Ofgem's final decision on changes to network charging

On 21 November 2019, Ofgem published its final decision on changes to network charging arising from its "Targeted Charging Review" (TCR). The changes will have significant implications for different classes of generators.

Background

The gas and electricity markets regulator Ofgem has been taking forward a number of different work streams aimed at reforming how the costs of using the electricity transmission network (and, to a slightly lesser extent, the distribution network) are recovered from its users. The raft of changes being proposed have been spearheaded by the rise in the number of generators connected to the distribution network (referred to as embedded generators). This led the industry and Ofgem to closely examine the so-called "embedded benefits" (i.e. network costs that can be avoided by smaller embedded generators) to ensure that smaller embedded generators (i.e. those below 100 MW) are not being given an unjustified advantage, which could lead to market distortions. This has subsequently led to a wider review of network charging to ensure that, in Ofgem's words, "the costs of the network are kept as low as possible and shared more fairly across its users".

The first embedded benefits review

In July 2016 Ofgem proposed changes to the charging arrangements for smaller embedded generators. So-called "embedded benefits" come in the form of both payments that smaller embedded generators receive for helping suppliers to avoid transmission charges, and also avoided transmission generation charges that these generators do not pay. As discussed in Figure 1, TNUoS charges have a locational element, which varies according to the distribution network area and a residual element, which is a fixed amount across the GB system. In the July 2016 review, Ofgem focused on TNUoS demand residual (TDR) payments, because suppliers were able to reduce their liability for these payments (but it became customary for suppliers to pass on that benefit to smaller embedded generators, which therefore meant no net saving to consumers) by reducing their transmission system demand using smaller embedded generators during so-called Triad periods (peak periods of demand). This was because TDR payments were calculated on the basis of net demand by suppliers (that is, gross demand minus the export from any connected embedded generation).

Ofgem therefore decided to implement code modifications which had the practical effect of reducing the level of TDR payments (referred to in the industry as Triad payments) to smaller embedded generators to that of avoided grid supply point (GSP) costs. A GSP is a point at which the transmission system is connected to a distribution system. It was recognised that embedded generation can offset the need for reinforcement at a GSP, and therefore Ofgem considered that avoided GSP costs are a "true" embedded benefit that should continue to exist.

The targeted charging review

In March 2017, Ofgem launched a consultation on its Targeted Charging Review (TCR) and on its proposal to launch a Significant Code Review (SCR) process to review the relevant charges. Following this consultation, in August 2017, Ofgem announced the launch of the TCR SCR.

The scope of the TCR SCR

The TCR SCR has focused on:

• the ongoing residual charges for transmission and distribution, which are levied on both generation and demand; and
• the remaining non-locational embedded benefits (other than the so-called Triad payments, which were dealt with by the earlier Ofgem review).

Residual charges

Ofgem notes that unlike forward-looking charges, residual charges are not intended to send signals or provide incentives to use networks in any particular way. Ofgem and some industry participants are of the view that the existing GB charging arrangements provide opportunities for some users to more easily avoid paying residual charges and therefore increase the costs borne by others.

Having considered various possible approaches, including a new way of applying the residual charge to generators, Ofgem has reached the conclusion that transmission demand residual and distribution residual charges should be levied on final demand users only (i.e. end consumers, including industrial and domestic consumers, who use the electricity supplied by electricity networks).

Ofgem has therefore decided to implement a fixed residual charge for final demand consumers only, with distinct arrangements for unmetered sites. For domestic consumers, there will be a single transmission residual charge, and a single distribution residual charge within each of the 14 distribution networks. This means that all domestic customers within each of the 14 distribution networks will pay the same level of residual charge. For non-domestic consumers, there will a single set of transmission residual charges, and a set of distribution residual charges for each of the 14 distribution networks, for each fixed charging band. Bands will be defined by a consumer’s voltage level and, where further segmentation is required, further boundaries will be defined based on agreed capacity for larger consumers for whom this data is readily available, and net consumption volume for smaller consumers for whom this data does not routinely exist. Charges for unmetered customers will be derived considering their net consumption volume or agreed capacity, on the basis of their "profiled" demand and the applicable charging model.

These changes will be implemented for transmission charges in 2021 and for distribution charges in 2022.

Remaining non-locational embedded benefits

The second part of the TCR SCR assessed the non-locational embedded benefits which were not covered in Ofgem's 2017 decision to cut embedded benefits. The scale of the non-locational embedded benefits has increased significantly in recent years. Ofgem held the view that there was no clear relationship between these benefits, which are ultimately funded by consumers, and the costs of operating the electricity system.

