EMBEDDED GENERATION CONNECTION INCENTIVES FOR DISTRIBUTION NETWORK OPERATORS Report Number: K/EL/00286/REP URN 02/1148 Contractor Ilex Energy Consulting Prepared by Peter Williams Stephen Andrews The work described in this report was carried out under contract as part of the DTI Sustainable Energy Programmes. The views and judgements expressed in this report are those of the contractor and do not necessarily reflect those of the DTI. First Published 2002 © Crown copyright Disclaimer While ILEX considers that the information and opinions given in this work are sound, all parties must rely upon their own skill and judgement when making use of it. ILEX does not make any representation or warranty, expressed or implied, as to the accuracy or completeness of the information contained in this report and assumes no responsibility for the accuracy or completeness of such information. ILEX will not assume any liability to anyone for any loss or damage arising out of the provision of this report. TABLE OF CONTENTS INTRODUCTION I 1. REVIEW OF THE EXISTING OBLIGATIONS ON DISTRIBUTION NETWORK OPERATORS 1 2. REVIEW OF DNO PRACTICE 9 3. INTRODUCTION OF THE UTILITIES ACT 2000 21 4. DNO INCENTIVES - PROBLEMS AND PROSPECTS 36 ANNEX A: DNO QUESTIONNAIRE 60 [This page is intentionally blank] INTRODUCTION This is a final report on the work undertaken by ILEX on the ‘Connection Incentives for Distribution Network Operators’ project - commissioned by the DTI as part of the New and Renewable Energy Programme. This work covers the tasks of the project as described in the original proposal and subsequently formalised under contract between ILEX and ETSU1. This final report incorporates the content of the interim report which was submitted in February 2002. Background Re-structuring of the electricity industry in the UK in 1989 led to the creation of Regional Electricity Companies (REC) who were responsible for the distribution and supply of electricity to local customers. Under their Public Electricity Supply (PES) licences, these regional companies were required to promote competition in energy retail (supply) and to publish charges for third party access to the distribution system. Over recent years the distinction between the distribution and supply functions of the Public Electricity Suppliers (PESs) has become more pronounced with PESs having to internally separate their supply and distribution businesses and to carefully monitor and control the flows of information between businesses. The Utilities Act 2000 formalised this split by issuing separate licences for both the ‘wires’ business (distribution) and the energy retail business (supply). Recent Government targets for renewable and CHP generation2 will have a material impact on the distribution businesses since most of this small generation capacity will be embedded in local distribution networks. Whilst reform of local planning regulations and improvements to the treatment of small generation within the New Electricity Trading Arrangements (NETA) may go some way to assist in Government meeting its targets, it is widely acknowledged that successful technical and commercial integration of embedded generation into distribution networks must be achieved if the 2010 targets are to be met. In the light of this, and following on from the work carried out by the Embedded Generation Working Group, the DTI, through ETSU3, has commissioned a number of projects associated with the connection of embedded generation through its Renewable Energy Programme. It is recognised that the commercial and regulatory implications for the newly licensed Distribution Network Operators (DNOs) of connecting increasing 1 Agreement/contract ref. K/EL/00286/00/00. 2 Government targets are for 10% of electricity supplied to be from renewable sources and for an increase in installed CHP generation to 10GW - both by 2010. 3 The Energy Technology Support Unit - now renamed Future Energy Solutions. i numbers of embedded generation needs to be afforded full and careful consideration as the industry moves forward. This project addresses the issue of DNOs’ incentives for the connection of embedded generation. Final report content Section 1 reviews the obligations on the Public Electricity Suppliers (PESs) relating to connection incentives for connection of embedded generation in the period between privatisation in 1990 and the introduction of the Utilities Act 2000 Section 2 examines current DNO practices associated with the connection of embedded generation including their interpretation of the various statutory and regulatory obligations. Business organisation and the processes and policies adopted by some of the DNOs, is also explored. This is based on consultation with three DNOs. Section 3 looks at the changes