UKPR Report - Embedded Benefits - Exec Summary

The effects
of changes
to Embedded
Benefits on the
Energy Trilemma
May 2016
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prepared by KPMG LLP in accordance
with specific terms of reference
agreed between UK Power Reserve
(“UKPR” or “the addressee”) and
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| The effects of changes to Embedded Benefits on the Energy Trilemma
Executive summary
Distributed generation has significant benefits for a power
system. It enhances security of supply, contributes to
decarbonisation, and brings down energy bills by helping to avoid
network investment costs.
Government and regulatory policies
have encouraged investment in small
scale electricity generation connected
to local distribution networks. More
than 25 GW is now connected in
Great Britain and, in some locations
it now exports energy to the national
transmission grid used for bulk power
transport. Distributed generation
helps ensure that electricity supply
and demand is balanced, especially
during stress events and times of
peak demand. Over recent years,
as capacity margins have fallen,
this flexible generation has played a
key role in reducing peak demand,
underpinning security of supply.
Generators connected at up to132 kV
on the distribution system in England
and Wales are called embedded or
distributed generators and are treated
as negative demand for the purposes
of transmission charging. These
generators do not pay transmission
charges and they may also receive a
benefit from suppliers because they
help reduce their peak demand and
transmission charges. Together, this is
known as “embedded benefits”.There
are significant variations in the level of
embedded benefits for different plant
depending on technology and location.
There is a debate to be had around
what constitutes a fair and costreflective arrangement for meeting
the costs of the electricity network
in an energy system with high levels
of distributed generation, However,
changes to the current incentive
regime risk significant reductions in
distributed generation and increased
risks to security of supply at a time
when short term capacity margins
are tight. Currently, Ofgem (along
with Government) is considering
if embedded benefits should be
modified, as they are perceived to
be encouraging the development of
distributed generation rather than the
larger-scale transmission connected
generation needed to support long
term capacity margins.
The rapidly changing market
dynamics we face today present a
huge challenge for the Government,
Ofgem and the industry as a whole.
Regulatory and associated charging
regimes are and should be reviewed
periodically to ensure that they are fit
for purpose for the future as well as
today. Retrospective action is very rare
in the UK irrespective of the political
party in Government. Given the level
of distributed generation on the UK
system, Ofgem and Government will
need to carefully consider the impact
of their decision on the investment
decisions thus far in distributed
generation and the impact of any
changes in regulation on short and
long term security of supply.
UK Power Reserve Ltd, a United
Kingdom-based energy company, has
commissioned KPMG to conduct an
independent analysis of the effect of
potential changes to the embedded
benefits regime on the achievement
of UK energy policy objectives to
provide policy considerations for
the Regulator and Government. This
report has examined the advantages
and disadvantages of options for
changing the current embedded
benefits regime. This report, however,
does not aim to provide alternative
methodologies to the current charging
Headlines from the Analysis
We have analysed the impact of two
stylised alternative policy options for
changes to the embedded benefits
regime, compared to a ‘Status Quo’
scenario. These are:
1) The immediate removal of
Triad payments for all distributed
generators could lead to:
a) security of supply risks
An immediate removal of embedded
benefits could make a proportion
of existing distributed generation
uneconomic. We estimate that if
embedded benefits were removed
for all plant, approximately 2,100MW
of new distributed generation in the
T-4 2015 auction could be withdrawn.
This withdrawal could have
significant impacts on near term
security of supply.
b) increase in cost to consumers:
Any sudden changes to the current
embedded benefits regime that
investors perceive as retrospective
could increase costs of capital for
a wider range of energy projects
reflecting increased regulatory and
political risk.
The removal of embedded benefits
is likely to increase the price at
which distributed generation bids
into future Capacity Market auctions.
This will shift the supply curve of
participating plant upwards, and
could increase the clearing price in
future auctions compared to Status
Quo, although these impacts are
highly uncertain at this stage.
