Ofgem launch Significant Code Review on residual network charging

United Kingdom
On Friday 4 August, Ofgem launched the Targeted Charging Review (“TCR”) Significant Code Review (“SCR”), which will set out how it intends to alter arrangements for residual charges for electricity networks, alongside other matters. The SCR follows Ofgem’s consultation on the TCR which closed in May, which we reported about here. The SCR follows the joint publication by Ofgem and the government of the “Upgrading our Energy System” plan at the end of July, in which Ofgem had announced its imminent intention to clarify the scope of the TCR, which we reported about here

Last week also saw the publication of Ofgem’s Strategy for Regulating the Future Energy System, in which it announced its ‘holistic’ approach to future energy regulation, that takes into account a number of key areas such as the alignment of system and network operator interests, ‘neutral’ regulation which does not favour particular technologies over others, a predictable regulatory regime and the promotion of competition and market-based mechanisms.

Why?

The decision letter that launched the SCR reveals Ofgem’s concern that “the current framework for residual charging may result in inefficient use of the networks”. It argues that some network users are using new technologies to adjust the timing and volume of production or consumption of electricity to reduce their exposure to residual charges, meaning that they increasingly fall on users without access to such flexibility (such as residential, small business and vulnerable customers).

What is covered by the SCR?

The scope of the SCR and its stated objectives include:

  • to consider reform of residual charging for transmission and distribution, for both generation and demand; and
  • to keep the other embedded benefits that it feels may be distorting investment or dispatch decisions under review.

While ‘forward-looking’ network charges are designed to incentivise the efficient use of the network and to reflect the network users’ impact on current and future investment costs, residual charges are ‘top-up’ charges set to ensure that the network’s efficient costs (determined through price controls) can be covered after other charges have been levied. Therefore, the scope of the SCR will be to focus on the means of recovering residual network charges from network users, as residual charging can distort the incentives provided by forward-looking charges or encourage other behaviour to reduce exposure to charges, all of which Ofgem believes could increase system costs.

The SCR does not set out proposals to further reduce embedded benefits available to smaller (sub-100MW) generators connected to the distribution system, following Ofgem’s decision  to cut the embedded benefit payments paid by suppliers to such generators for helping them to avoid Transmission Network Use of System (“TNUoS”) charges during Triad periods (which we previously reported about here). However, Ofgem states that these will be kept under review during the SCR, and further action could be taken if it finds evidence that these are leading to significant distortions and impacts on consumers.

What is out of scope of the SCR?

The following items will be excluded from the scope of the SCR:

  • forward-looking use of system charges;
  • connection charges; and
  • charging arrangements for storage.

Although Ofgem expresses the view that network charges for storage put it at a disadvantage to generation in providing the same or similar services, it states that any changes to such network charges for storage should proceed through the usual code modification process, allowing the consideration of other approaches to address these issues.

Approach and process

In line with the previous consultation, Ofgem will consider three core principles for assessing options for residual charging:

  1. Reducing distortions: Ofgem state that they will seek to reduce the harm caused by distortions arising from residual cost recovery and to the signals created by the forward-looking charges, which may in turn affect decisions on where to connect generation and demand to electricity networks. In addition, it will seek to reduce distortion to competition between network users, thus reducing the overall system costs borne by consumers.
  2. Fairness: As for fairness, this consideration will apply specifically in relation to residential, microbusiness and vulnerable customers, given that overall residual charges are broadly fixed in the short term, and any changes may reduce bills for some network users and increase bills for others.
  3. Proportionality and practical considerations: Finally, Ofgem state that when deciding to make changes it will consider whether costs can be justified by the estimated value of reducing distortions, alongside the question of whether changes can be made in relation to some users but not others. The preference is for network charges to be as predictable as possible, while reducing the extent to which some users’ relative contributions change materially owing to other the decisions of other users.

In terms of process, rather than raising modification proposals to the industry codes itself, or leading an end-to-end process to develop code modifications, Ofgem has chosen to direct licensees to raise modification proposals themselves at the conclusion of the SCR process. However, it has reserved the right to change this approach in the future.

Next steps

If Ofgem concludes that changes to residual charges would best serve consumers’ interests, Ofgem state that they intend to publish a draft Impact Assessment and a ‘minded to’ decision on any proposed new residual charges arrangements by the second quarter of 2018, before the decision is published along with the final Impact Assessment in the following quarter.

After the final phase of the SCR (which is to be led by industry through working groups and code panel meetings), Ofgem expects to make a final decision on the resulting modifications by early 2019 in order for any new arrangements to have effect from the 2020/2021 charging year.