Grandfathering cuts to embedded benefits would save £590m

Increased triad avoidance payments offset by lower wholesale prices and reduced capacity market costs

Exempting winners in the first two capacity markets auctions from a proposed cut to embedded benefits would save consumers £590 million, analysis by Aurora Energy Research has concluded.

The research found that a projected £800 million increase in the value of the triad avoidance payments collected by distributed generators would be more than offset by reduced prices on the wholesale power market and lower costs in future capacity auctions.  

The study was commissioned by peaking plant developer UK Power Reserve, which won a large number of contracts for distribution-connected reciprocating engines in the four-year-ahead (T-4) capacity market auctions in 2014 and 2015.  

Shortly after the later of the two auctions, Ofgem announced it was reviewing the triad avoidance payments available to distributed generators, due to concerns that the increasingly valuable revenues were leaving transmission-connected generation at a disadvantage.

Distributed generators enjoy a number of financial upsides known as embedded benefits due to exemptions from transmission and balancing charges.

These benefits include triad avoidance payments which they can collect from power purchasers in exchange for reducing their Transmission Network Use of System (TNUoS) charges. They are able to do this because the power they generate is effectively counted as negative demand during the triad periods used to determine buyers’ charges.

TNUoS charges are split between a locational element, which reflects the cost of the network reinforcements needed to accommodate additional generation in different regions, and a residual element, which reflects the costs of maintaining the existing network.

At the beginning of March, Ofgem announced plans to slash the value of the triad avoidance payments relating to the residual element of the TNUoS charges from the current level of around £45/kW to just £2/kW.

Ofgem said the changes would be phased in over three years, but plants which secured capacity agreements before its review was announced would not be grandfathered. Citing an impact assessment conducted by LCP and Frontier Economics, the regulator said exempting these plants from the changes would cost consumers an additional £800 million.

However, in its response to Ofgem’s consultation on the proposed reforms, UK Power Reserve said this figure only reflects the cost of higher triad avoidance payments and does incorporate the impact of other effects on the energy system.

The analysis conducted by Aurora found that offering an exemption to the plants which secured capacity agreements in 2014 and 2015 would also depress prices in the wholesale market.

If the triad avoidance payments were kept at the current level of £45/kW, peakload prices would be on average £0.22/MWh lower for the duration of the plants’ 15-year capacity contracts and energy bills would be cut by a total of £330 million.

According to the study, grandfathering the plants in this way would additionally reduce the cost of future capacity market auctions by a total of more than £1 billion.  

The investment case for the distributed generation which won contracts was heavily dependent on triad avoidance payments. Aurora estimated that without an exemption up to 20 per cent of the affected plants could be scrapped and that filling this gap in future capacity auctions would cost an extra £250 million.

The consultancy firm said the failure to offer an exemption could also increase capacity market costs due to a loss of investor confidence. It calculated that a one per cent increase in the hurdle rate for new reciprocating engines – the rate of return needed to attract investors – would increase spending in future auctions by £810 million.

By subtracting these figures from the extra £800 million of triad avoidance payments which the plants would receive, Aurora concluded that grandfathering would lead to a total saving to the energy system of £590 million.

UK Power Reserve said: “A decision not to grandfather [this] capacity flies in the face of the stated intention of Ofgem and government to promote innovation and a flexible energy system. 

“By not grandfathering, committed capacity is disproportionately and unfairly impacted by the minded-to decision, despite this capacity being some of the [capacity market's] first movers and innovators.”

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