Making progress: Ofgem publishes call for input on long-duration electricity storage cap and floor regime

In October 2024, the Department for Energy Security & Net Zero (“DESNZ”) confirmed its intention to introduce a cap and floor regime (“Regime”) to encourage investment in long-duration electricity storage (“LDES”). This decision was outlined in its response (the “Response”) to its January 2024 consultation (the “Consultation”), which aimed to address the challenges and opportunities associated with investment in LDES. It also announced that Ofgem would administer the Regime. The Response noted that Ofgem and DESNZ intend to publish a joint Technical Decision Document (“TDD”) by Q1 2025 containing the Regime details, with the ambitious goal of approving the first projects under the first cap and floor window by Q2 2026.

On 18 December 2024, Ofgem published an open letter (the “Open Letter”) outlining its proposed work plan, timelines, and preliminary ideas regarding the first allocation window and eligibility criteria for the Regime. Ofgem is seeking stakeholder feedback to help inform the decisions it expects to make in the joint TDD with DESNZ.

Cap and floor timelines

Ofgem's Open Letter outlines its proposed application windows for managing the delivery of the Regime. These regular windows will allow developers to submit project proposals for consideration once they have reached sufficient maturity. The first application window, referred to as "Window 1," is proposed to open in Q2 2025, with Ofgem also expecting to publish detailed application guidance at this time.

In alignment with the UK Government's Clean Power 2030 plan, projects submitted during Window 1 will be prioritised based on their ability to deliver by 2030. Recognising that a hard 2030 deadline may not be feasible for all projects, Ofgem has proposed allowing developers to indicate whether they anticipate completing their projects by the end of 2030 or, alternatively, by the end of 2033. This flexibility is designed to avoid unnecessarily excluding potentially viable projects while still maintaining focus on the 2030 targets.

By Q3 2025, projects meeting the eligibility criteria will be invited to begin formal assessment (“Project Assessment”). Decisions granting approval in principle to successful eligible projects are expected by Q2 2026. Ofgem also aims to develop the project documents including a modified generation licence, regulatory instructions and guidance and other relevant changes to codes for the regime by Q2 2026. Following this, from Q3 2026 onwards, Ofgem plans to begin monitoring approved projects against key milestones to ensure adherence to the regime.

A clear target capacity may also be introduced to provide clarity and transparency to the process. Ofgem is also considering setting a cap on total capacity eligible in Window 1 to ensure only projects with significant consumer benefits are approved.

Ofgem invites stakeholder feedback on the proposed timeline and suggestions to improve process efficiency. Comments are also sought on the two delivery tracks (2030 and 2033) and their prioritisation within Window 1.

Project eligibility criteria

NESO is expected to play a key role in determining the eligibility criteria for the Regime, in line with proposals from the Response. NESO will also support Ofgem’s assessment of projects, with only those meeting the eligibility criteria progressing to the Project Assessment stage.

Deliverability

Developers will be required to decide whether to submit under the 2030 or 2033 delivery track and provide all required information upfront, as revisions or additional evidence will not be accepted during the eligibility assessment process.

To assess deliverability, Ofgem proposes that projects should have:

• FEED Studies: Comprehensive technical and risk management plans.
• Economic Viability Studies: Financial models detailing lifecycle costs, including capital and operational expenses, and projected revenue.
• Timelines and Milestones: Detailed project development and implementation plans.
• Stakeholder Engagement: Evidence of local community, and planning authority engagement.
• Financing Plans: Evidence of a plan to secure necessary funding.

Additionally, for Window 1, Ofgem expects projects to have:

• Grid Connection Agreements: A firm grid connection or evidence of securing one with a grid connection date of 2030/2033.
• Planning Consents: Necessary planning consents or evidence of submitted applications likely to be approved before the start of the Project Assessment stage (Q3 2025).

Ofgem invites comments on its proposed approach to assessing project deliverability, including feedback on the requirements for any of the above evidence. It remains to be seen exactly what the contents of the required evidence should include; this is expected to be outlined in the guidance published when Window 1 opens. However, given the lead times for these items, stakeholders will be keen to understand the detail of these requirements as soon as possible.

