Expert Commission on Energy Regulation: main report

Scotland's Energy Supply Network

The majority of Scotland's population lives in cities. However, Scotland's geography means that it also has a diverse and distributed rural base with many consumers living in rural areas, including Islands. As a result, whilst some areas are still poorly served for electricity and in particular gas, there are more miles of transmission wire (and gas pipeline) per head of population in Scotland than the rest of the UK. The additional costs for electricity and gas transmission and distribution assets are currently socialised across the whole of the UK, as outlined below.

Transmission Costs and Investment

Ofgem estimated in 2010 that the cost of the investment needed to secure energy supplies and meet Britain's climate change targets could be as much as £200 billion in the period up to 2020 ^[19] , with £38 billion required for investment in gas and electricity transmission assets ^[20] .

Investments in the transmission infrastructure in GB have been made on an economic basis to enable the upgrade of aging electricity transmission assets, and to provide improved and new connections for existing and new electricity generators.

Ofgem's transmission price control review process (RIIO-T1) confirmed the fast-track price control decisions on SP Transmission Ltd and Scottish Hydro Electric Transmission Ltd, which own the transmission networks in Scotland. This resulted
in Ofgem agreeing price controls providing for investment of
£7.6 billion, which could be brought forward during the period in question (2013-2021) ^[21] . This announcement demonstrated the investment requirement and the value of the existing and new generation on the network.

In addition, recent forecasts and modeling from National Grid ^[22] suggest that planned transmission capacity upgrades in Scotland during 2014-2015 will amount to around 12% of total UK capacity.

However, the higher transmission use of system (TnUOS) charges which apply in Scotland mean that this 12% of capacity will account for around 21% of total GB TnUOS charges during the same period. Meanwhile, Ofgem has recently confirmed ^[23] that there will be a further delay to the outcome of Project TransmiT, its review of GB transmission charging arrangements.

Distribution Costs

Hydro Benefits Replacement Scheme and Common Tariff Obligation ^[24]

The Hydro Benefit Replacement Scheme is designed to protect consumers from the higher costs of distributing electricity in the North of Scotland. It is funded by charges on all licensed suppliers across Great Britain.

• The North of Scotland has the highest system length per 1,000 customers of any distribution network. At 63.2km this is more than double the GB average of 27.2km per 1,000 customers
• Distribution costs for consumers in the North of Scotland remain higher than elsewhere, even after the reduction from the scheme has been applied. The assistance provided an average bill reduction of £36 a year to each domestic consumer in the North of Scotland
• In 2013-2014 the energy consumption tariff which was levied on GB consumers (via charges on all electricity suppliers) was 0.018972 p/kWh ^[25] and provided a total capital support of £54.45 million

The Common Tariff Obligation ensures that electricity suppliers in the North of Scotland are not able to charge comparable domestic customers different prices solely on the basis of their location within the area. This is designed to protect customers in remote rural areas from the relatively high costs of supplying electricity in these areas.

There is a statutory requirement to review the scheme and obligation every three years. Following the latest review (2012), DECC has decided to retain these schemes as they continue to meet their policy objectives of protecting electricity consumers in the North of Scotland.

Support for Lerwick Power Station, Shetland Islands ^[26]

Shetland is not connected to the main electricity network in GB. This means that the islands rely entirely on local sources of generation, with supply and demand on the islands also balanced locally. At any given time there cannot be more generation than demand, or vice versa, meaning that a significant percentage of the generation must have a reliable and controllable output.

The network on Shetland is classified as a distribution network, since it does not have voltages greater than 33kV. It is owned and operated by Scottish Hydro Electric Power Distribution ( SHEPD), a distribution network operator ( DNO). It was agreed during the introduction of BETTA that SHEPD would also administer the electricity supply on the islands - meaning that they are responsible for balancing the islands' demand and supply.

This agreement was designed so that prices for Shetland's customers would remain in line with those on the mainland. As there are higher costs associated with electricity supply on Shetland, it was agreed at the time of the fourth distribution price control (DPCR4) for the period 2005-2010 that the cost differential should be recovered from all SHEPD customers.

The resulting cross subsidy fluctuates from year to year due to the variation in the cost of fuel for generation at Lerwick power station ( LPS), the cost of the contracted third party generation (from the independent, Sullom Voe Terminal Power Station) and the price of electricity on the mainland. The difference between the GB-market price and the cost of electricity produced on Shetland sets the level of the cross subsidy met by SHEPD customers. The amount that SHEPD can re-charge for operating and maintaining LPS is set at a fixed allowance in the current price control period (DPCR5).

