RenewableUK- Written evidence- (ONZ0049)

Net zero in the power sector

1. In 2019 the government legislated to commit the UK to “net zero” emissions by 2050. Under the Climate Change Act 2008, the government is required to meet climate goal via a series of 5-yearly budgets. The move was accompanied by a report from the Climate Change Committee setting out what would be required to meet this ambition at least cost. The CCC’s Sixth Carbon Budget report suggest that the UK will need to effectively completely decarbonise the power sector by 2035. The CCC also recommends deployment of around 95GW of offshore wind by 2050 and at least 30GW of onshore wind[1]. National Grid ESO’s Future Energy Scenarios for a net zero system also suggest that we will require up to 113GW of offshore wind and 45GW of onshore wind by 2050[2]. At the same time, we anticipate rising demand from electrification of heat and transport.

2. Delivering this capacity will require significant investment in our energy networks to carry the power around the country. It also represents a significant divergence from today’s energy networks. Market design and network charging are currently still based on a fossil fuel system: large, centralised coal and gas plants could be built broadly anywhere, and were incentivised to be built close to demand, minimising transport costs. However, in an efficient renewables-based system, generation will be built where the renewable resources are best: in the north and west for onshore wind, and the North Sea and Celtic Sea for fixed and floating offshore wind; solar will be built in the south. Furthermore, the future power system will also be characterised by many smaller generators, such as rooftop solar, onshore wind.

Ofgem’s role

3. Ofgem will play a central role in transforming the electricity system to a net zero network, as the regulator governs three key aspects of network investment and build. Ofgem’s current role focusses on minimising costs to consumers by ensure economic and efficient use and development of the electricity networks. This is laid out in the Utilities Act 2000[3]. The Act also provides for Ofgem to arbitrate on social and environmental matters, but this is relegated to guidance from the Secretary of State. While Ofgem does have the remit therefore to ensure environmental issues, this is very much a secondary consideration.

4. In pursuing an economic and efficient network, Ofgem’s focus tends to be on short term costs, looking at specific outcomes and seeking the cheapest solution. There is nothing wrong with this per se, and meets the remit to pursue economy and efficiency. However, in doing so, Ofgem tends to not to consider longer term needs and efficiencies. Specifically, in the pursuit of net zero, significant investment in infrastructure is required; investment in future network, that does not have an immediate use – anticipatory investment – is avoided. A short-term focus on costs, and the cheapest solution for specific network development, means that long-term value is ignored, and later costs are increased. This can be due to Ofgem’s tendency to focus on distributional gains: shifting costs from consumers to generators, but ignoring the impact that this has on energy prices, ultimately paid by consumers. Ofgem should focus more on whole system gains for consumer benefit.

5. For example, Ofgem is responsible for administering the Offshore Transmission Owner (OFTO) tender process. Under the current regime, when a wind farm is built the transmission assets that carry power to shore must be passed over to an independent operator. The tender process that transfers ownership from the developer that builds the asset to the OFTO is run by Ofgem. The Offshore wind industry sees that invariably, the assets are transferred to the OFTO bidder that offers the cheapest contract, not the best offer, and that this often leads to poor maintenance of assets, which then fail, and adds further long-term costs to consumers through cable repairs.

6. Ofgem delivers network investment in two ways. First, the network charging regime that governs how generators (and users) are charged for network access. These rules are supposed to incentivise location and behaviour of generators, but are still very much based around the needs and attributes of fossil fuel generation, not renewable generation. Second, the network owners’ price controls that govern network investment. Under the current regime, network investment is driven by short-term need. That is, decisions are made on what immediate need for network reinforcement and build out is required. However, this does not account for the long-term anticipated need of a net zero network.

Network charging and net zero

7. To fund network investment and maintenance, network users – both generators and demand users – pay network charges. These charges vary depending on the type of user, size, which part of the network they are connecting to (high voltage transmission or lower voltage distribution networks) and where in the country they are connecting.

8. Transmission Network Use of System (TNUoS) costs are paid by transmission connected Generators (and distribution connected sites over 100MW, and those smaller, but with contracts with the ESO) and all UK demand. These charges are set to recover a proportion of the costs faced by the UK’s three Transmission Operators (TOs) when investing in and maintaining the transmission grid. The tariffs are based on an agreed methodology and administered by the ESO. Generators and suppliers are set charges that differ depending on how they use the transmission network, and also where they are located in the country.

9. The latter aspect, the locational charge, is a key feature of the current system. Charges are designed to incentivise generators to locate near demand, reduce requirements for transmission network investment, and minimise network losses. However, to meet our net zero ambition, we will need to build much more renewable generation, as noted. To do this most cost effectively, we should be locating renewable generators where the natural resources to power them are most abundant. This means onshore wind in Scotland and Wales, fixed and floating wind offshore in the north sea, and solar in the south. Our transmission system needs to be strengthened to help transport this electricity to the end user, these elements need to be balanced against delivering a low-cost electricity network in the longer term.

10. The current locational charging methodology, directed by Ofgem does not align with these principles. Instead, it is trying to force generators to locate where it would be solely cheapest from a network perspective, and does not reflect the reality of where the best – and cheapest - renewable resources are located. This means that renewable projects are made less competitive with fossil fuel generation, and the pace of emissions reduction is slowed.