Capacity and duration limits

In the Response, DESNZ proposed that only projects capable of discharging at full power for at least six hours should be eligible for the Regime, dividing projects into two streams:

• Stream 1: Established technologies with a Technology Readiness Level (“TRL”) of 9, proven through successful operations (e.g. pumped storage hydro), and a minimum capacity of 100 MW.
• Stream 2: Novel technologies with a TRL of 8, deployed in a demonstration phase, and a minimum capacity of 50 MW.

In the Open Letter, Ofgem is considering increasing the discharge duration requirement to 8 or 10 hours for Stream 1 projects in Window 1, while maintaining the 100 MW minimum capacity threshold.

Whilst the Open Letter does not propose changes to Stream 2 capacity requirements, Ofgem has indicated that, if it receives compelling stakeholder evidence, it may consider lowering the capacity requirement for Stream 2 in the TDD. This reflects feedback from stakeholders during the Consultation supporting a lower threshold, with suggestions ranging from 1 MW to 20 MW.

Ofgem is seeking stakeholder feedback on the potential impact of extending the minimum discharge duration to 10 hours, whether developers would re-scope their projects to meet the new Stream 1 requirements or discontinue them, and views on the consumer benefits of longer versus shorter minimum discharge durations.

Technology readiness

For Stream 1, Ofgem suggested that applicants would not need to provide detailed evidence of their TRL, as its deliverability assessment would suffice. For Stream 2, developers must provide detailed evidence demonstrating TRL 8 to support their eligibility.

Ofgem is requesting feedback on the decision not to require detailed TRL evidence for Stream 1 projects and what evidence should be required to demonstrate TRL 8 status for Stream 2.

A final decision, informed by advice from NESO and stakeholder feedback, will be made in the TDD.

Extension and refurbishment of existing LDES assets

The Open Letter explores whether the Regime should apply only to new projects or also include significant upgrades to existing assets, such as expanding pumped storage or converting hydropower. Ofgem suggests that projects involving substantial refurbishments to expand capacity or change the purpose of existing assets could be eligible for the Regime, while routine maintenance or minor upgrades would not qualify. Stakeholder feedback is sought on criteria to ensure refurbished projects deliver comparable benefits to new ones.

Project assessment and cost assessment

Assessment methods

The Open Letter outlines that, following the eligibility assessment, shortlisted projects will proceed to the Project Assessment stage, where their costs and benefits will be assessed to approve projects under the Regime. Developers will be required to submit all relevant information and analysis at the start of this stage, with guidance provided by Ofgem ahead of the submission.

The Project Assessment framework will follow Ofgem’s existing methodology for electricity interconnectors, focusing on three main areas:

• Consumer Benefits: Changes in wholesale market prices, payments under the cap and floor mechanism, capacity market costs, and CfD scheme costs etc.
• Producer Benefits: Changes in wholesale prices, CfD revenues, etc.
• LDES Developer Benefits: Revenues from arbitrage, capacity market revenues, revenue cannibalisation, construction and operating costs, etc.

The cost-benefit analysis may also seek to consider renewable integration, CO2 emissions, and their non-monetary impacts.

Projects will be assessed using two methods to determine the value and effectiveness of the potential project:

• First Addition Method: Evaluates the impact of each project as if it were the only one built.
• Marginal Addition Method: Assesses the benefits of each project individually, assuming it is the last to be built in the Window 1 group.

Cost Assessment

Developers will be expected to submit cost details to enable Ofgem to assess project costs to ensure they are economic and efficient and set preliminary cap and floor values. This includes providing evidence of thorough procurement processes and detailed evaluations of a minimum of three bids with justifications for contractor selection.

To incentivise developers to control costs and meet timelines, Ofgem proposes:

• Performance-Based Incentives: Bonuses for achieving cost-efficiency and timeline targets, such as milestone allowances added to the floor for completing specific project stages on time and within budget.
• Penalties for Delays or Overruns: Financial penalties for unjustified delays or exceeding budgets, ensuring accountability.

Projects will have “backstop” dates (two years beyond target delivery for 2030 and 2033 tracks), after which cap and floor support may be withdrawn if timelines are not met, to incentivise timely delivery.

In a departure from the approach with interconnectors, cost assessment is expected to occur in two stages:

1. Project Assessment (PA): Developers’ preliminary cap and floor levels will be set at PA or financial close, when Ofgem decides which projects will receive the Regime, based on expected costs.
2. Post Construction Review (PCR): Final cap and floor levels will be determined at project commissioning based on eligible cost changes and final cost assessment, informed by developers’ annual reports submitted during construction.

