THE TRADABLE VALUE OF DISTRIBUTED GENERATION

THE TRADABLE VALUE OF DISTRIBUTED GENERATION CONTRACT NUMBER: DG/DTI/00047 URN NUMBER: 05/1228 1

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THE TRADABLE VALUE OF DISTRIBUTED GENERATION CONTRACT NUMBER DG/DTI/00047 URN NUMBER: 05/1228 Contractor ILEX ENERGY CONSULTING The work described in this report was carried out under contract as part of the DTI Technology Programme: New and Renewable Energy, which is managed by Future Energy Solutions. The views and judgements expressed in this report are those of the contractor and do not necessarily reflect those of the DTI or Future Energy Solutions. First published 2005 Crown Copyright 2005 3

THE TRADABLE VALUE OF DISTRIBUTED GENERATION Introduction This guide is intended for generators of all scales and all technologies connected to the distribution network. It aims to provide a high-level assessment of the tradable value of distributed generation in current market conditions. By its general nature this guide can only provide an indication of the value that individual generators can receive and therefore parties should not rely on it as the basis for any actions, decisions or undertakings. The guide contains three main sections. The first sets out the elements of value that distributed generators may be rewarded for. The second discusses how generators can realise these values and provides worked examples for three typical generators at varying scales. The final section contains references to sources of further information. Elements of value There are a number of sources from which distributed generation may derive value. These are shown in Figure 1. Figure 1 Sources of tradable value for distributed generation Wholesale electricity Renewable Obligation Certificates EU EU Emissions Trading Trading Scheme Scheme Value Value of of distributed distributed generation generation Levy Levy Exemption Certificates Ancillary Ancillary services services Embedded benefits benefits Source: ILEX Energy Consulting Not all generators will be eligible for all of these elements of value. The value an individual generator can realise will depend on its technology, location, size, operating profile and connection voltage. The values we identify are believed to be accurate or reflective of market practice as of April 2005. However, readers should be aware that prices can change rapidly and market practices vary. 4

Energy sales Wholesale power prices provide a benchmark for the value of energy sold by distributed generators. Power is priced half-hourly and prices vary considerably depending on the season and time of day. At present, the traded value for baseload power (continuous generation) over the year from April 2005 is 3.1p/kWh. This value takes account of the effects of the introduction of the EU Emissions Trading Scheme (ETS) and the new GB-wide electricity trading arrangements, BETTA. Generators should be aware that power prices vary considerably and historically annual prices have dropped below 1.8p/kWh. The value received by a generator will depend on the time of day and season when it generates and the predictability of that generation. The annual traded value for peak power (7am-7pm, Mon-Fri) is currently 3.7p/kWh, but peak generation over winter (October-March) is valued at 4.5p/kWh. Conversely, generators exporting over summer and at night are likely to receive lower annual prices. The value of energy from distributed generators whose level of export is difficult to predict may not match wholesale power prices because unpredictability results in an imbalance cost. In general, the less predictable the export, the higher the imbalance cost. As an example, unpredictability would reduce the value on the wholesale market of output from a wind farm by 0.2p/kWh or more. CHP plant may also incur relatively high imbalance costs if unpredictable variations in on-site demand create an intermittent export profile. Renewable Obligation Certificates (ROCs) Under the Renewables Obligation, eligible generators 1 receive ROCs for each megawatt-hour of power that they generate. Electricity suppliers can either redeem ROCs purchased from renewable generators or pay a buyout price for a set proportion of their demand that increases each year to 2015/16. Buyout payments are recycled to suppliers who redeem ROCs, raising the value of ROCs above the buyout price. The greater the gap between the Obligation and annual eligible generation, the higher the ROC price. The buyout price is set at 3.2p/kWh from April 2005 and ROC prices are currently trading at around 4.7p/kWh. In the next few years, most market analysts expect the ROC ROC eligible sources Landfill gas Sewage gas Advanced mixed waste technologies: Anaerobic digestion Pyrolysis Gasification Conventional hydro: Capacity less than 20MW New hydro: Irrespective of capacity Onshore wind Offshore wind Agricultural and forestry residues Energy crops Co-firing of biomass with fossil fuels (until 2016) Wave and tidal power Photovoltaics 5

