Constraints and conflicts of interest

Last week my colleagues at the Renewable Energy Foundation drew attention to the substantial constraint payments being made to the new Viking Energy wind farm in Shetland - https://www.ref.org.uk/ref-blog/382-newly-opened-viking-wind-farm-taking-nearly-three-times-its-cfd-price-in-august-2024 . The wind farm is controlled and largely owned by a subsidiary of SSE. It exports its power from Shetland to the North of Scotland via a new HVDC subsea transmission link that is owned and operated by another subsidiary of SSE. The transmission link connects to the transmission network in the North of Scotland which is also owned and controlled by a subsidiary of SSE. Any notion of unbundling functions in the electricity system to avoid conflicts of interest have clearly not been applied in this case. This article explains the background to this arrangement and discusses what should – but probably won’t – be done about it.

This story goes back 70 years to the reorganisation of the electricity sector in the Scotland under the 1950s Conservative government. Notwithstanding the formal enactment of devolution in 1998, Scotland was run in the post-war period as a largely separate fiefdom by civil servants based in Edinburgh who reported to the Secretary of State for Scotland. Partly for political reasons and partly because Scotland has a separate legal system, much of the legislation enacted for England & Wales was implemented with significant modifications in Scotland.

Crucially for our purposes, between 1947 and 1954 the electricity sector in Scotland was restructured into two vertically integrated companies which controlled generation, transmission and distribution – the South of Scotland Electricity Board (SSEB) and the North of Scotland Hydro-Electricity Board (NSHEB). The NSHEB was run during this period by a forceful and effective politician, Thomas Johnston, who was Secretary of State for Scotland during WWII and then Chairman of the NSHEB from 1945 to 1959. During this period the NSHEB built or started construction of 48 hydro schemes which were commissioned between 1950 and 1963. To transport the power from its hydro plants to the main sources of demand in the East and North-East of Scotland, the NSHEB built an extensive transmission network – the Highland Grid – operating at 132 kV.

In the South of Scotland, the SSEB operated in conditions that were much more similar to the North of England with a concentration of population in the Central Belt from Glasgow to Edinburgh. The SSEB relied initially on coal-fired plants in Glasgow and later on the Firth of Forth (Longannet and Cockenzie). These were supplemented by 3 nuclear plants - Hunterston A & B (in Ayrshire) commissioned in 1964 and 1976 and Torness (in East Lothian) commissioned in 1988. Its transmission network was smaller than that of the NSHEB, despite its much higher population. Crucial components in this network were (a) the 275 kV connection from the West of Scotland to the main CEGB grid at Carlisle built to transport power from Hunterston B, and (b) the 400 KV line from SE Scotland to NE England built to transport power from Torness.

The different structure of the electricity industry in Scotland was reinforced by the privatisation of the electricity industry between 1989 and 1991. In England & Wales the industry was unbundled into separate generation, transmission and distribution companies. The generation and distribution companies were floated on the Stock Exchange while shares in National Grid were held by the new distribution companies. The two Scottish utilities were sold separately as Scottish Power (SSEB) and Scottish Hydro-Electric (NSHEB) in 1991 with no unbundling other than the formation of separate group companies. The nuclear plants operated by SSEB were transferred to British Nuclear before privatisation.

Throughout its history Scottish Hydro-Electric, which is now a large part of the SSE Group, has operated as an integrated and relatively self-contained entity in a manner that is akin to that of electricity utilities in the US South. Its links to the South of Scotland and the rest of the UK have been – and remain – much weaker than those of Scottish Power.

The best illustration of this, to an almost absurd degree, can be seen in the large Peterhead power station. This was planned as 1,320 MW oil-fired steam plant but shortly after commissioning in 1980-82 it was converted to burn waste gas from the nearby St Fergus gas terminal. It was repowered in the early 2000s to operate as a combined cycle plant with a nameplate capacity of 2,407 MW but later downgraded to 1,840 MW. However, throughout the last 20 years the transmission entry capacity for the plants has been far less than its nameplate capacity. From 2010 the transmission entry capacity was 1,180 MW and this was reduced to 400 MW in 2014.

From the company’s point of view, such decisions may be seen as a reasonable response to the incentives created by regulatory decisions. However, it has not been shy about lobbying the Scottish Government vigorously to protect its privileged position as both generator and transmission operator in the North of Scotland. As a comparison, this appears to be no different from the behaviour of Dominion Energy lobbying state legislators in Richmond, Virginia and Raleigh, North Carolina, on behalf of its regulated utilities in those states.

