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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.

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