As Ofgem continues consulting on its Targeted Charging Review (TCR), Energy UK Policy Manger Joseph Underwood explains why it matters and what changes might result.
It’s not an aspect of the sector you’ll read much about in the media, but network charges and how we fund the cost of transporting electricity along wires and cables across Great Britain naturally play a vital role in the operation of the UK energy system.
As an unseen and, at times, very technical area this low profile is not surprising but if you consider that the charges, levied on either generators or end consumers, to use the electricity transmission or distribution system amount to around £8bn a year, you get an idea of how much is stake.
What’s more as we transition to the future energy system, the nature of this essential function is changing as we further decarbonise generation as well as doing the same in transport and heating in pursuit of the net-zero target. The comparatively straightforward task of transmitting power one way over long distances from a small number of power stations to our homes and businesses now needs to be flexible enough to adapt to a different world. One with countless smaller localised generation sources, where intermittent renewables provide an increasing share of the growing demand from wider electrification – and where more and more consumers and businesses will be looking to sell excess power (stored in their Electric Vehicle’s battery for example) back to the grid.
So the case for changing how we fund transmission and generation and incentivise the right investment is evident and in August last year, Ofgem launched the ‘Targeted Charging Review’ (TCR) which aims to reform residual (of which more below) charges to ensure it meets the interests of current and future network users. We expect a decision on the exact changes this summer but the changes won’t be fully implemented until at least 2022/23.
So, what is changing? Bear with me as I do my best to try and explain the intricacies and quirks…
Network companies have what is known as a Maximum Allowable Revenue (MAR) collected through locational charges (charges based on a user’s geographical location on the system) and residual charges (charges which cannot be attributed to geographical location and are hence are spread across all users). Historically, locational charges have not covered the MAR, leaving the rest to be covered by the residual element.
An additional complication here is that EU legislation puts a limit on the amount you can charge (a cap of €2.5/MWh) transmission connected generation in order to (roughly) harmonise network costs across member states. Recently however, locational charges have been increasing and are higher than are allowed to be collected! So in order to balance this out and bring the overall charge under the threshold, the residual element needs to be negative…
After analysis and modelling, Ofgem intend to set this Transmission Generation Residual (TGR) to zero and there seems to be broad industry support for this – but of course, this still leaves average transmission generator charges above the EU cap.
Therefore, to maintain compliance with this cap, Ofgem have instructed the Electricity System Operator (National Grid) to raise a modification to the Connection Use of System Code (CUSC). In effect, this change would remove generation assets connected to expensive offshore transmission networks from the EU cap, while (less expensive) onshore assets would remain covered by the cap. So most remaining GB generation will face lower charges on average.
There is some industry concern regarding this approach – the main one being because this fix is only temporary and the average cost will eventually creep above the €2.5/MWh limit in a few years anyway. As an alternative solution, some have suggested moving the location of the ‘reference node’ further north. This is the point from which locational charges are calculated depending on the distance – so if you are actually located at the node, the charge is zero. The reference node is currently located in London as the historic centre of demand and Ofgem may be reluctant to move it and base the system round an artificially convenient (for this particular purpose) locational signal.
In addition, Ofgem have also proposed different ways to reform how the demand (i.e. for those in receipt of the power like homes and businesses) transmission residual and distribution residual charges are collected. Their preferred choice is to use a ‘fixed charge’ where charges are set for individual customer bands.
As is often the case with changes like this, there are inevitably winners and losers. While this will lower customer bills on average, some will face higher charges – likely to be those consumers with lower energy usage and/or have on-site generation (i.e. solar panels). The thinking being that that these users are not currently paying for ‘reserving’ network capacity which they only use in limited circumstances.
The assessment and modelling Ofgem has carried out has given a strong case for reforming the residual charge with their preferred options indicating £0.8bn - £3.2bn in system benefits and £0.5bn - £1.6bn in consumer benefits being realised by 2040.
Ofgem have also proposed to remove the “Embedded Benefit” for eponymous generators (usually small generators which are connected to the distribution rather than transmission network) and to apply balancing services charges to smaller embedded generation. Ofgem states that these proposed changes could reduce consumer costs by up to £6bn but these were viewed by some as a last-minute addition to the TCR, which has raised concerns about the effect on investment, particularly for distributed and renewable projects.
Ofgem believes that their proposed changes will increase overall system benefits but, as we’ve said, some groups of users will gain and some will lose out – such as the lowest consuming domestic and small non-domestic consumers and businesses which have invested in on-site generation. The regulator’s job is to weigh these against the longer-term benefits of the charging reform.
So there is still much to play for and as Energy UK, we’ll continue to watch events closely and represent the views of our members as Ofgem moves towards a final decision.