11. Furthermore, the UK is unique in the scale of variation of locational charges that we impose on generators. A recent report from RIDG[4] showed that Scottish generators pay 16 times more to use the transmission system than the European average; of the 36 European countries covered by ENTSOE, 20 do not charge generators at all and only 5 charge generators based on location (three of which are GB, Northern Ireland and Ireland). As we become increasingly connected with Europe’s electricity grids via the interconnectors, our renewable generators are being put at a disadvantage, and we risk importing more, often less renewable, generation from Europe, rather than taking advantage of the renewable resources we have.

12. In another example, over recent years Ofgem has been under significant code reforms under the Targeted Charging Review (TCR) the Access and Forward Looking Charges Significant Code Review (AFLC SRC). Oxera Consulting published[5] an analysis of the Impact Assessment published alongside the TCR. This analysis showed the Impact Assessment was flawed, and did not take into account the cost of carbon and the need to meet zero. When these are taken into account, the reforms would actually increase costs to consumers, reversing the alleged saving of £113m to a net cost of as much as £333m.

13. Similarly, the recently published minded-to position on the review of Access and Forward-Looking Charges to reform how users pay for access to the network and are incentivised to behave efficiently. The Impact Assessment showed a benefit to consumers of the changes being proposed, but did not properly consider the true impacts on emissions. The analysis explicit fixed the deployment of renewable generation, and did not consider how changes to network charging arrangement would effect renewables deployment nor the resulting emissions.

RIIO-2 controls and investment in net zero

14. Ofgem’s overriding focus is on keeping costs to consumers down. This is quite right as the economic regulator. As with the OFTO process noted above, we are concerned that Ofgem’s focus is too often on the short-term costs, rather than long-term value. Costs can be reduced by minimising investment or delaying necessary improvements to the network. While this may reduce bills today, it stores up problems for the future.

15. The price control framework overall is an effective policy in keeping costs down. However, they are limited in their timeframe, running for just 5 years. This makes the long-term planning of networks that are require for net zero more challenging. The ESO publishes the Energy Ten Year Statement and the Network Options Assessment each year, which set out the medium-term needs of the network, but there is no mechanism to translate the long-term needs and design of the network in to investment beyond the timeframe of the RIIO-2 price controls, as network owners will have no clarity about whether they will be able to recover these costs. Delivering a network fit for net zero goes beyond delivering new capacity. A large proportion of the original spending cuts made to the electricity transmission networks’ business plans for the RIIO-2 price control relate to the operation and maintenance of the network, such as inspection allowance or deferrals to critical asset replacement schemes. Relying on a ‘do the minimum’ approach as the baseline is inefficient and will result in higher costs to the consumer in the long term.

Ofgem’s relationship to BEIS and Parliament

16. Ofgem is an independent regulator tasked with the economic and efficient development of the networks, and energy market. In our conversations with both BEIS and Ofgem, it is very clear that independence is well-regarded. While we agree that it is important that Ofgem is insulated from political decisions, this insulation also prevent Ofgem’s strategy aligning from the Government’s net zero strategy. For example, when Ofgem published their open letter on the future charging and access regime in 2019[6], they stated that their modelling: “recognised that reform … would directly impact revenues of grid-connected generation, assuming that Contracts for Difference (CfD) support payments for new build generators would adjust to maintain decarbonisation targets in the reform scenarios.”

17. Thus, while their modelling showed that network costs may be reduced by their reforms, they recognised that costs may be increased for consumers elsewhere, in this case through the CfD, but this was not their concern. Again, this shows that Ofgem’s narrow remit to protect consumers from costs in one area, may increase costs elsewhere. RenewableUK’s analysis showed that proposed reforms would increase CfD strike prices for onshore wind by as much as £4/MWh, while reducing the total volume of low carbon energy delivered.

18. The Energy Act 1989 provides the opportunity for Parliament to issue a Strategy and Policy Statement (SPS), to guide Ofgem’s hand beyond just their statutory duties. However, despite a consultation in 2014, this tool has never been used. We understand that there is work underway to prepare a fresh consultation on a new SPS. We strongly believe that this must set out a clear role and focus for Ofgem to support decarbonisation through the lowest cost route, in the long term.

19. Even so, our members are concerned that Ofgem’s role in delivering net zero will not be clearly defined, and there will not be adequate recourse to challenge Ofgem’s decisions when they appear to be at odds with the delivery of net zero. We therefore support a statutory duty for Ofgem to deliver net zero emissions, that can be challenged in court if necessary. Evidence shows that net zero is not a conflict with consumer costs, if managed properly. Ofgem’s current remit, under section 3A of the Electricity Act 1989 requires Ofgem to project consumers’ “interests in the reduction of electricity-supply emissions of targeted greenhouse gases.” However, we believe that this obligation should be strengthened to require Ofgem to act in the interests of consumers, including the need to meet the legally binding net zero commitments under the Climate Change Act 2008, as amended.

For more information, contact:

Barnaby Wharton

Director, Future Electricity Systems | RenewableUK

27 August 2021

5