Accordingly, Ofgem has concluded that the following changes are to be made to these charges:

Transmission Generation Residual (TGR) payments: smaller embedded generators are currently not subject to transmission generation residual payments, while larger generators are, and therefore this was originally an embedded benefit for smaller embedded generators. However, recently the TGR has become negative, and therefore it has become a benefit to those who receive the TGR credits, which are the transmission-connected and larger distributed generators. Ofgem has decided that the TGR should be set to have a zero value, subject to complying with EU Regulation 838/2010. EU Regulation 838/2010 requires the annual average transmission charges paid by generators to be within a certain range (a "cap and floor"), and currently the TGR plays a role in compliance with EU Regulation 838/2010.

BSUoS charges – payments from suppliers: smaller embedded generators can get paid for helping suppliers reduce their contribution to the costs of balancing the system. Suppliers pass on most of these savings to smaller embedded generators through contractual arrangements and then recover the cost of these payments from other customers. Ofgem has decided that suppliers should be charged BSUoS using gross demand measured at the GSP. This will have the effect of removing payments from suppliers to smaller embedded generators, which constituted an embedded benefit.

BSUoS charges - avoided charges: smaller embedded generators also avoid paying generation BSUoS charges, which all other generators connected to transmission and distribution networks are required to pay. Ofgem has decided to defer its decision on this embedded benefit, subject to the full outcome of the second Balancing Services Charges Taskforce (see below) which is considering how BSUoS charges should be reformed.

Small Generator Discount: this is a reduction in transmission charges for certain small generators, which was introduced to create a level playing field between under 100 MW 132 kV transmission connected generators in Scotland and offshore generators, and those that are distribution connected at 132 kV in England and Wales. This has been extended until 2021, and Ofgem has said that it considers that the reforms flowing from the TCR will mean the distortions that the Smaller Generator Discount is designed to compensate for (the transmission residual charges) will be removed.

Implementation of changes

Ofgem has issued detailed directions alongside its decision requiring the changes to be implemented through modifications to the relevant industry codes.

Second Balancing Services Charges Taskforce

In February 2019 Ofgem asked the ESO to launch a task force to provide analysis to support decisions on the future direction of BSUoS charges. In particular, the task force examined the potential and feasibility for some elements of BSUoS being made more cost-reflective and hence provide stronger forward-looking signals. The task force concluded that "it is not feasible to charge any of the components of BSUoS in a more cost-reflective and forward-looking manner that would effectively influence user behaviour. Therefore, the costs within BSUoS should all be treated on a cost-recovery basis." The task force believes that cost-recovery charges should aim to minimise market distorting signals, to benefit the system and ultimately consumers. However, it found the current structure of the charge may inadvertently send signals that are detrimental to the system. Ofgem has therefore asked the ESO to launch a second Balancing Services Charges Taskforce with the aim of determining who should pay for, and the design of, balancing services charges in line with the TCR principles. The conclusions of the second task force must be submitted to Ofgem by the end of June 2020. Ofgem will then make a decision on whether to accept the recommendations and the next steps to be undertaken.

Impact of changes

The changes will have an impact on the revenue stream of most generators. Larger generators will miss out on TGR payments, which are currently equal to £2.30. Analysis by Aurora Energy Research predicts that, for example, once TGR is reduced to zero, a wind farm bidding for a Contract for Difference will have to increase its bid by £2/MWh to ensure the same Internal Rate of Return for any given load factor assumption. For embedded generators, industry commentators have predicted that the loss of further embedded benefits will have an impact on new projects coming forward, particularly for subsidiary free projects, such as future solar PV projects. The impact may be even more significant if the outcome of the second Balancing Services Charges Taskforce is that smaller embedded generators will be required to pay BSUoS charges.

Significantly, the reforms will also have an impact on existing generating plant, as existing projects are not immune to the reforms. Ofgem itself acknowledged, in its "minded to decision", that "there is a risk that these changes could lead to the cancellation of some projects, including renewable generators which have been awarded CfD contracts and smaller generators which have been awarded CM contracts, which are not yet online and which would face an increase in charges".

Moreover, the new approach to transmission demand residual and distribution residual charging will have implication for so-called "behind the meter" generation. The reason for this is that while some onsite generation arrangements may still play a role in reducing a consumer's net consumption volume, electricity end users will no longer will able to reduce their liability for network charges by using behind the meter generation at peak periods (given that consumption at peak periods will no longer be used to calculate liability for residual charges).

Authors: Justyna Bremen, Senior Expertise Lawyer, and Antony Skinner, Partner