The arrangements to supply electricity on Shetland cost around £29 million in 2010-2011. The majority of the costs are from the fuel and operating cost of running Lerwick power station (£16 million) and the rest from third party contracts (£13 million). A third of this £29 million was recovered directly from Shetland's customers through their electricity supply bills. The remainder was recovered from customers connected across SHEPD's distribution network. SHEPD calculates that, in 2010-2011, the additional cost of providing a supply on Shetland resulted in an average cost across all their customers of £27.

Ofgem has recently reviewed the proposals from SHEPD for replacing Lerwick power station and has made a Determination on the company's submission ^[27] .

Gas Supply - Statutory Independent Undertakings

Scotland has five Statutory Independent Undertakings ( SIUs) for gas supplies that are operating gas networks not connected by pipeline to the rest of the network. Four use Liquefied Natural Gas ( LNG) and one uses Liquefied Petroleum Gas ( LPG). Campbeltown, Oban, Wick and Thurso have SIUs supplied with LNG by road tanker from a depot at Avonmouth, near Bristol. The fifth SIU, Stornoway, uses LPG.

There are around 7,500 gas customers in the four affected SIUs, mainly domestic. The Gas Act 1986 obliges Scotia Gas Networks ( SGN) to continue to provide a gas supply, 'where required', to all customers already connected to the network. There is no gas storage facility in Scotland and a limited amount in England, which is provided via the Avonmouth LNG site.

The supply to the SIUs has relied on commercially available sources of LPG that are delivered by ship and road tanker along with LNG whose supply was sourced from National Grid's facility in Glenmavis, North Lanarkshire. In 2012 this facility was closed by National Grid when it reached the end of its operational life and the only available source of LNG in the right specification is from National Grid's facility in Avonmouth, Bristol.

SGN has invested in additional storage capacity and transport fleet to provide assurance that this change would not have an impact on the supply to the SIUs which rely on LNG. However, in 2013 National Grid notified SGN of its intention to close the Avonmouth LNG site in April 2018. As a consequence of this and requirements set by Ofgem as part of the RIIO GD1 price control, SGN are investigating the best long-term options for the supply of energy to the SIUs including non-gas solutions.

The cost of delivery for gas supplies from the point of entry to the system through to end consumers is becoming increasingly important. Gas currently forms approximately 60% ^[28] of the household bill in the domestic sector in Scotland where gas is available, and in future, there may be greater diversity in supply sources to Scotland and requirements for an increasing flow from the South to the North. Events in Ukraine during 2013 and 2014 ^[29] highlight wider concerns in Europe over the security and price of gas supplies.

Thermal Capacity

The reduction in thermal generation capacity in GB has raised significant concerns for security of supply. A key issue in Scotland is the continuity of thermal generation capacity in the future where currently a structural deficiency exists. Existing locational signals within transmission pricing are currently unlikely to deliver new thermal generating capacity in Scotland. While this goes beyond the Commission's remit, the Commission recommends that Scottish Government explores how the development of new thermal power stations in Scotland can be encouraged, either to maintain the technical operability of the overall GB system or to ensure security of supply.

Consumer Issues

While the single GB-market has helped increase the number of players in wholesale electricity, the retail market in Scotland has not experienced significant increases in competition. The incumbent utilities - Scottish Power, Scottish and Southern Energy, and Scottish Gas - have retained a high market share, and the loyalty of customers to their 'brand'.

In the UK, the 'big 6' electricity and gas supply companies have a market share of around 95%. In Scotland, there is particular concentration in the 'big 3'. It is particularly important to maintain the attractiveness of the market to new entrants and other existing participants in Scotland in order to drive consumer competition.

This is an important issue, as retail market arrangements could, if so wished, develop differently in Scotland, taking into account the wider single market business structure. Any change could affect the attractiveness of the market to existing and new entrants and hence the levels of competition. Where changes are mandatory and unilateral across the market, then the business impacts are uniform. Encouraging market entry for new participants in the electricity and gas retail markets is more challenging in Scotland as there is a smaller pool of potential customers who could be persuaded to switch to a new supplier. This is even more of an issue where populations are rural and dispersed. Where any changes are introduced only within a smaller market such as Scotland, there may be differential impacts (e.g. system issues) for market participants to consider and address.