Supplementary memorandum by Ofgem
1. On 28 April 2008 Ofgem's Managing Director
of Networks, Steve Smith, gave oral evidence to the Committee
as part of its inquiry into the EU Renewable Energy Target. Subsequently
the Committee took evidence from other witnesses who, like us,
have focused on the challenges facing the energy networks. This
supplementary memorandum contains further information that may
be useful to the Committee.
2. On 26 June we published, jointly with
the Government, the conclusions of the Transmission Access Review.
This will see major reforms of the grid access rules to make it
easier for new generators to connect.1 We hope to see the new
regime in place by 2010. In parallel, we will develop and implement
a new incentive framework for the transmission companies that
will allow them to invest in new capacity ahead of contractual
commitments from new renewable generators. This is necessary because
the Government has not yet put in place financial support mechanisms
to deliver the 2020 targets, and developers may not be able to
make financial commitments to the transmission companies. Given
the long lead times for new transmission build, this will make
sure that the physical capacity of the network keeps up with demand
for capacity. However, our framework will also protect customers
from paying for inefficient investments in capacity that is not
required or is under-utilised. Under the proposals, the returns
on transmission companies' investment will be linked to how much
generation connects post-construction. Shareholders will, therefore,
take on some of the risk of inefficient network investment in
return for being able to earn higher returns.
3. In addition, we have identified short
term measures which can be implemented before these new arrangements
are in place to deal with the existing queue of renewable generators
waiting to get onto the grid. This may enable up to 1 gigawatt
(GW) of renewable generation with planning consents to connect
to the grid faster than under the current rules. Furthermore,
the wider context of high energy prices and rising fuel poverty
means it is particularly important for Ofgem to ensure that consumers,
especially the vulnerable, are protected from excessive and inefficient
costs as the industry strives to meet the target.
REFORMING ACCESS
TO THE
GRID
4. A vital requirement for meeting the Government's
renewable energy target is to change the rules governing access
to the electricity transmission network. (See Ofgem's initial
memorandum, paras 20-26.) The long overdue reform of the access
regime has, however, been blocked in the past by the electricity
industry. The Commons Innovation, Universities and Skills Committee
recognised this in its recent report on renewables. "[Our]
frustration is compounded by the knowledge that Ofgem attempted
to pilot transmission access reform in 1999 and 2000 but, under
threats of legal action, was unable to proceed." At the time,
many in the industry argued that reform was unnecessary. In addition,
existing conventional generators have had an incentive to oppose
reform as they do not want to share their access rights with,
for example, new renewable generators.
5. We want a new grid access regime which
requires all generators to make a clearer financial commitment
of their future demand for capacity—or else give up their
access rights to new renewable generators who may be more willing
to make such a commitment. This approach has two significant advantages.
First, it gives National Grid a lot more information about generators'
demand for access to the network, which in turn allows them to
invest in new capacity to meet that demand where necessary. Second,
it allows for much greater sharing of capacity. For example, much
renewable generation is intermittent, and if a wind farm and a
conventional power station use the same lines on the network,
the conventional generator can start running when the wind is
not blowing.
6. We are pleased that the industry is now
making much more positive comments about access reform and we
hope they will follow these with real action to amend the industry
rules. As the transmission access review draws to a close, National
Grid (NG) has raised a suite of proposed changes to the key industry
codes to reform the current arrangements based around three distinct
models of reform. The proposals are now being analysed and discussed
and NG will present its recommendations to Ofgem in September.
We will then carry out an impact assessment on the proposals before
reaching our final decision on which model to implement. We aim
to have new arrangements in place by April 2010, which will also
time for the necessary IT system development, though the timetable
may be threatened if any of our decisions are subject to legal
challenge. 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. Ofgem is doing
all in its power to facilitate the reforms.
SHORT TERM
MEASURES TO
BRIDGE THE
GAP
7. The signs of progress on transmission
access reform are promising. However, the 2020 target is too pressing
for us to wait for a new regime to be in place. A lot can be done
in the meantime to help bridge the gap. For example, we have encouraged
National Grid to move away from a "first come first served"
approach to dealing with the queue for grid connections. At present,
generators who have finance and planning permission may be further
down the queue than generators who do not have either in place
but who approached National Grid first. National Grid is now taking
a more robust approach to removing unviable or purely speculative
projects. National Grid is also progressing an amendment to the
industry codes which would make it easier for existing and new
generators to share access to the grid.
