Ofgem has announced plans to recover residual electricity network costs – worth roughly £4 billion each year – through fixed charges on consumers.
The regulator compared the charges to the line rental arrangements for telephones, claiming they would lower energy bills for most households and ensure individual network users pay their fair share towards the sunk costs of the existing power grid.
Ofgem has proposed the reforms as part of its significant code review examining both residual network charges and embedded benefits.
Residual charges are used to pay for existing network infrastructure. Unlike the forward-looking charges intended to fund investments in new capacity, they are not designed to reflect users’ impact on costs or send price signals to use the network in a particular way. The charges are levied on both generation and demand, although mainly on the latter.
On the demand side, they are applied as both volumetric consumption and peak demand charges. At the transmission level, large energy users and suppliers are charged according to their demand during the “triads” – the three half-hour settlement periods each year in which demand on the transmission network is greatest.
However, Ofgem believes these arrangements allow network users to reduce their exposure to residual charges with on-site generation, demand-side response or storage and in doing so shift the burden onto others. It says they also result in inefficient investment decisions, leading to higher network costs that are ultimately passed on to consumers.
To address these concerns, the regulator launched a significant code review in August 2017 with the aim of overhauling residual charging.
In an update published the following November, Ofgem unveiled proposals to shift the cost burden solely onto demand, claiming this would level the playing-field between different types of generation.
The paper also outlined potential mechanisms for allocating residual charges, which included fixed charges, ex ante and ex post capacity charges, and gross volumetric consumption charges.
In its minded-to decision, Ofgem has now revealed fixed charges as its preferred option. Under this model, consumers would be split into segments with corresponding fixed charges per user.
The regulator is also considering “agreed capacity charges” as a second option. Under this model, larger users with an explicit connection agreement would be charged on the basis of their agreed capacity. Households and smaller businesses would be charged on the basis of their assumed capacity.
According to Ofgem’s analysis, these reforms will reduce whole-system costs by between £800 million and £3.2 billion by 2040. Of this, between £500 million and £1.6 billion will flow to consumers through lower energy bills.
The regulator says the reforms will also have distributional effects, with the impacts depending on individual usage. Those with higher usage will likely see their bills fall, whilst those with lower usage may see them rise.
Ofgem has given assurances that the majority of households will benefit. It says the median domestic consumer can expect to save £8 on their annual bill.
However, the regulator also concedes that bills for households consuming the least amount of electricity will likely increase by between £2 and £22.
The decision was welcomed by Gillian Cooper, head of energy policy at Citizens Advice, who said: “Today’s (28 November) announcement should result in a more level playing field when it comes to electricity network charges. Large industry will pay a fairer share, while most people should ultimately benefit from lower costs.
“There are major changes in the way we use energy on the way, including the development of electric vehicles and smart products and services. This review and others are essential to developing a fairer energy system that is fit for the future”.
However, Chris Hewett, chief executive of the Solar Trade Association, warned that fixed charges would reward “profligate energy users” whilst penalising those that have taken action to reduce their consumption.
“Under this option the hardest-hit sector will be the thousands of forward-thinking businesses across Britain who invest in storage and on-site generation,” he remarked.
“We are concerned the regulator is taking a short-sighted approach and that the tremendous whole system value of flexible, low-carbon, onsite energy generation is not yet being reflected back to our innovators and risk-takers.”
Hewett added: “The current piecemeal approach means we cannot assess the net overall effect of charging reforms and where we may end up, and this contributes to investment uncertainty.
“Deterring investment in smart energy technologies will ultimately end up costing all consumers more in the medium to long-term, including the most vulnerable households.”
Ofgem is now consulting on the proposals, including the time frame for implementation. The regulator says the earliest the reforms could be practically introduced would be April 2021.
However, it is also considering whether or not they should be phased in gradually over the following two years. This would allow users to adjust to the changes over time but would also increase the complexity of charging arrangements during the crossover.
The deadline for responses is 4 February. Ofgem plans to make a final decision in mid-2019.
Ofgem has additionally proposed changes to the favourable charging arrangements enjoyed by generators connected to distribution networks – collectively known as embedded benefits.
The significant code review was prompted in part by the regulator’s efforts to reduce one of these benefits, namely the triad avoidance payments available to small-scale embedded generators.
Shortly before the launch of the review, Ofgem confirmed plans to almost entirely remove the residual elements of these payments over a period of three years, starting in April 2018.
Ofgem has avoided revisiting this particular topic as part of the review. However, the regulator has examined a number of similar embedded benefits and suggested several reforms. They include:
- Ending generators’ exposure to residual transmission charges. Ofgem says this will remove a benefit from larger generators that receive a rebate currently due to an EU cap on their transmission charges.
- Ending an exemption from balancing services charges for small-scale embedded generators (less than 100MW).
- Charging suppliers for balancing services on the basis of gross rather than net demand at the relevant grid supply point. This would prevent local embedded generators from receiving avoidance payments from suppliers in exchange for reducing their charges.
Ofgem says the changes will have a limited effect on systems costs, with the impact by 2040 ranging from minus £110 million to plus £160 million. However, the benefits to consumers are expected to amount to between £4.5 billion and £6 billion – the equivalent of a £7 saving on the median household bill.
The reforms will be introduced in either April 2020 or April 2021. The last two were both proposed separately by a subsidiary of Engie in September.
Furthermore, Ofgem has committed to holding a consultation on extending the discount on transmission charges for small generators in Scotland until the new residual charging arrangements are implemented from April 2021 onwards. It is currently set to end on 31 March 2019.