price to fall closer to the buyout price, as eligible generation grows faster than the level of the Obligation. Climate Change Levy Exemption Certificates (LECs) Levy Exemption Certificates (LECs) are awarded to renewable and Good Quality 2 CHP generators for each kilowatt-hour of energy exported to the network. LECs have a value by enabling suppliers to avoid paying the Climate Change Levy (CCL). The CCL is a tax on energy, including electricity, which licensed electricity suppliers must levy on their supply to non-domestic customers unless they are able to show (LECs) against this supply. The CCL is set at 0.43p/kWh and has not been changed since its introduction in April 2001. The future of the Levy is uncertain, not least because its purpose (to mitigate climate change) now overlaps that of the EU ETS. The Government is currently consulting on changes to the UK Climate Change Programme, of which the Levy is a part. The outcome of the consultation should be known later this year. Embedded benefits Embedded benefits are a series of avoided costs that result from the generator being connected to the distribution network rather than the high-voltage transmission network. Transmission Network Use of System (TNUoS) charge avoidance The System Operator, National Grid Company (NGC) levies TNUoS charges on suppliers and generators to recover the costs of maintaining the transmission system. Provided they are licenceexempt (generally less than 100MW), distributed generators will avoid the generator charges (though these may be payments to generators in the southern UK) and can earn one of two supplier TNUoS benefits. If they are metered half-hourly, they avoid Triad charges. Otherwise they attract a consumption charge benefit. The level of these zonal charges, and therefore the embedded benefit, is shown for 2005/06 in Figure 2. These charges have been subject to a substantial consultation in the run up to BETTA, and so are not expected to change materially for the next couple of years. 6

Figure 2 Value of supplier TNUoS benefits by region Triad payments for half-hourly metered generation 0-5/kW 5-10/kW 10-15/kW 15-20/kW 20+/kW Consumption payments for non-half-hourly metered generation 0-5/MWh 5-10/MWh 10-15/MWh 15-20/MWh 20-25/MWh 25+/MWh NGC may introduce a new charge on suppliers during 2005 of around 0.013p/kWh to recover Hydro Benefit costs. Distributed generators may able to acquire a share of the avoided charge as a benefit, if they reduce suppliers liability. However, the precise mechanism through which this charge will be applied (and any embedded benefits that will arise) is unlikely to be known before June 2005. Balancing Services Use of System (BSUoS) charge avoidance NGC levies BSUoS charges on suppliers and generators to recover the costs of balancing energy flows on the transmission system. Distributed generation reduces the BSUoS charge that suppliers must pay by reducing consumption. BSUoS varies half-hourly, and the average charge for the latest financial year was 0.044p/kWh. At present, BSUoS charges are not expected to change materially going forward. In addition, the balancing system produces small half-hourly residual cashflows that are generally negative (a disbenefit to distributed generators) but can be positive (a benefit) and are allocated to suppliers in the same way as BSUoS charges. These funds (known as the Residual Cashflow Reallocation Cashflow (RCRC) or the beer fund ) produced an average disbenefit for embedded generators of 0.004p/kWh over 2004/05. This value is unlikely to become any more material in future years. Reduced energy losses In most cases, distributed generation reduces energy flows through the transmission and distribution networks and thereby reduces 7

energy losses. The value of distributed generators exports should be grossed up automatically by an appropriate loss factor when calculating the value of power exports and the TNUoS and BSUoS benefits. In general, the lower the voltage level at which the generation is connected, the higher the factor, varying from around 10% for domestic generation in regions with high losses, such as London, to 1% at high voltages in the network (132kV). Ancillary service provision Ancillary service is a generic term for a range of power-related services that can be provided by certain types of generator. Such services include frequency response and start-up capabilities in the event of a power outage. In practice, the main ancillary service likely to be provided by distributed generation is Standing Reserve most likely to be provided by diesel and gas-fired conventional standby generation plant that can start up rapidly on demand. Generators with suitable plant in excess of 1MW can tender to NGC to provide such services. EU Emissions Trading Scheme allocations The EU ETS covers all thermal generation plant with an input capacity greater than 20MW th. In the first phase of the Scheme, which runs from 2005 to 2008, these plant have been allocated allowances based on their historic emissions. All new thermal plant commissioned before 31 December 2007 will receive an allocation of allowances equivalent to that for a gas-fired plant. New thermal renewable generators, which do not need to surrender allowances, may be able to sell their allocation. At the time of going to press, allowances are trading at 15 per tonne of carbon dioxide (CO 2 ), which is worth around 0.7p/kWh to a biomass-fuelled power plant. The future direction of allowance prices is very uncertain. Benefits of on-site generation For on-site generation selling direct to demand, the value of distributed generation should include the values above, subject to eligibility, and avoided per-unit charges for use of the distribution network (DUoS charges) and supplier retail margins. For generators that meet a local load (such as domestic microgeneration or CHP plants), this value is effectively rewarded through avoided charges for energy imports. Summary The elements of value described above not only apply differently to different types of generation, but also vary in their significance. Table 8

