation sites and for grid connections/upgrades);
— obtaining access to the electricity
transmission grid;
— constraints in the supply chain for
generation (eg wind turbines) and connections (especially offshore);
— sourcing finance from investors and
debt suppliers;
— cost-effective support mechanisms;
and
— achieving the best balance between
the heat and electricity sectors.
9. Some of these barriers are outside Ofgem's
statutory responsibilities and powers. For example, Ofgem does
not have responsibility in respect of planning decisions. It is
estimated that there are currently 8GW of renewable generation
capacity delayed within the onshore planning system. A further
3.2GW is currently awaiting consent offshore.
10. Ofgem has an important role to play
in helping to meet the target through the way we regulate the
monopoly transmission and distribution networks which carry electricity
from generators to customers. We set price controls for all of
the network companies every five years and these create the financial
incentives on network companies to invest to expand capacity on
their networks to connect new generation. We also have the power
to approve or reject any changes to the way they charge for use
of their networks and any changes to the commercial rules that
govern how generators connect to and access the networks through
various industry codes. In addition, we can hear and settle any
disputes between a network company and a generator over the terms
of their connection to the network.
Question 2—How coherent are these proposals
in the context of the EU's energy policies in general and the
Third Energy Package in particular?
11. The European Commission emphasised in
its Strategic Energy Review in January 2007 that its clear policy
direction is to work towards sustainable energy markets. The Commission
listed a number of options aimed at achieving sustainable, competitive
and secure energy supplies in the EU. The "Green Package"
and the "Third Energy Package" provide the legislative
basis for delivering this vision. The two packages must be seen
together and are very important, significant and welcome initiatives
by the Commission. The Third Package initiatives are a vital step
in delivering a fully liberalised EU energy market. The Green
Package sets out a clear and significant commitment to promoting
renewable technologies, reducing carbon emissions and increasing
energy efficiency measures in the EU. Taken together, these initiatives,
when agreed, will allow for a paradigm shift in the EU energy
market which should include a buoyant market in renewables.Where
there are specific overlaps between the two initiatives it is
important that they be consistent with each other and with the
overall policy objective of securing sustainable and competitive
energy markets.
Question 3—To what extent are these targets
capable of improving the EU's security of energy supplies?
12. An increase in the amount of energy
from renewable sources could increase the overall generation capacity
available, as well as delivering a more diverse energy mix and
lowering reliance on imported fossil fuels. This could improve
security of supply.
13. However, there are potential risks to
security of supply. Wind is an intermittent resource and there
is limited experience of the operational challenges of running
an integrated transmission system reliably and within existing
quality standards with such a high proportion of intermittent
generation. The scale of the 2020 target and the limited time
available to meet it could also reduce security of supply. Ambitious
renewables targets, especially if supported by attractive financial
incentives, could divert investment away from other generation
technologies. In addition, the short space of time may require
the use of similar technologies or the same manufacturing design
for a significant proportion of our generation fleet. This reduces
diversity and increases the risks associated with "type faults"
being discovered with a particular turbine design. There are also
risks associated with some technologies that are not yet fully
tested in operational conditions such as offshore wind.
14. Nevertheless, an overall reduction in
security of supply could still be justifiable given the carbon
savings and other benefits associated with action to tackle climate
change.
Question 4—How effective has the existing
legislation (2001/77/EC) been in encouraging grid access for renewable
energy generators?
15. The Internal Market in Electricity Directive
requires that grid operators do not discriminate in the terms
they offer for connection and access to their networks. If properly
implemented, this should create a level playing field and prevent,
for example, grid operators owned by vertically integrated companies[4]
stopping new entrant renewable generators being denied access
to the system on reasonable terms.
16. The Renewables Directive allows renewable
generators to be given priority access to electricity grids ahead
of other forms of generation but it does not require Member States
do so. This is a matter for each Member State.
Question 5—To what extent does grid access
remain a significant barrier to increased consumption of renewable
energies? Is it consistently a problem across all Member States?
