1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar

Court rules Ofgem’s “embedded benefits” decision not flawed

In a judgment dated 22 June 2018, the High Court (Lavender J) dismissed a challenge brought by a number of electricity generators (the Claimants) against a decision of the Gas and Electricity Markets Authority (Ofgem) to approve proposed modifications to the Connection and Use of System Code (CUSC), under which charges for use of the GB transmission network are levied.

Ofgem’s decision

The modification proposals were formally made in May 2016; Ofgem’s decision was taken in June 2017; and it came into force on 1 April 2018. Its most noted effect was to remove (over a three year period) a key element of the revenues of small “embedded” generators (i.e. those connected to a distribution network rather than directly to the transmission network).

Under one part of the transmission charging framework, known as the Transmission Demand Residual (TDR) charge, payments are effectively made in respect of the amount by which the supply of power from small embedded generators reduces consumption of electricity from other, mostly transmission-connected, sources in the periods of peak demand (known as “Triads”) from which the charge is calculated. These negative charges, commonly referred to as “Triad payments”, are typically made to electricity suppliers (as the small embedded generators themselves are not parties to the transmission charging arrangements), but the suppliers typically pass on about 90% of their value.

The overall costs of the transmission network have increased significantly in recent years. So too have TDR charges and the amount of Triad payments accruing to small embedded generators.  The Claimants, some of whom had made the development of small generating plants designed to capture Triad payments into a business model, argued that the system was rewarding them fairly for reducing the need for investment in the transmission network.  Ofgem, drawing on work that had been done in preparing the CUSC modifications and a series of consultations leading up to its decision, formed the view that the small embedded generators were being rewarded excessively, ultimately at the expense of consumers of electricity.  Whilst Ofgem acknowledged that they do make some positive contributions in reducing the amount of reinforcement necessary at Grid Supply Points, it drastically reduced the level of transmission charging related benefits that will be available to them in the future.

The judgment

The judgment of Lavender J is worth reading.  At 36 pages, it is as concise a free-standing account of both the issues and the decision-making process as you are likely to find.

The Claimants were refused permission to challenge Ofgem’s decision on grounds of irrationality. Their remaining grounds were that Ofgem failed to take account of material considerations and/or facts; and that the decision unjustifiably discriminated against the small embedded generators.

On the first point, Lavender J found that rather than failing to take account of a material consideration by not understanding the argument the Claimants were making, Ofgem had engaged adequately with them and disagreed with their assessment of the contribution made by small embedded generation. (This had been in part a battle of expert economic appraisals, in which Ofgem’s decision was buttressed by LCP/Frontier Economics whilst the Claimants found support in criticisms of Ofgem’s approach made by NERA/Imperial College.)  It was also not an error of law for Ofgem to require the Claimants to provide evidence in support of their case rather than making its own inquiries to find such evidence.

The second point had two limbs. The Claimants argued that Ofgem should have treated them in the same way as providers of behind the meter generation (BTMG) and commercial demand side response (DSR), which, like them, reduce a supplier’s net demand for electricity – but that it had not done so.  They also argued that it was unlawfully discriminatory to treat small embedded generators as if they were in a comparable position to transmission-connected generators – when they were not.

The judge was satisfied that “looking in the round” there was “enough of a relevant difference between” small embedded generators and BTMG / commercial DSR on the one hand and transmission-connected generators on the other, to justify their different treatment by Ofgem.

What next?

On a reading of the judgment with no more knowledge of the parties’ submissions than the judgment itself reveals, it does not seem very likely that it will be successfully appealed. Some readers may disagree with some of the judge’s reasoning, for example in support of his findings of “relevant differences” between the small embedded generators and BTMG / commercial DSR / transmission-connected generators.  But as he points out, there will be scope to remedy any perceived unfairness in the context of Ofgem’s ongoing Targeted Charging Review: Significant Code Review.

Ultimately this is one of those judicial review cases that serves as a reminder of the limits of judicial review as a mechanism for challenging decisions by economic regulators, as the court deferred to the expert regulator and did not appear to have thought that there was anything so bad in the decision under challenge or its results as to justify any attempt to use the essentially procedural categories of judicial review more creatively to strike it down. One can speculate whether the reasoning, if not the result, would have been different if Ofgem’s decision had been one that was subject to review by the Competition and Markets Authority rather than the court (like another recent Ofgem decision on a CUSC modification in the case of EDF Energy (Thermal Generation) Ltd v. Gas and Electricity Markets Authority, but even that process does not amount to a substantive reopening of the decision that is being challenged.

When the CUSC modification was originally proposed, some may have felt that it was an attack on the small embedded generators by those seeking to develop new transmission-connected generation. For them, the Triad revenues of smaller generators enabled the latter to bid down the clearing price in Capacity Market auctions to a level which made it impossible for e.g. new combined cycle gas turbine projects to stay in the auction – thus losing their chance of a subsidy that would allow them to be built.