8. We estimate that these shorter term measures
are capable of bringing forward 1GW of new renewable connections
including just under 600 MW of projects that already have planning
consent. We remain open to any other ideas which will accelerate
longer term investment in the grid to meet the target.
LONGER TERM
MEASURES LOOKING
TO 2020
9. Even with transmission access reform,
there are still significant challenges ahead. For example, the
Government has not yet put in place the subsidy mechanisms to
deliver the 2020 targets. This means that renewable generators
may not be able to signal their future capacity needs to National
Grid and sign contracts because of the uncertainty over what financial
support they will receive. By the time the subsidy mechanism is
clear, there may not be sufficient time to build the capacity
early enough to meet the target.
10. Ofgem is therefore engaged in several
projects to help ensure the grid can be properly configured for
the renewables challenge. We have asked the transmission companies
to produce an investment study to identify the options to invest
to provide the extra transmission capacity that will be required
to deliver the 2020 targets. We are also working with the companies
and will implement a new investment incentive framework that will
allow them to reach decisions on the necessary investments given
the long lead times for significant transmission investment. This
will make sure, subject to the planning regime, that we have the
necessary grid capacity in place in time to meet the 2020 targets.
The framework will allow this investment to take place whilst
protecting customers from the risk of having to pay for substantial
investment in new transmission that is not required. This is clearly
important given the context of rising energy bills.
11. All this is in addition to Ofgem's existing
work through our price controls. For example, we are allowing
a 160% increase in investment in the onshore electricity grid,
with flexibility for the network operators to go beyond this amount
in response to demand for additional capacity. We are also implementing,
with the Department for Business, the new offshore electricity
transmission regime which will allow the potential of marine renewables
to be fully and quickly achieved.
12. These contributions should allow a significant
expansion in renewables by eliminating undue network barriers.
PROTECTING CONSUMERS
13. The measures needed to meet the renewables
target will not be cheap. This raises particularly important choices
at a time of high energy prices and rising fuel poverty. The companies
understandably wish to protect their shareholders from as much
risk as possible, and to transfer the risk and potentially more
of the costs to the consumer. However, at a time when around 4.5
million households could be in fuel poverty, we believe it is
vital that consumers are protected from excessive or inefficient
transmission costs.
14. That is why, for example, our new incentive
package encourages the transmission companies to manage some of
the stranding risk that there is not enough demand from generators
to use the new capacity once it has been built. In return for
taking on more of this risk, the companies will be allowed to
invest early and earn higher returns. Measures such as this allow
us to be more confident, on customers' behalf, that the investments
requested by the transmission companies are genuinely required.
At the same time, we want to see more long term commitments from
generators to use their capacity rights—or else make way
for new renewable generators who are ready and willing to connect.
OFGEM'S
DUTIES
15. Some witnesses have raised the issue
of Ofgem's statutory duties and whether they are appropriate for
the challenges ahead. Our primary duty is to protect consumers.
Sustainable development features in our secondary duties. The
above actions have all been taken under our existing suite of
powers and duties.
16. It is for Parliament to decide whether
these duties are right, or whether they need to change. We can
offer some general thoughts that may be helpful as you approach
this issue:
— We are keen that our duties should
be broadly consistent over time. This is because unprecedented
investment will be needed in the energy sector over the next few
years. This in turn requires a stable regulatory regime that gives
investors confidence.
— Some proposals for changes to our
duties are based on creating twin principal objectives. This approach
could involve granting the responsibility to make potentially
difficult trade-offs. In this context it is for Parliament to
consider the scale of the discretion it wishes to grant an unelected
regulator.
— Finally, if we are granted additional
duties, it is important for policymakers to consider the powers
that are needed to fulfil them.
17. We would be happy to answer any further
questions or provide any additional information that the Committee
may find useful.
30 June 2008
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