The Transmission Access Review
17. Ofgem is undertaking jointly with the
Government a review of the charging and commercial arrangements
to gain access to the transmission network and we will publish
our final report in May.
18. We originally called for reform in 2000
and primary legislation was introduced by the Government to enable
changes to be made. However, the industry argued at the time that
reform was unnecessary as the transmission system was unlikely
to be constrained for the foreseeable future. Since then, a large
queue has emerged of generators waiting to connect to the transmission
system or to receive an offer to connect.
19. Ofgem and BERR hope that the necessary
reforms can be designed and implemented under the existing industry
code governance framework, even though previous attempts to implement
reforms have been very slow and piecemeal. National Grid has announced
that it will raise a suite of proposed modifications to the current
arrangements based around three distinct models of reform. The
proposals will be analysed by the industry before coming to Ofgem
for decision. The Government has made clear that it will consider
primary legislation if the industry does not improve its performance
and bring forward appropriate reforms quickly.
Why transmission access needs to be reformed
20. The current arrangements for access
to the transmission network were designed for fossil fuel and
nuclear generation with relatively high load factors. They do
not allow low load factor plant such as wind to share existing
capacity with conventional generators. Nor do they provide the
transmission companies with enough information about the plans
of new and existing generators in order to build infrastructure
and allocate capacity in a certain and timely manner. Major reforms
of the existing arrangements are therefore necessary to allow
significant volumes of new renewable and other low carbon generation
to connect to the system.
21. Requests for connections to the transmission
network are dealt with on a "first come, first served"
basis. This means that generators who have finance and planning
permission may be further down the queue than generators who do
not have either in place but who may have approached National
Grid first. Transmission companies therefore lack certainty over
new users' plans to proceed to connection, as well as existing
generators' intentions to continue to use the transmission system
for a defined period. Without user commitment it is difficult
to present a robust case as to why the transmission licensees
should risk building large infrastructure substantially ahead
of need. If the transmission licensees predict the need for a
new line incorrectly, investment could be wasted and the costs
would have to be paid by consumers. We are also concerned at the
level of asset stranding risk that customers could face.
22. Conversely, appropriate user commitment
would allow the transmission licensees to proceed and build projects
several years in advance of need so that the major reinforcements
could be delivered to coincide with generators' wishes to connect.
In the case of existing generators, if a more appropriate level
of user commitment was provided, the transmission licensees would
have better information on when a particular generator would exit
the system, and when its capacity would be available for others
to use. This is a prime example of how existing infrastructure
could be used more efficiently.
23. The connection of renewable generators
represents an additional challenge. Transmission companies have
traditionally adopted an approach of "invest then connect"
when dealing with new generation connection requests. They will
not allow a generator to connect until they have invested to increase
capacity in the transmission system. This work can take several
years. Generators are only able to connect quickly to the transmission
system if they choose to connect in an area of the system that
has spare capacity. However, renewable generators only have intermittent
output and low load factors and when connected will displace existing
fossil fuelled generation. This is because Britain has very limited
export capacity and electricity demand is not very sensitive to
changes in price, so the extra electricity is unlikely to be absorbed
by additional demand in Britain or on the continent. Transmission
companies could therefore take a different approach and connect
renewable generators without investing to increase overall network
capacity substantially. Renewable generators and fossil fuelled
generators would then share capacity on the system.
24. However, this may not work in all locations.
For example, it may not be possible where the transmission system
is already constrained and there is not enough capacity to allow
existing generators to export their power to other parts of the
system, such as in Scotland. If two generators wish to dispatch
their electricity to the same part on the network at the same
time, one must be paid a premium for not being able to do so (ie
it is constrained off). If no generators wish to dispatch their
electricity, but National Grid estimates that more power is needed
in order to balance supply and demand, it can force a generator
to dispatch in return for being paid a premium (ie it is constrained
on). Simply connecting more generation will add to the existing
costs of constraints on the system and raise customers' bills.