1 summarises the relative importance of each value for the major types of distributed generation. Table 1 Significance of value elements for generation technologies High Med Low N/A Negative Wholesale price ROCs LECs TNUoS Emb. benefits EU ETS On-site Anc. service Wind, hydro Renewables CHP Other Waste µpv LFG, biomas s Gas/ diesel Biomas s Micro Gas, diesel Source: ILEX Energy Consulting Applicable generators: Current New Realising value No distributed generator will be able to secure the full market value of its output. Generators are typically dependent on suppliers (to whom most of the values accrue) to pass through a proportion of the full value. In the first instance, pass-through rates depend on the supplier s transaction costs and on the relative bargaining power of the supplier and the generator. As a result, the generator s size is a key determinant of the proportion of the theoretical value that it receives. For the purposes of this guide, we have defined three sizes of generator: Small generators include most PV systems, other forms of domestic generation and slightly larger power sources up to a capacity of around 1 MW; Medium generation begins at this threshold and runs up to around 10 MW, including, for example, industrial CHP plant and older wind farms; and Large generation includes everything over this size and is likely to include all generation whose economics depends solely on the sale of power to the network, notably including most new wind farms. 9

Figure 3 illustrates the total market value of all the tradable elements of value arising from embedded generation. It also summaries the portion of that market value which an embedded generator is likely to be able to realise, based on the size, technology and contracting arrangements of projects described in the worked examples below. The length of contract will also be critical to the value received, particularly where there is uncertainty over future prices, which may reduce the value offered in longer-term contracts. Figure 3 The total market value of the tradable elements of generation and the portion of that value likely to be realised by embedded generators in each worked example Tradable value of export (p/kwh). 9 8 7 6 5 4 3 2 1 ROCs LECs BSUoS/RCRC TNUoS Loss benefits Power Composite tariff 0 Total market Wind CHP Micro PV value Realisable values for example technologies Note: Wind farm of 30MW, CHP unit of 3MW, PV system of 1.5kW capacity Source: ILEX Energy Consulting Small distributed generators Generators in this category are most likely to receive a composite tariff from a supplier that incorporates all of the relevant value elements in a single fixed or Seasonal Time of Day price. They are unlikely to be able to negotiate either the structure of the contract or its commercial terms. For renewable and CHP generators at this scale, the regulatory arrangements allowing them to receive ROCs and/or LECs have only recently been put in place and remain untested. Similarly, the arrangements allowing suppliers to be rewarded for connecting generators whose output is not metered half-hourly are still evolving. Providing that the generating equipment is correctly connected and metered 1 accessing this value is a matter of finding a supplier that offers an appropriate tariff. 10

Worked example 1: A domestic PV system Domestic PV systems are typically mounted on, or integrated within, the roof of a house. Systems might have a peak output of between 1 and 2 kw and generate 700 to 1,400 kwh of electricity in a year in the UK. Table 2 sets out the market and realisable values of output for a 1.5 kw system that generates 1,050 kwh in a year. The baseload price represents the market value for a generator that operated continuously throughout the year, whereas the profiled value is an estimate based on the expected operating profile of a domestic PV system. The value of power and ROCs dominate. The value of power is for exports only, whereas the value for ROCs may be realised on all generation. Empirical data from DTI PV field trials suggest that PV systems of this scale export around 50% of their generation. The value of losses for a connection at the lowest voltage level in the distribution network is calculated as 8% of the power, BSUoS and TNUoS benefits. Table 2 Domestic PV market and realisable values (p/kwh of export) Source of value Baseloa d Market value Export profiled Power 3.10 3.34 ROCs * 4.72 4.49 LECs 0.43 0.43 TNUoS 0.19 0.14 (Triad) BSUoS/RCRC 0.04 0.04 Losses 0.27 0.28 Realisable value Passthrough Tariff Total 8.75 8.73 46%/60% 4.00 *ROC values can apply to each unit of generation not just on export, summed annually to the nearest MWh. Higher value assumed all generation exported, lower value reflects tariff versus actual market value. Source: ILEX Energy Consulting In practice, the current costs of metering the export from microgeneration, so that a supplier can be rewarded through the settlement system, exceed its value. As a result, suppliers at present tend to offer a tariff that is for the ROCs only. Medium distributed generators At this scale, generators are most likely to be offered a standard contract incorporating the majority of value elements in a bundled tariff, but perhaps separately specifying the value to be paid for LECs 11

