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Second, when it examined the contribution that could be made to the capacity market by DSR, the PTE observed as follows in paragraphs 96 to 106 of that report: ‘96. Distributed Energy Resources (“DER”) is the term we prefer to use when discussing the contribution that can be made to managing situations when transmission connected generators are unable to meet the demand for electricity. We prefer this term to the commonly used “Demand Side Response”, which possibly imports a preconception that the only (or main) contribution of the demand side is the temporary reduction in demand. DER, on the other hand, implies the full range of resource that can mitigate the need for solving capacity problems other than building new power stations. There is a pressing need to initiate the gathering of more information in this area to inform future decisions, especially as there is no over-arching organisation analysing the totality of the electricity system. These resources include: (a) Direct load control (b) Embedded generation (c) Standby generation (d) Demand response (e) Energy Efficiency (f) Fuel substitution (burn gas instead of electricity for example) (g) Interruptible loads (h) Integrated DSM project (such as using the batteries of parked electric cars as reserve power) (i) Load shifting (j) Smart metering (k) Power factor correction. 97. It is important to recognise that the list of candidates who could provide demand side capacity is quite extensive so as to be aware of what is being modelled. It is also important to note that there are qualitative differences between these resources. 98. For example, load shifting could involve a user of electricity for refrigeration being incentivised to curtail its demand for electricity for a few hours and to rely on thermal inertia to avoid harm. Such a user may well have a supply contract for perhaps two years that is renegotiated annually or biannually, in which case that consumer would be responsive to short term auction signals. 99. On the other hand, another potential resource may be considering installing a co-generation plant or building energy management system to optimise demand side response, but needs the certainty of a long-term capacity contract to secure finance. The essential point is that in estimating demand side response, it is essential to identify the potential resources which are likely to respond to capacity market signals and those who will not because the incentives do not meet their needs. 100. We note that the DECC methodology for determining the level of contribution to capacity made by DSR is very much in line with approaches adopted in New England and PJM (except impact on losses). To this extent this precipitates an opportunity to validate assumptions by using those systems as a means to compare and contrast. 101. In conversations with DECC and NG, we were made aware that the demand side is not yet understood as well as conventional generation. This is not a criticism as it has not been part of NG’s role. NG is quite separate from the Distribution Network Operators and licensed electricity suppliers, and there is no one who has both an overall detailed understanding of, together with the incentive to, marshal demand side data. For example, the answers to questions such as “what is the average availability of embedded [combined heat and power] at times of system stress” is not known, even if annual averages are known. 102. For all these reasons, we fully appreciate that NG were unable to carry out analysis on the demand side with the rigour and distinction that has been the hallmark of much of their other work. Nevertheless, this implies an urgent need to create a systematic process for ensuring that the resources of the demand side are not wasted only for new generation to step into the inefficiency gap. ... 104. Although the Panel does not claim to know the full potential demand side resource that might be available, the Panel believes that the design as it stands necessitates relatively modest assumptions regarding the capacity that can be sourced. One aspect of this is that the capacity mechanism is more suited to some behaviours, methods and technologies than others.

105. Therefore, although the international experience of DER, particularly in the US, that the Panel circulated suggest the potential for significant and successful participation of DER in the capacity markets, which in turn led to the reduction in the need for additional generation capacity, the expectations in the current UK design need to be more modest. We would argue as further evidence for modest expectations is that, for example, conventional generation that will receive [Transmission Network Use of System] related payments and revenues from the capacity mechanism, whereas distributed generation could be in a position that is less incentivised than conventional generation if it cannot access both triad avoidance benefits and capacity mechanism revenues. 106. Based on the Panel’s interpretation of the proposed capacity market for DER, we believe that there will be limited uptake of the total potential that has been demonstrated in other markets with capacity auctions, particularly those in the US and that, the cure to understanding this would be a greatly enhanced understanding of the range of demand resources available. The key modelling impact is that its impact on the assumed level of peak demand, which is the primary driver of the capacity to procure, is not as open to challenge as might be expected.’