introduced by the Utilities Act 2000 - in particular, the new obligations placed on the DNOs and how these might affect the connection of embedded generation. The requirements of the new Electricity Distribution Standard Licence conditions are also explored and these are compared and contrasted with the obligations which previous existed under the Electricity Act 1989. The final part of Section 3 reviews the overall impact which the Utilities Act 2000 has had on the policies and practice adopted by DNOs in respect to the connection of embedded generation - together with the costs and penalties of non-compliance. Section 4 reviews the current regulatory treatment of the DNOs and explores the issues and opportunities associated with the creation of an effective incentive regime for the connection of embedded generation. The section concludes with ideas of how an incentive framework might look and work in practice and also looks at the means by which any new incentive framework might be could be governed. ii 1. REVIEW OF THE EXISTING OBLIGATIONS ON DISTRIBUTION NETWORK OPERATORS 1.1 There are a number of legal and licence obligations which must be considered before the concept of new, or further, DNO incentives for connecting embedded generation can be explored. Compliance with these statutory duties and regulatory requirements are non-negotiable and therefore represent the foundations upon which any incentive regime is built. 1.2 This section reviews the statutory, regulatory and licence obligations placed upon electricity distributors in England and Wales which are relevant to facilitating and encouraging the connection of small scale, embedded, generation. 1.3 The section goes on to briefly review any European Directives which are likely to have an impact on the connection of Embedded Generation and also highlights the relevant aspects of UK competition law. 1.4 The Utilities Act 2000 amends the Electricity Act 1989 and also introduces some important new obligations which are particularly relevant to the connection of embedded generation. The impact of the Utilities Act 2000 and an assessment of how the introduction of new obligations have affected current DNO practice, and may modify future DNO behaviour, is addressed section 3 of this report. The Electricity Act 1989 1.5 The Electricity Act 1989 underpins the governance and structure of the post- privatised electricity industry. It introduced the concept of Public Electricity Suppliers (PESs) and established the framework within which parties could connect to, and use, the distribution networks. Background 1.6 The Electricity Act 1989 (“the 1989 Act”) received royal assent on 27 July 1989 and applied to England, Wales and Scotland. In essence, the 1989 Act provided for the: • re-structuring of the electricity supply industry and the transfer from public to private ownership; • establishment of a new regulatory regime under the direction of the Director General of Electricity Supply; and • issue of licences for the generation, transmission or supply of electricity. 1.7 The 1989 Act introduced the requirement on those who wished to generate, transmit or publicly supply electricity to do so under licence. The Act prohibited anybody from carrying out any of these activities unless licensed or exempted from the requirement to be licensed. The 1989 Act empowered the Director General of Electricity Supply (DGES) to grant licences. 1 Public Electricity Suppliers (PESs) 1.8 At privatisation of the industry in 1990 the old Area Electricity Boards became Regional Electricity Companies (RECs). These RECs, by virtue of the licensing regime, all became Public Electricity Suppliers (PESs) and were awarded appropriate licences by the then DGES. Each REC was required to fulfil specific obligations associated with its authorised area4 as laid down in each of the PES licences. 1.9 The term “supply” of electricity was drafted to mean the provision of electricity to customer premises and included the distribution of electricity through ownership and operation of the local lines and cables and well as the wholesale purchase and sale of electricity to final customers. Those wanting to carry out this function were required, by the 1989 Act, to obtain a licence to do so as Public Electricity Suppliers (PESs). 1.10 The 1989 Electricity Act also introduced the concept of the second tier supplier whereby those participants in possession of an appropriate licence could compete with the incumbent suppliers, i.e. the local RECs, to supply electricity to eligible customers. Competition in electricity supply was introduced in three stages following privatisation. Firstly, in 1990, the largest customers, those over 1MW, were able to choose their supplier. In 1994 this threshold reduced to include