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Subsidies paid to small power stations and generators that help keep the lights on in the UK at times of high demand will be cut under proposals announced by Ofgem on Wednesday.

The energy regulator has proposed reducing levels of payments received by small generators – typically gas and diesel – which avoid the national transmission system and connect directly to local power distribution networks.

Larger generators argue the payments have distorted the market and allowed developers of small plants to bid for contracts to generate electricity in future winters at low prices. Smaller generators are also able to avoid hefty transmission costs paid by large power plants.

But developers of small generators have warned a reduction in the system of subsidies could put 2,000 megawatts of generating capacity at risk. This is the equivalent of about two nuclear reactors.

Ofgem on Wednesday launched a consultation to reduce such “embedded benefit” payments from around £45 per kilowatt to £2 per kilowatt. The changes will be phased in between 2018 and 2020, the regulator said. A final decision will be reached in May.

Ofgem believes the changes could potentially save consumers up to £7bn by 2034 – the equivalent of £20 per household a year. Consumers ultimately fund the payments through their energy bills.

“We believe the proposed reforms would not have a material impact on security of supply,” Ofgem said in a statement.

The UK is relying on a large amount of capacity from small power generators to keep the lights on in forthcoming winters after the UK government set up auctions through which companies could bid for subsidy contracts to deliver power at peak times.

The auctions were designed to try and incentivise energy companies to build new large scale gas plants to replace coal plants that are being phased out by 2025.

But one of the surprise results was the proliferation of small generators, including polluting diesel generators, that were aided by additional subsidies. The auctions have no yet delivered any large scale gas plants.

However, analysts believe that, even with the changes to embedded benefits, Britain will still be relying on small generators to deliver large amounts of power in future when it is most needed.

Energy analysts at Aurora say there are still other kinds of embedded benefit subsidies that will encourage smaller generators to bid in future auctions.

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