To account for unexpected costs, developers must include contingency allowances in the project assessment submissions, which will be adjusted based on actual spending at the PCR. Throughout construction, developers will be required to monitor and report risk profiles and cost changes, providing explanations for cost increases. Following achieving commercial operations, developers must submit annual operational reports detailing costs and revenue during the term of the Regime.

The Regime

Approach to cap and floor

Ofgem suggests that the floor does not need to cover 100% of allowable project costs. Setting the floor at 80%—as seen in interconnector projects—could be viable in their view. This approach would incentivise developers to innovate in construction and operation by exposing them to more risk at the floor, while maintaining bankability. However, given the nature of LDES technologies participating in Window 1, concern has been expressed by stakeholders about how workable this approach would be.

The Open Letter sets out two possible options for determining the floor:

• Administrative (Notional) Cap and Floor: Ofgem would determine costs of debt, equity capital, and equity internal rate of return for LDES projects based on market evidence, including data from developers.
• Market-Driven Cap and Floor: A market-based approach would allow competition among lenders to set a floor that fully covers debt, removing ‘basis risk’ for equity and lenders. Ofgem suggests that this method would enable debt financing up to 80% of efficient (allowable) project costs.

Those projects that are equity financed would need to be competitive with those that are debt financed.

Ofgem's preference is to set the cap through a competitive process, enabling developers to bid their expected returns as part of their applications which was the approach followed in NeuConnect and Greenlink interconnectors . If it proceeds with this option, it has suggested it may need to implement benchmarking to ensure consumers are not exposed to undue costs and risks at the cap.

Given the limited recent track record of developing LDES projects in Great Britain, and the various technological and construction risks, there is a concern amongst stakeholders on the focus on debt financing in establishing the floor at the PA stage (Q3 2025). As lender appetite is yet to be determined, a comprehensive lending package may be difficult to achieve by that deadline given policy uncertainty, and debt financing during construction may not be the optimum financing solution for these projects.

Additionally, Ofgem intends to include provisions in the LDES licence to ensure the financial resilience of operators. This may involve adopting recent requirements for network companies, such as minimum equity requirements. This is expected to be set out in the TDD.

Ofgem is seeking stakeholder input on whether setting the floor at 80% of project costs is viable, potentially alongside a higher cap, and welcomes suggestions for improving the cap and floor design through a competitive process.

Gaming risk and mitigation

To address concerns raised by stakeholders about gaming risks in response to the Consultation (specifically gaming of gross margin and market manipulation), Ofgem has proposed additional regulations to the standard and special licence conditions to protect consumers, such as, implementing a soft cap with profit-sharing above the cap. Ofgem is seeking stakeholder views on potential requirements, including:

• Detailed Reporting and Inspection: Requirements for in-house managed LDES assets to ensure accurate trade allocations or opting for arms-length arrangements with third-party optimisers responsible for commercial decision-making and trade execution.
• Capacity Market Participation: Mandating LDES cap and floor projects to participate in the Capacity Market as price takers and bid their full capacity into auctions, similar to requirements for interconnectors.
• Structured Transactions: Prohibiting LDES structured transactions between supported LDES and other assets, requiring the use of standard products with well-defined market reference prices.
• Cost Allocation: Requiring detailed cost allocation information, including fixed and variable costs, for co-located assets and setting a minimum efficiency requirement for each project.

To ensure accurate data collection and accountability, Ofgem proposes that each LDES asset should have its own metering point.

Ofgem welcomes stakeholder views on the benefits of in-house trading teams managing LDES assets and how to mitigate potential gaming risks. It is also considering whether regulatory obligations and reporting requirements would sufficiently protect consumers or if LDES assets should instead be traded via third parties and welcomes stakeholder views on this.

Conclusion and next steps

The Open Letter marks a significant milestone in advancing a new wave of LDES projects in Great Britain, addressing crucial barriers to investment. Stakeholders are encouraged to contribute their feedback on the Regime's design and proposals to ensure it meets industry needs while protecting consumers.

Stakeholder input will play a vital role in shaping the TDD expected in Q1 2025. The timeline is ambitious, aiming for the first projects to be granted support by Q2 2026 to enable delivery by 2030. Developers, investors, and other stakeholders are encouraged to actively engage with Ofgem and DESNZ to ensure their insights and priorities are incorporated into the final regime design.