and/or ROCs (if the generator is eligible) and the Supplier TNUoS (Triad) benefit. They are likely to be able to negotiate the price of the elements, but will have limited room to negotiate the contract structure. Unlike small-scale generation, this section of the market is sufficiently established that tariffs offered will reflect a broadly consistent proportion of the market value of the output. Securing a tariff will require approaching a supplier or independent consolidator willing to sign a contract and negotiating appropriate terms. Worked example 2: An industrial CHP scheme This example uses a 3MW industrial CHP scheme, fuelled by natural gas. The plant will most likely be used to meet a local steam/heat load, with some of the generation being used on site and the remainder exported to the local distribution network. Table 3 shows the baseload market value, the market value for the expected profile the CHP plant (assuming that it operates continuously during winter and on weekdays only during summer) and the realisable portion of this value. We have assumed that the plant exports 50% of the electricity it generates, mainly during off-peak periods. The value that the operator receives through avoiding the need to import power when the plant is operating is not shown. This plant is assumed to be characterised as good quality and so eligible to earn LECs. The value of losses benefit for a connection at the 11kV voltage level in the distribution network is calculated as 5% of the power, BSUoS and TNUoS benefits. Electricity exports account for the majority of the value, as a gas CHP plant does not earn ROCs. The realisable value per kilowatt-hour for the TNUoS (Triad) benefit is shown separately from the aggregate value for the other elements, reflecting the most likely contract structure and the benefit available in the East Midlands region. 12

Table 3 CHP market and realisable values (p/kwh of export) Source of value Baseload Market value Export profiled Realisable value Passthrough Tariff Power 3.10 2.97 90% 2.67 ROCs 0.00 0.00 70% 0.00 LECs 0.43 0.43 60% 0.26 TNUoS 0.15 0.12 0.07 (Triad) 60% BSUoS/RCRC 0.04 0.04 60% 0.03 Losses 0.17 0.16 60% 0.09 Total 3.89 3.72 84% 3.12 Source: ILEX Energy Consulting If the generator is an eligible renewable technology, it could also qualify for ROCs on its gross generation, adding approximately 3.2p/kWh, assuming a pass-through rate of 70%. Large distributed generators Large generators will be able to negotiate a bespoke contract or contracts with one or more buyers of their output. The pass-through rates are likely to be higher than those received by medium-scale generators. In addition, for distribution-connected generators at the larger end of the scale, trading directly in the wholesale market may be an option. Worked example 3: A wind farm This example is for a wind farm of 30MW, connected to the distribution network at 33kV. The farm is eligible for ROCs and LECs, but as a non-thermal plant is excluded from EU ETS. The realisable value per kilowatt-hour for the TNUoS (Triad) benefit is shown for the Southern Scotland region. Because the plant is connected relatively high up the distribution network, the value of losses is calculated as 2% of the power, BSUoS and TNUoS benefits. 13

Table 4 Wind farm market and realisable values (p/kwh of generation) Source of value Baseloa d Market value Export profiled Realisable value Passthrough Tariff Power 3.10 3.09 95% 2.94 ROCs 4.72 4.72 80% 3.77 LECs 0.43 0.43 70% 0.30 TNUoS (Triad) 0.05 0.10 70% 0.07 BSUoS/RCRC 0.04 0.04 70% 0.03 Losses 0.06 0.06 70% 0.04 Total 8.40 8.45 85% 7.15 Source: ILEX Energy Consulting The export-profiled power price for wind would tend to be better than baseload, as generation tends to be greater at peakier times of the day and year. However, uncertainty over the timing and volume of generation will reduce this value due to the imbalance costs that could be incurred (assumed at 0.2p/kWh in the example above). More predictable generation technologies could benefit from lower imbalance costs. New thermal renewable generation, such as a large biomass-fired CHP plant, commissioning prior to 2008, may be able to earn additional income of around 0.7p/kWh during 2005, 2006 and 2007 by selling any unused allocation of CO 2 emissions allowances, at current CO 2 prices. References 1 Ofgem site, for information on the Renewables Obligation and their work on smaller generators: http://www.ofgem.gov.uk/ofgem/index.jsp DTI renewable energy site: http://www.dti.gov.uk/renewables/ 2 Defra information on CHP, including definition of Good Quality: http://www.defra.gov.uk/environment/energy/chp/ 14