However, two years on, the most recent Capacity Market auctions have not produced the higher clearing prices that might have been expected if the price was effectively set by small embedded generators and the latter depended to a material extent on the Triad payments they were about to lose as a result of Ofgem’s decision. This would suggest either that small embedded generators had more confidence in the Claimants’ case than appears to have been justified; or that, for whatever reason, Ofgem’s decision may be less harmful to their interests than it may at first have seemed.

Meanwhile, Ofgem’s Targeted Charging Review has a long way to run, and it will be interesting to see whether it reaches its conclusion without legal challenge or two along the way.

, , , , , ,

Court rules Ofgem’s “embedded benefits” decision not flawed

Close but no cigar? What’s different about the T-4 Capacity Market auction results of 2016?

They say a picture is worth a thousand words, so rather than writing a lengthy post on the provisional results of the four-year ahead GB Capacity Market Auction, published on 9 December 2016 by National Grid, we are focusing on two pictures and inviting you to spot the difference between them.

The first, immediately below, shows the progress of bidding in the 2016 auction.  In simple terms:

  • the process starts with all prequalified potential providers of capacity “in” at the cap price of £75/kw/year and the price then goes down by £5 with each round;
  • the auction clears when the purple line, whose progress from right to left shows how many bidders are left in after each round, converges with the red line “demand curve” drawn on the graph by the Government as part of the auction parameters;
  • all bidders still in at that point get a capacity agreement at the clearing price.

The big right to left moves occurred when the price moved between £35 and £30 and below £25.  In particular, each of these moves saw 6GW of capacity drop out.

2016 progress of bidding chart

Now look at the equivalent presentation of results from last year’s auction.  The purple line slopes more gradually, and the biggest right to left moves happen much earlier on in the bidding, between £60 and £50.  (The picture from 2014 is very similar to the 2015 one.)

2015 progress of bidding chart

It’s only an educated guess, of course, but it seems likely that much of the big leftward shifts in both auctions represented the exiting of bidders with plans to build large-scale proposed combined cycle gas turbine (CCGT) plants.  As a group, they are almost certain to have higher per MW development costs than other categories of new build projects competing for capacity agreements (small gas or diesel projects based on reciprocating engines, open-cycle gas projects, or battery based storage).  And the amount of capacity involved corresponds roughly with the big CCGT projects in the auction.

If the above is correct, why were proposed new big CCGT plants apparently prepared to tolerate prices almost 50% lower this year?  Perhaps they were hoping that a price between £30 and £35 would be where the auction cleared this time, on the basis that:

  • the clearing price is effectively set by the bidding behaviour of a sub-set of the smaller-scale, distribution-connected, fossil fuel generators;
  • on top of their power sales revenue, these smaller-scale generators have two main projected sources of income: capacity agreements and so-called residual demand TNUoS benefits;
  • Ofgem has issued what amounted to a warning that residual demand TNUoS benefits could be very sharply reduced by the time plants bidding in this year’s auction are commissioned;
  • the anticipated loss in residual demand TNUoS benefit revenue would be enough to push the smaller-scale generators to want a significantly higher capacity market price than the clearing prices seen in 2014 and 2015, both of which were below £20;
  • lower gas prices and slightly higher projected wholesale power prices may make a low capacity market price more bearable for CCGT plant, and there may other ways to mitigate merchant risk through innovative trading arrangements.

Maybe Ofgem’s warning wasn’t strong enough.  Maybe the smaller-scale generators reckon that Ofgem’s bark will turn out to have been worse than its bite on this.  In any event, the outcome has shown that for now, simply expanding the amount of capacity to be procured under an auction, as the Government appeared to be hoping when it adopted a limited change of approach to the 2016 auction, isn’t enough to ensure that some new GB CCGT plant is financeable and gets built.  Instead, a somewhat higher price will be paid to all successful bidders, including existing plant, for a larger amount of capacity than the Government thought we really needed.

As usual on these occasions, the Government has professed itself happy with the result of the auction, and it is fair to note that of the two new gas-fired plants with a capacity of around 300 MW that have been successful in the auction, one is described in the Capacity Market register as being CCGT.  But if a new generation of big CCGT plants is an important part of our new lower carbon power mix, there is some way to go.  A possibly more promising approach to using a capacity market to stimulate new CCGT build is suggested by the European Commission’s recent Winter Package of Energy Union proposals: set a date beyond which existing coal-fired plant will be ineligible for capacity market payments.  This is not among the options canvassed in the Government’s recent consultation on achieving the closure of coal-fired plant by 2025.  There would of course be an element of risk in adopting such an approach (coal plant might stay open because it can still make money without a subsidy, resulting in overcapacity, or alternatively coal plant might close immediately, before the new CCGT plant is built, leaving a generation gap), but it might be worth considering.

, , , , , , , , ,

Close but no cigar? What’s different about the T-4 Capacity Market auction results of 2016?