We estimate an upper bound net
cost increase in future auctions
of £1.3bn in a scenario where the
removal of embedded benefits
means new CCGT becomes the
marginal plant. In addition, we
believe that the 2,100MW of new
build distributed generation that has
been successful in the 2014 and 2015
T-4 auctions will struggle to reach
financial close. Our estimates of the
cost of replacing this lost capacity
in future capacity market auctions
ranges from £19m to £63m, or £285
to £945m over the typical 15 year
contract duration for new build plant.
2) Transitional arrangements, where
embedded benefits are partially
protected for existing distributed
generators and new build projects
that are financially committed. Our
conclusions were:
In this scenario, the impact of policy
change on investment sentiment
would be more limited, provided
that a decision to pursue this policy
was made quickly. Delayed decisions
and policy uncertainty would have
a negative impact on investment
Future embedded benefits removal
would have an impact on the supply
curve of participating plant in future
auctions, but this would be more
limited compared to Option 1, as
existing plant would continue to bid
into the market as they do currently.
Our estimate is that an auction with
the same parameters as the T-4 2014
auction would have been £200m
more expensive compared to the
Status Quo.
Advantages of change
Disadvantages of change
Enhance medium
security of
to consumers
by consumers
removing distortions
by removing
the Capacity
in Market
the Capacity
to theMarket
the development
of large,
of large,
Investor uncertainty
on investment
on investment
Affordability —
term security
of supplyRetrospective
policy action
raise financing costs as investors to
energy risk
security risks
Reducing incentives for
development of diesel
generation and the associated
environment impacts
Ensure fair charging
arrangements –—nonNondiscriminatory/ costreflective
network charging
charging arrangements
to reflect transmission
transmission system
Potential impact of change
Sudden changes in the embedded
benefits regime could have a
significant impact on the UK energy
market. Investors have financed
embedded generation (renewable
and conventional) in recent years
with the expectation of a stable
regulatory regime. While there are
calls for a review of the charging
methodology, a sudden change for
existing investments would impact
investor confidence for the future,
not only in distributed energy but
across the entire energy sector.
This could result in substantial risks to
security of supply and increased costs
to consumers.
As a part of the report, KPMG
analysed the potential advantages
and disadvantages of change to the
embedded benefits regime on the UK
electricity market as summarised on
Decarbonisation —
Affordability – increased capacity
a perceived
Distributed generationfinancing
as investors
in increased
by embedded
need for network upgrades/
Network investment- distributed
Security of supply —
Long term security of supply –
generation incentivised by
Implementation of change —
Distributed generation
Capacity Market competitiveness
embedded benefits avoids need for
May take considerable time to
contributes to Capacity Market
will reduce; CCGT’s may still not
network upgrades or reinforcement
implement in a rapidly changing
competitiveness; CCGTs may still
and complex charging regime
not emerge
Implementation of change – may
Balancing services – distake considerable time to implement
in a complex charging regime, taking
flexible distributed
generation that can
up quickly account of (for example) locational
can ramp up quickly impacts and energy profiles.
to meet peak
to meet peak demand
1 National Grid, ‘Future Energy Scenarios 2015’, Figure 68,
2 See, Q10
| The effects of changes to Embedded Benefits on the Energy Trilemma
The effects of changes to Embedded Benefits on the Energy Trilemma |
Transitional policy considerations
The immediate removal of embedded
benefits could lead to the withdrawal
of large amounts of distributed
generation and put pressure on the
UK’s short term capacity margins.
If changes are deemed appropriate,
the report identifies a number of
transitional measures that could
be considered under Ofgem’s
review, helping to maintain investor
confidence. These focus on:
• Transition from existing Triad
arrangements: transitional
arrangements that allow
existing distributed generation
to continue to provide Triad
services, recognising that existing
capacity market bids were based
on assumptions of embedded
• Change Capacity Market
tender rules – a choice could be
introduced into future Capacity
Market tenders where new build
generation was offered the choice
to either obtain a 15 year contract
or a Triad embedded benefit but
not both.