There is, however, one large difference. The consequences of decisions made in Richmond and Raleigh fall almost entirely on customers in those states. In contrast, SSE’s lobbying has the effect of transferring a significant share of the costs of investing in and operating transmission networks in the North of Scotland onto customers in the rest of the UJK. This is not robbing Peter to pay his brother Paul. It is picking the pockets of electricity customers in the South of England to benefit SSE as the primary investor in networks and generation in the North of Scotland.

Let us turn to the case of the Viking Energy project in Shetland which, as John Constable and Lee Moroney of the Renewable Energy Foundation have documented, has been receiving large constraint payments to compensate for restrictions on its output because of bottlenecks on the transmission lines from the North to the South of Scotland. Who controls Viking Energy? SSE Renewables, a subsidiary of SSE. Who owns the HVDC transmission line from Shetland to the North of Scotland? SSEN Transmission, another subsidiary of SSE. Who owns the transmission network to which the subsea transmission line is connected? Scottish-Hydro Electricity Transmission (SHETL), another subsidiary of SSE and trading as SSEN Transmission.

This is self-dealing on a grand scale. We should remember that the subsidies which underpin the investment which SSE has made in the Viking Energy wind farm and in the construction of the Shetland to Scotland transmission line are paid by all electricity customers in the UK. Viking Energy has two CfD contracts under the Remote Island Wind arrangement at an average strike price of £66.60 per MWh.

As Constable & Moroney point out, SSE has declared expected start dates of 31^st March 2027 for one contract and 31^st March 2028 for the second contract. The two contracts have different terms with respect to postponing the start date and penalties for not executing the option. This means that Viking Energy has almost unlimited scope to shift power between CfD and open market sales in a way that earns the highest return.

At the same time, by commissioning the HVDC transmission link and starting to deliver power over it, SHETL can add the cost of the link to their Regulatory Asset Base on which they can earn their permitted cost of capital as well as recovering any operating costs.

The Viking Energy project is only the most visible manifestation of the overlapping interests of SSE subsidiaries in the North of Scotland. The Highland Council has a database listing all applications for wind farm developments in its area. There are 51 wind farms with a capacity of at least 10 MW either in operation or under construction. The total capacity of these wind farms is 4.8 GW, of which 2.2 GW are offshore plants and 2.6 onshore plants. SSE is operator and/or (part-)owner of 13 wind farms – 1 (Beatrice) offshore and the remainder onshore. The total capacity of SSE wind farms is 1.8 GW, of which 1.2 GW are onshore projects.

Let us look at what is happening. SSE subsidiaries build wind farms in the North of Scotland which connect to either the distribution network run by SSEN Distribution or the transmission network run by SSEN Transmission. Unfortunately, investment in the transmission network has been insufficient to handle all of the power that can be deliver by wind farms in the area, so some of the wind farm output must be constrained because of network bottlenecks. SSE wind farms bid to receive the resulting constraint payments.

In 2023 SSE wind farms received £41 million in constraint payments, roughly a third of total constraint payments of £119 million made to wind farms in the North of Scotland. However, as the constraint payments made to Viking Energy in August 2024 suggest, the situation is likely to get much worse within 2-3 years. In addition to the 440 MW from Viking Energy, a further 540 MW of wind farm capacity is under development by SSE in the North of Scotland out of a total of 1.4 GW under development.

SSE will claim, with some reason, that this is not their fault. The key decisions on incentives for developing new wind farms, planning consents, and investments in new transmission capacity are made by the Scottish and UK governments directly or via Ofgem as regulator. Nonetheless, SSE has benefitted greatly from the general incoherence of policymaking within Scotland and at the UK level. The Viking Energy project was projected to be completed in 2027-28, yet it is operating in 2024 with no apparent attempt to delay it until there is sufficient capacity in the transmission network that will receive its output.

Neither is the situation in the North of Scotland unique. The three largest recipients of constraint payments in 2023 were Moray East (controlled by EDP and Engie), Seagreen (controlled by SSE) and Clyde Wind Farm (controlled by SSE). Seagreen connects to the SSEN Transmission network in Angus, while Clyde connects to the Scottish Power transmission network in the South of Scotland. There are not just bottlenecks in the North of Scotland but ones throughout the transmission system in Scotland as potential exports of wind power from Scotland have expanded far more rapidly than transmission capacity. Again, everything is due to get much worse as large offshore projects such as Moray West, Neart na Gaoithe, and Inchcape are completed.

