The End of the Triad? Update on Ofgem's Targeted Charging Review

On 28 November 2018, Ofgem published its “minded to” decision on its Targeted Charging Review. The decision sets out Ofgem’s view that the residual aspect of electricity transmission and distribution network charges should be based on fixed tariffs for different classes of consumers rather than the other options under consideration such as usage during periods of peak demand. Ofgem also proposes to remove most of the remaining “embedded benefits” enjoyed by smaller distribution-connected generators. In this article, we consider the decision, and its implications for the industry, in more detail.

Status of Ofgem’s network charging reviews

Alongside its procedure for setting the RIIO-2 price controls, which will determine the maximum allowable revenues for transmission and distribution network operators, Ofgem has been reviewing the network charging regime to consider the best way for these revenues to be recouped from system users to ensure that the correct price signals are sent to the market. Ofgem is conducting this review in three separate workstreams:

• Targeted Charging Review (“TCR”) – this workstream relates to the “residual” aspect of network charging as opposed to forward-looking charges. The latter is designed to provide cost signals to network users to reflect how and when they use the network. By contrast, residual charges are not designed to provide incentives to use the network in a particular way. However, Ofgem is concerned that the current arrangements incentivise users to invest in on-site generation, Demand Side Response and storage. Last year, Ofgem launched a significant code review to implement the outcomes from the TCR. Our most recent article on this, following Ofgem’s previous TCR update, can be found here. The TCR is the focus of this article.
• Electricity network access project – this project focuses on the local impact of each network user’s connection on the network operator’s costs as well as considering innovation in the depth and duration of connections. Ofgem issued a consultation on this in July 2018, as we reported here.
• Transmission Demand Residual payments review – Ofgem issued a decision last year on its separate consultation regarding the most substantial embedded benefit, as we reported here. In short, following Ofgem’s 2017 consultation decision, EGs’ output is no longer subtracted from demand, and a new tariff for EGs is being phased in that is designed to reflect the actual reduction they cause in reinforcement costs caused by EGs (estimated at £3/kW-£7/kW).

Alongside the TCR “minded to” decision on 28 November, Ofgem also published an open letter confirming that it has asked National Grid Electricity System Operator to launch a task force to review balancing services charges as a priority. Ofgem will take account of the conclusions of this task force when deciding on the balancing services charges aspects of the TCR and the electricity network access project.

Network residual charges

The stated aim of the TCR is to find a fair and proportionate method of ironing out harmful distortions to the market. In particular, Ofgem aims to prevent users with the means to modify their behaviour to avoid residual charges from doing so at the expense of users without such means. Ofgem considers that a segmented fixed charges approach best achieves this aim.

Network residual charges are currently determined for larger users by reference to consumption during the Triad periods of peak demand, and for smaller users via per-unit consumption charges. Ofgem has provisionally decided to shift to a scheme of fixed charges based on different user “segments”. Under this scheme, segments would be determined by reference to the voltage level and line loss factor class of each connection. The fixed charge allocated to each segment would seek to reflect the volume consumed by that segment as a proportion of total consumption.

Ofgem has also confirmed the opinion it has given in previous publications that network residual charges should be levied on only demand users (i.e. suppliers) and not generation users.

In Ofgem’s view, the most viable alternative to the fixed charge approach, allocating charges on the basis of agreed connection capacities (or, in the case of smaller users, deemed capacities), still presents a risk of manipulation by users who can afford to be flexible with their connection capacity.

Embedded benefits

Smaller distribution-connected generators (“EGs”) have been able to obtain certain benefits in relation to residual network charges by virtue of their treatment as “negative demand” when ascertaining supplier volumes for the purposes of determining use of system charges. However, Ofgem continues to consider that these benefits reward behaviours that are not necessarily beneficial to the market, and has proposed further restrictions on them:

• Balancing demand residual payments – as with TNUoS charges, EGs can currently obtain payments from suppliers for helping them to avoid BSUoS charges. In the TCR, Ofgem proposes to remove this benefit by charging suppliers using gross demand at the grid supply point level.
• Balancing generation residual charge – EGs are currently exempt from BSUoS charges. In the TCR, Ofgem proposes to remove this benefit.
• Transmission generation residual charge – While the value of the charge has been negative, it is due to become positive again upon the implementation of CMP261 – so the exclusion of EGs from this charge is set to become a benefit. In the TCR, Ofgem is proposing to set the default value of the charge to £0, reflecting its conclusion that network residual charges should be borne by only demand users.

Next steps

Stakeholders have until 4 February 2019 to respond to the decision. Ofgem has opened the question of timescales for implementation up to stakeholders:

• In relation to the proposed changes network residual charges, Ofgem is consulting on whether these should apply from April 2021 or whether there should be a phase-in period from April 2021 to April 2023; and
• Ofgem is proposing that its suggested changes to embedded benefits should come into effect in either April 2020 or April 2021.