25. As part of the Transmission Access Review,
BERR and Ofgem will be assessing what the potential benefits (primarily
a reduction in carbon dioxide emissions) and costs (higher constraint
costs for electricity customers) if we moved from the existing
approach to a "connect and manage" approach where the
transmission company simply allowed all renewable generation to
connect on request and then managed any resulting transmission
constraints.
26. Regardless of the improvements that
are made to the transmission access regime, the single largest
difficulty faced by renewable generators and transmission owners
will remain planning provisions—particularly for major electricity
infrastructure. This can be illustrated by the case of the upgrade
to the Beauly-Denny line. This project was referred to a public
inquiry by the relevant planning authorities and has already undergone
a two year consultation process, prior to a further period after
which Scottish Ministers will take their decision on whether to
allow planning permission for the line. Whilst we recognise that
the UK Government's Planning Bill aims to improve the planning
process for major infrastructure projects, this legislation would
apply only to England and Wales, where planning delays are less
acute.
Funding to renew the energy networks
27. Ofgem has played its part in providing
the necessary funding for the transmission companies to invest
to increase capacity to connect new renewable and other low carbon
generation. In recent price reviews Ofgem has allowed an unprecedented
100% increase in investment in the energy networks to upgrade
the existing pipes and wires and connect new generation, much
of it from renewable sources. The Transmission Price Control Review
for 2007-12 allows the electricity transmission companies to invest
£3.8 billion to maintain and upgrade their networks. The
funding is flexible and transmission companies' funding will increase
automatically if more generation seeks connection than was assumed
when the price control was set.
28. Prior to that, in 2004 Ofgem approved
£560 million of additional investment in transmission capacity
outside the normal price control process to avoid delay in the
upgrade work necessary to connect renewables. The main project
affected was the upgrade to the line running from Beauly, west
of Inverness, to Denny, west of Falkirk: a key part of transmission
network in Scotland where much proposed renewable generation is
located. This allowance has not been used because of major difficulties
in gaining planning permission. In 2006 the Scottish Executive
referred the project to a public inquiry.
29. There is the potential for more investment
as more generation comes forward. For example, we are facilitating
more "localised energy" (smaller-scale distributed energy
and household-scale microgeneration) which we are addressing through
our work on the next Distribution Price Control Review for the
period 2010-15.
A new offshore electricity transmission regime
30. Offshore, there is the potential for
over 30GW of renewable offshore wind generation to connect to
the system, potentially operating at a load factor higher than
35%. Together with BERR we have been developing and implementing
a new regulatory regime for offshore transmission to make sure
this generation can access the onshore market. Offshore transmission
has different technical characteristics and it costs much more
to build lines offshore than onshore. BERR and Ofgem have therefore
decided to base the arrangements around competitive tenders for
major offshore transmission projects. Ofgem will organise tenders
and appoint the most competitive bid to build, own and maintain
the offshore transmission lines. Subject to the Energy Bill becoming
law, the first tenders are likely to commence in the first quarter
of next year.
31. The challenge lies in rebuilding the
transmission system to accommodate this major change in the location
and nature of flows across the transmission system. Funding of
onshore reinforcement works should not present difficulties since
Ofgem can allow the expenditure provided it is efficiently incurred.
However, the sheer magnitude of the task will place an immense
burden on the planning system.
32. Our discussions with other energy regulators
through the Council for European Energy Regulators suggest that
grid access and planning constraints for new transmission lines
are also significant issues in many other Member States.
Question 6—How does Use of System charging
affect grid access for renewable energy generators? How far can
the different levels of renewable energies take-up in different
Member States be attributed to Use of System charging and cost
sharing rules?
