The UK energy heat map

November 2016  |  SPECIAL REPORT: ENERGY & NATURAL RESOURCES

Financier Worldwide Magazine

November 2016 Issue

November 2016 Issue


It now seems certain that the UK will leave the EU by March 2019. It remains to be seen how Brexit will impact UK energy policy, but in the interregnum a number of moving parts continue to shift the energy landscape.

Undoubtedly, this year’s hot topic is energy storage, with National Grid having awarded the first enhanced frequency response contracts in August, meaning that battery storage will be used for balancing services at grid scale for the first time. Storage also offers game changing potential in the near term to ‘time shift’ renewables and level out demand and supply across the system, making it easier to balance the network. However, technical, commercial and regulatory challenges to its widespread deployment remain. The revenues stream and commercial proposition available to storage providers remain uncertain and storage continues (for now) to be treated as ‘generation’ for regulatory purposes, with resultant double charging in some areas and the EU’s unbundling regime preventing TSOs and DNOs from owning generation assets.

The UK government’s focus also appears to have shifted away from prioritising decarbonisation at an acceptable cost to keeping the lights on at the lowest cost. Security of supply is now a much talked about concern with tightening capacity margins and uncertainty as to when Hinkley Point C (which was finally signed in September) will produce first power. All eyes will be on December’s capacity market auction to see if the additional 3GW’s of capacity available in the auction will create an effective price signal for new gas.

Support for renewables continues in the background with £730m committed across three CfD auctions in this parliament. The first auction was expected to make available up to £290m to pot two (less established) technologies this year, but is rumoured to have been delayed into the new year. The lack of certainty about the overall level of government support for low carbon generation, through the Levy Control Framework, post 2020/21 also remains a key concern.

Generation continues to decentralise and Ofgem’s current review of embedded benefits (the economic benefits of a generator being distribution connected), which started out with a view to addressing the unexpected success of small diesel generators in the capacity market auction, looks like it may blossom into a root and branch review of how transmission system costs are allocated across market participants. Add to that the competition and markets authority’s call for a move to locational pricing for transmission losses and we may see fundamental changes to whole system cost allocation in the near future. As part of these changes, Ofgem may also look to address the increase in triad avoidance (as consumers look to load shed at peak) and system cost allocation to network connected on-site generation to avoid generators being incentivised to move behind the meter. Much of this reform may be needed to reflect the changing nature of our energy system, but it risks creating uncertainty and introducing ‘retrospective’ change that impacts the revenue streams of existing generation assets. We may also see fundamental reform of National Grid’s role in the market through the split of its existing business to create an independent system operator (ISO) to act as system architect for the UK network and a separate transmission ownership and operation business.

Another area attracting a lot of attention is transmission, with a ‘pipeline’ of interconnectors and competitively procured onshore transmission upgrades (CATO) expected to reach the market shortly alongside the continuing success of the OFTO competitive model. An additional 9GWs of interconnector capacity is anticipated (twice the current level of interconnection). It is interesting to note that just at the point where the UK is looking to exit the EU, the country’s security of supply is likely to become more dependent than ever before on importing power from other EU states.

The combined effect of storage, concerns about energy security, increases in intermittent and decentralised generation and the prevalence of market led and competitively procured transmission investment means that we may see more system, regulatory and market mechanism reform in the coming years than at any point since the introduction of NETA in 2001. That challenge increases if we move to electrify vehicles and heat. Even without Brexit, our energy market is going through a period of unprecedented transition and the reforms needed to allow for this will need to be carefully managed to retain developer, investor and funder confidence. In a time of Brexit turbulence, the Autumn Statement provides the government with a clear opportunity to set out its vision for our energy future. Let’s hope they take it.

 

Alex Harrison is an energy lawyer at Hogan Lovells. He can be contacted on +44 (0)20 7296 5853 or by email: alex.harrison@hoganlovells.com.

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