Ofgem has given preliminary approval to a modification to the Uniform Network Code that would reduce the variation between gas transmission charges in different parts of the country.
It said the changes are necessary as the transmission network is operating “well below” full capacity, meaning the location of flows has a limited impact on costs.
Transmission fees are split between capacity charges, which grant users the rights to flow gas onto and off the network but are payable regardless of whether they are exercised, and commodity charges, which are paid on actual flows. Both sets are further divided into entry and exit charges. The recovery of costs is evenly split between entry and exit charges.
The commodity charges are used to recover any residual costs that are not recouped through the capacity charges. Ofgem said the low utilisation of the transmission network has led to an increase in the proportion of costs recovered through commodity charges – a trend that is set to continue. The capacity charges vary based on the location of entry or exit. The commodity charges do not.
Following a two-year review, Ofgem concluded in 2015 that the gas transmission charging regime required fundamental reform and asked industry stakeholders to submit proposals for its overhaul.
However, the regulator announced in 2018 that none of the eleven options put forward were compliant with new EU regulations designed to harmonise charging arrangements that came into effect between 2017 and 2019.
Eleven new proposals were submitted for consideration in May. Of these, Ofgem deemed two to be compliant with the new EU rules – UNC678 and UNC687A.
The core difference between the two is the methodology for the calculating the reference prices for different entry and exit points, which are currently intended to reflect long-run marginal costs. Discounts are applied to the reference prices to determine the reserve prices for capacity auctions.
UNC678 would introduce a “capacity weighted distance” (CWD) methodology, whereby the reference price for each entry point would be based on the capacity and distance to all exit points to which flows may occur. The reference price for each exit point would likewise be based on the capacity and distance to all feasible entry points.
The alternative modification UNC678A would flatten reference prices across the network, removing any variation between entry and exit points. This has been dubbed the “postage stamp” (PS) model.
In its minded-to decision, Ofgem said the PS model “better reflects the characteristics of the GB gas transmission system”.
“As the gas system is largely operating well below capacity and location is not a significant driver of cost, we think that a PS approach to pricing is more appropriate,” it explained.
“CWD would send signals to users at relatively distant points to shift or reduce demand but with no, or only marginal, benefits given that the system exists and is largely operating below capacity.”
Ofgem also noted that the distances in the CWD methodology would be averaged across all possible entry and exit points and may not represent real physical flows given that the transmission network is highly meshed.
It continued: “Shippers book entry and exit capacity independently and nominate flows without specifying specific routes and therefore it is very difficult to determine flows, and to allocate flows to specific assets.
“This type of treatment of distance is therefore unlikely to generate prices that are accurately reflective of the physical transportation routes actually used.”
By flattening the charges between locations, Ofgem said the PS model would enhance competition and encourage gas to be supplied from the cheapest source, regardless of its location on the network.
The impact assessment undertaken by CEPA estimated the net present benefits to consumers of the PS methodology at £0.84 billion over the first ten years. This compares to £0.87 billion under the CWD methodology.
The analysis also found that the CWD model would be more beneficial to domestic consumers, whilst the PS model would favour non-domestic customers.
Net present benefits between 2022 and 2031
Ofgem admitted that the PS approach may raise carbon dioxide emissions slightly due to an increase in gas usage but said any impact would be “marginal and dependent on broader market outcomes”. It said gas storage facilities may also incur higher costs.
Its minded-to decision goes against that of the UNC panel which voted to reject all eleven of the modifications it considered at a meeting in May 2019. The regulator is now consulting on the proposed changes, which it plans to implement at the beginning of the new gas year in October 2020. The deadline for responses is 24 February.