33. In line with the European Commission's
position on promotion of markets in energy, the GB mechanism for
use of system charging is designed to reflect the costs of locating
at different points on the network. Under this approach, if a
generator is located far from a centre of demand, or connects
in a part of the system where generation already exceeds demand
in that location, it will pay a higher transmission charge, reflecting
the cost of the transmission lines necessary to move power from
where it is produced to where it used. This promotes competition
between generators (for example between renewable and other low
carbon forms of generation) and helps them to make economically
efficient decisions. For example, it enables offshore wind farms
to trade off the costs of onshore and offshore transmission when
deciding where to connect to the onshore system. As more renewable
generation comes onto the system, displacing existing fossil fuel
plant, it encourages generators to examine the costs and impact
on the transmission system when considering which fossil fuel
power stations to close. Finally, it promotes a more sustainable
energy system as the transmission system has its own environmental
impact through its visual amenity and carbon footprint.
34. There is no evidence that locational
charging in the UK has yet proved a barrier to renewable deployment—even
in Scotland where the locational charges are highest. There is
currently a total of over 13GW of renewable generation that is
connected or is seeking to connect to the transmission system
in Scotland at today's charges. Wind farm developers in the remotest
and most expensive parts of Scotland (including the Scottish Islands)
have indicated to Ofgem that the subsidy provided by the Renewable
Obligation is sufficient to make projects financially viable at
current wholesale prices and transmission charges.
35. It is difficult to determine whether
the increased penetration of renewable generation in other Member
States can be attributed to different use of system arrangements.
The degree of penetration is more likely to be affected by the
financial support mechanism in place; the ease of obtaining planning
consent for renewable technologies such as wind; geographical
factor such as the availability of hydro resources; whether there
is spare capacity on the transmission system; whether planning
is a problem for major expansions of the transmission network;
and whether renewables are given priority access to the grid.
Ofgem has not seen any studies or evidence to suggest that different
transmission charges in different Member States are a major factor
in explaining why some Member States have a much higher renewable
energy penetration than others.
Question 7—What impact do the various systems
of reinforcement planning and work have on encouraging renewable
generation? How important is the issue of constraint in increasing
Member States' renewable generation?
36. The main challenges faced by developers
as a consequence of the way in which reinforcements are planned
and delivered fall into two main areas:
— a mismatch in timing. It often takes
longer to get planning consent for the necessary grid reinforcements
than it does for the renewable generation itself; and
— a lack of certainty about which generators
will connect to and stay connected to the grid.
37. Ultimately both issues can be resolved
by new and existing generators providing an appropriate level
of user commitment to use the transmission system. Our Transmission
Access Review sets out this analysis and considers the issue of
constraints. More information can be found in our answer to Question
5.
Question 8—To what extent is further co-ordination
of National Regulatory Authorities needed to encourage grid access
for renewable energy generators?
38. The EU Third Energy Package of internal
market measures currently under negotiation is designed to provide
reinforced coordination between national energy regulators. The
measures include the establishment of an Agency of EU regulators
to help facilitate the development of the internal market, especially
on cross border issues and other areas most critical for market
entry.
39. Whilst there are significant legal and
political difficulties in agreeing the powers and responsibilities
of the Agency, once agreed, these improvements in regulatory coordination
would not be specific to any one type of energy generation and
will help address the current "regulatory gap" on cross
border issues. To the extent that a specific renewable grid access
situation is a cross border issue, it will benefit from this enhanced
regulatory coordination. There are other elements of the third
package where an element of enhanced regulatory coordination is
envisaged and which should encourage new entrants and connections.
Amongst others, these include: addressing problems in market concentration
and vertical foreclosure; better coordination of investment in
capacity; overseeing development of compatible network operation
codes; improving access to interconnectors; and improving transparency
of information.
Question 9—How far do current regulations
inhibit access to the grid?
40. The existing transmission licence regime
broadly ensures that all generators who apply for a connection
are given an "offer" setting out, amongst other things,
the costs and terms associated with connecting in their particular
location. In this sense there are no direct barriers to applying
for a transmission connection. There are, however, issues relating
to the queue of generators wishing to connect which need to be
addressed. This is discussed in further detail in our answer to
Question 5.
Question 10—At what level should the EU
be involved in harmonising or regulating support schemes offered
by Member States to encourage renewable energy generation?