• Gross TNUoS charging - for future
Capacity Market auctions, changes
could potentially be made to
the TNUoS embedded benefit
calculation, i.e. move from net
to to gross from net to remove
TNUoS embedded benefits being
paid to new build exportable
distributed generation. The future
level of embedded benefits for
new capacity could be adjusted
by a sharing factor such that a
proportion of transmission charges
are passed through to distributed
• Changes to Triad charging
methodology - for example,
switching from the current three
peaks approach to a 4-7pm winter
weekday baseline calculation
could reduce the incentive for Triad
• Achieving policy aims through
targeted instruments outside of
the embedded benefits regime.
This could include an emissions
performance standard for diesel
generators or limits to their
running hours
• Whole Systems Approach to
energy policy. In reviewing the
charging methodology, Ofgem
and Government should not
consider power sector in isolation
from both heat and transport,
which will each have significant
impacts on the power sector and
require significant investment in
A transition path could well be a
combination of changes that both
maintain the benefits of embedded
generation with closer alignment
to consumers’ interests. KPMG in
this report has not attempted to
create such a transition matrix and
analyse the options, but recognises
the possible value in doing so in the
Stability of future charging regimes
is crucial to allow generators to
accurately forecast revenue and
provide investor confidence. Any
recommendations to change the
structure of network charging should
consider future impacts on both
energy production and consumption.
For example, fixed, forecastable
cost signals will incentivise
different behaviour from ex-post
cost variations; location signals for
generation stations should be strong
enough to drive the most cost
reflective outcome for the consumer.
Potential regime change will need
to consider such issues, and how to
make changes.
Network charging concepts and
methodologies have undergone a
revision in the last decade as Ofgem
has operated under a widening
statutory remit. The economics
of plant, especially geographically
remote based renewables and
nuclear, have called into question the
previously laudable long run marginal
cost (LRMC) approach. The difficulty
associated with this debate, and the
legitimacy of a range of approaches,
has spawned reviews of charges
that take years to conclude. For
example, project Transmit has run for
over five years.
Any changes to charging regimes
must recognise the hurdles that
legitimate consultation and challenge
Short term security of supply
Ofgem’s current review of embedded
benefits will be played out against
a very tough security of supply
backdrop in the short term. Whilst
arguments for change may be valid in
a world of plentiful capacity this very
tight capacity picture may provide
a very useful parameter for the
debate in the short term. We note
that the Secretary of State said in
her November Energy Policy Reset
statement ‘Energy security is the first
Implementation of change must take
account of impacts on security of
supply, especially in the short term.
Ofgem’s latest view of security
of supply for winter 2016/17 was
published in Summer 2015 and is set
out below. They state ‘Uncertainty
around the outlook for winter 2016/17
has increased. Margins could tighten
if further power stations close or
mothball. However, we have identified
a significant potential for the market
to respond positively and reduce the
risks to security of supply’.
Figure 1: Ofgem review of security of supply for winter 2016/17
Amber Rudd’s speech on a new direction for UK energy policy, November 2015,
| The effects of changes to Embedded Benefits on the Energy Trilemma
The effects of changes to Embedded Benefits on the Energy Trilemma |
Table 1: Summary of energy trilemma impacts versus Do Nothing under policy options
Security of supply
Investor confidence
Removal of embedded
Transitional arrangements
Distributed generation no longer
supplies power at peak —
increased risk of blackouts.
Build constraints on new CCGTs
mean this capacity cannot be
instantly replaced
Successful new build plant in
Capacity market auctions unable
ot reach financial close.
Transitional arrangements must be
designed so as to allow distributed
generation to supply power at
peak while capacity margins
remain tight.
Upward pressure on Capacity
Market price in future auctions
Savings associated with removing
embedded benefits small
Upward pressure on Capacity
Market price in future auctions
Less renewable generation
More transmission connected
capability meeting peak demand
— this must run on part load
at other times, thus increasing
Less renewable generation
Retrospective policy action
increases costs of capital across
energy sector
Translational arrangments
must be designed so as to
avoid appearance of retrospective
policy action.
| The effects of changes to Embedded Benefits on the Energy Trilemma