Belatedly, two 2 GW subsea transmission links from Scotland to the east coast of England have been approved and construction contracts have been signed. However, neither is expected to be commissioned until 2029. The history of the 2.2 GW Western Link from Ayrshire to North Wales, which took 6 years from start to final completion and suffered several serious outages, is not especially encouraging. A realistic assessment is that the transmission bottlenecks in Scotland are unlikely to be resolved until 2030 or 2031, i.e. 7-8 years after they have started to impose large costs on electricity customers throughout the UK.

Behind all of this lies what, in my view, is a litany of regulatory incompetence or official indulgence of the two Scottish power companies. I have mentioned that vertically integrated power utilities that control generation, transmission and distribution are not unusual in parts of the US. However, they are regulated as they are so that they can earn a regulated return on their entire asset base. The problem with SSE and Scottish Power is that they are vertically integrated companies that operate within a regulatory regime that treats each activity separately. This gives immense scope for gaming the regulatory system, whether or not such opportunities are exploited.

The original sin was, of course, the failure to separate transmission from generation and distribution when the two companies were privatized. This was indulgence of Scottish feelings whose consequences for customers in the rest of the UK have become increasingly large over time. Since Ofgem insists that the transmission systems serving offshore wind farms must be separated and transferred to independent OFTOs, it is outrageous that SSE was allowed to build and control the subsea transmission link from Shetland to the North of Scotland.

An immediate remedy would be to prohibit any constraint payments being made to wind farms that are now controlled or have in the past been controlled by companies that are connected to the local transmission operator. So, any wind farm currently or previously controlled by Scottish Power in the Central Belt or the South of Scotland or by SSE in the North of Scotland should not be eligible for constraint payments. Instead, they should be simply curtailed without any right to compensation.

The wind farms affected would, of course, complain vehemently but the whole system of constraint payments is rotten in general. Developments in the North of Scotland have highlighted the bizarre incentives to locate new wind farms behind transmission bottlenecks. Currently the two major beneficiaries are: Moray East and Seagreen among offshore wind farms, and Viking Energy and Stronelairg among onshore wind farms. On any reasonable external assessment, it has been obvious that the system must and will be changed as a condition for the large expansion in renewable generation capacity planned by 2030 or 2035.

One technical way of reducing the need for constraint payments is to adopt what is known as nodal transmission pricing. Under such an arrangement, capacity at key transmission nodes is auctioned so that systematic price differences signal the value of potential investments in enhancing capacity. It is likely that the cost of transmitting power from the North of Scotland to England would increase relative to the costs of transmission from offshore wind farms in East Anglia.

In 2023 the system operator – NG-ESO – started a new effort to make the case for nodal pricing, which would imply locational marginal pricing of electricity. However, the same case was made a decade ago and was strongly resisted by the Scottish Government, influenced heavily by the Scottish power companies and renewable generators in Scotland. The interests on both sides of this argument are so strong that there has been a stand-off for more than a decade on the issue.

For example, in 2022 Kathryn Porter wrote a piece on her blog Watt-Logic which argued that what the UK needs is more investment in infrastructure rather locational pricing. However, she makes one key though rather odd statement:

“if costs for wind generators increase as a result of their location in windy places, those costs will be passed back to consumers, who won’t care if the cost is called a generation cost or a network cost”.

This highlights the crucial issue, although in a back-to-front way. Nodal pricing is about resource rents. There is no reason that the costs should be passed on to consumers. Instead, generators located on the wrong side of nodal constraints should earn lower resource rents relative to those in more favourable locations. Don’t build wind farms in the Moray Firth or in the Flow Country of Caithness, but off the coast of East Anglia.

And this is precisely why the Scottish Government and the interests which lobby it want to resist nodal pricing. Currently they benefit hugely from income transfers from electricity customers in SE England to transmission networks and generators in Scotland, of which constraint payments are only a small part.

The current system of transmission charging is perverse and foolish, but shame and/or economic logic rarely outweigh greed. What may kill it is the increasing burden of payments accruing to companies like SSE which are pushing up electricity prices to the point where the wholesale market price of electricity accounts for barely 20% of the average retail price paid by households.