41. A variety of support mechanisms for
renewables are in operation across Member States. Whilst harmonisation
would be desirable, we think that a higher priority at this stage
is to make real progress in integrating the EU's energy markets.
Harmonisation at this stage could be onerous and expensive because
of the variety of schemes and the variety of market conditions
in which they operate.
Question 11—What impact have the various
schemes in operation across the Member States had on encouraging
renewable energy? How have these schemes affected take-up both
by producers and commercial and domestic consumers?
42. There are four main types of support
schemes for renewable energy currently used in various Member
States. These include feed-in tariffs; obligations or quotas;
tenders; and tax incentives or rebates. A feed-in tariff is an
additional premium (fixed or variable) paid on top of the electricity
market price that renewable energy producers receive. An obligation
or quota system normally involves a finite set of renewable energy
generation certificates being generated and traded, with penalties
in place for not possessing them, when it is mandatory to do so.
Tenders involve inviting companies to bid for the right to get
involved in renewable energy investments. Finally, tax incentives
or rebates provide tax advantages for those choosing to generate
renewable energy.
43. These schemes have had varying levels
of success in encouraging renewables and at very different costs
to customers and costs per tonne of CO2 emissions avoided.
A recent evaluation of their relative effectiveness concluded
that feed-in tariffs were generally more effective at encouraging
larger volumes of renewable generation at generally lower costs
than the other options.[5]
However, these studies are very context specific and a policy
that is ineffective and/or expensive in one Member State may be
more effective and cheaper in another Member State if, for example,
there are fewer planning constraints and more spare transmission
capacity.
44. The mandatory nature of obligations
means that is the costs are largely passed through to business
and domestic customers. This has been the case in Britain, where
the Renewables Obligation currently adds around £10 to a
domestic electricity bill per year and is set to rise to around
£20 a year by 2015. Even so, there remains a significant
gap between renewable generation targets under the scheme and
actual renewable output in Britain.
Question 12—Will cross-border renewables
markets be genuinely affected by the existence of a variety of
support schemes? Is necessary investment hampered by lack of market
harmonisation?
45. In the short term there may be an impact
if there are bottlenecks in the renewable manufacturing sector.
If a relatively small number of wind turbines are available, these
are likely to be deployed in countries with the most attractive
support schemes. However, even in the short term, there are a
range of other factors which will affect investment decisions
in renewables, eg ease of access to grid and planning constraints
will be of major significance. Any constraints in the manufacturing
base should ease over time as new manufacturing capacity is built
and any support scheme that offers commercial rates of return
to windfarm developers and does not have other significant barriers
(such as delays in obtaining planning permission or access to
the grid) will attract significant investment in renewable generation.
Question 13—To what extent would the enhanced
use of Guarantees of Origin certificates require the harmonisation
of support schemes?
46. The trade of Guarantees of Origin certificates
(GoOs) between Member States will generally be limited to those
countries who have met their interim targets. We do not consider
that harmonisation of support schemes is required in order to
trade GoOs between Member States. Together with BERR, we are committed
to working to ensure that issues arising in negotiations on the
Renewables Directive are addressed in an appropriate and timely
manner. The Council of European Energy Regulators is also reviewing
the use of GoOs.
25 April 2008
2 High wind penetration and current typical demand
patterns could lead to more volatile wholesale electricity prices.
Demand during night time in summer can fall to 30% of winter daytime
peak levels. Prices may even fall to zero at night time when there
is more wind generation than demand. Suppliers will therefore
have a strong incentive to offer new services and tariffs to encourage
customers to spread their demand across the day by, for example,
using more time controlled domestic appliances. Back
3
Much of the new renewable energy is likely to come from wind
power which, depending on location, can have load factors lower
than 35%. Back
4
Vertically integrated companies may have interests in more
than one part of the supply chain in energy: generation, transmission
and distribution networks, and supply. Back
5
Feed-in Tariffs and Quotas for Renewable Energy in Europe,
CESifo DICE Report, 4/2007. Back
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