Ofgem Targeted Charging Review Consultation: Residual Charges, Embedded Benefits and Storage

Following on from the recent Triads “minded to” decision, Ofgem has published a Targeted Charging Review (“TCR”) consultation focusing on (i) ‘residual’ charges; (ii) smaller embedded generation (“EG”) benefits; and (iii) storage charges. The driver for the TCR is Ofgem’s belief that the current residual charges, smaller EG embedded benefits, and the charging treatment for storage have the potential to create distortions, adversely affect competition, and increase costs for consumers.

In essence, Ofgem is proposing to:

• establish a set of principles and approaches to guide it in proposing changes to Transmission Network Use of System (“TNUoS”) and Distribution Use of System (“DUoS”) residual charges, which cumulatively rise to £2.26bn for 2017-2018. Ofgem has also carried out an international comparative study of similar charges and sets out five non-exhaustive alternatives to the current regime (i.e. based on net consumption, a fixed charge, based on gross consumption, based on connected capacity, or a hybrid);
• consider further changes to embedded benefits for smaller EG (e.g. TNUoS generation residual, TNUoS locational charges, BSUoS demand charge payments and BSUoS generation charge) to level the playing field with other forms of generation; and
• make changes to transmission and distribution residual charges and BSUoS charges for storage so as to not place it at a competitive disadvantage relative to other technologies. Ofgem is proposing that storage should pay only generation transmission and distribution residual charges, while being charged for both generation and demand 'forward-looking' charges. In relation to BSUoS charges, Ofgem is proposing to either (i) change the definition of a storage BMU to either importing or exporting regardless of actual activity in any settlement period (earning inverse import or export credits depending on actual power flows); or (ii) similarly to generation, be charged for BSUoS on the basis of its gross import or export.

What next?

Responses to the TCR consultation are due on 5 May 2017. In relation to residual charges and smaller EG benefits, Ofgem is proposing that any changes be effected by way of a Significant Code Review (“SCR”), whilst any changes to the charging regime for storage will best be carried forward by industry as Ofgem considers there to be “considerable industry agreement” on the storage elements. Nevertheless, an SCR is not certain and is a lengthy procedure (the time to carry out an SCR is c.18 months), and therefore Ofgem is inviting comments from industry on the perceived urgency of these reforms. While Ofgem is currently consulting on residual charges, it notes that ‘forward-looking’ charges may be the subject of review following discussions with BEIS.

Residual Charges

The transmission and distribution network companies in the UK are natural monopolies and obtain their revenues on the basis of price controls set by Ofgem. These revenues (mainly charges for connection to and use of their systems) are recovered from network users, generators and suppliers. The charges are mainly split into two categories:

(i) ‘forward-looking’ charges, which are intended to finance future improvements and reinforcements to the networks and incentivise efficient use by providing signals to market (e.g. for location, capacity, etc. of new generation); and

(ii) ‘residual’ charges, which are meant to top-up and make up for any deficit resulting after the ‘forward-looking’ charges have been levied.

Residual charges represent around 80% of revenues at transmission level and around 50% at distribution level.

Ofgem explains that the current residual charging regime was designed for a system with passive demand and large-scale, centrally-dispatched power stations; while today’s power systems are moving towards new technologies which are low carbon, more decentralised, dynamic, and responsive. The increased availability of smaller scale generation, private wire networks, and storage means that some consumers may more easily reduce net demand or peak net demand (by using generation and storage behind the meter). Therefore, those users who do not have/cannot afford these technologies will bear a higher burden of the residual charges. This can result in a lack of clear signals to the market and lead to potentially inefficient investment decisions and higher bills for consumers. Ofgem notes that residual charges are intended for revenue recovery only, and should not incentivise specific actions by network users (which is the remit of ‘forward-looking’ charges).

The regulator has carried out a review of international experience in residual charging (available here) and suggested a set of principles that should characterise the future regime of residual charges, also setting out a few options. Ofgem believes that residual charges should:

(i) minimise their impact on, or distortion of, decisions about when and how to access and use the network;

(ii) represent a cost-reflective and fair recovery of network costs, with everyone paying a share; and

(iii) minimise complexity, intervention and reduce volatility.

The potential options considered by Ofgem are:

• a charge linked to net (kWh) consumption – this would be similar to the current regime, albeit not linked to the time of consumption. This charge would be lower for consumers who reduce net demand, either by decreasing their demand or using generation behind the meter;
• a fixed price charge – this would be beneficial for reducing potential distortions to network use by separating residual cost recovery from users’ consumption or generation choices, and this is currently used in California and Nevada, USA;
• fixed charges set by connected capacity – successfully used in the Netherlands, this could be based on fuse size and accompanied by measures to protect smaller consumers. However, there is a concern that this would lead more users to move generation behind the meter so as to decrease connection capacity, thus endangering their security of supply when such generation fails;
• gross kWh consumption – currently used in Spain, such a charge would mean that whether generation is behind the meter or uses its own connection would not affect the quantum of the charge. However, this is complicated by difficulties in ascertaining the true gross consumption (i.e. accurately measuring generation from behind the meter); and
• a hybrid approach – this could mean, for example, that low usage domestic consumers pay on the basis of their net consumption whilst others pay fixed charges based on capacity.

Smaller EG Embedded Benefits

We have recently published a Law-Now on Ofgem’s ‘minded to’ decision as to embedded benefits, specifically Triad payments. The final decision in the Triad payments consultation is expected in May and Ofgem will take account of that decision in the TCR.

Ofgem is now consulting on other embedded benefits received by smaller EG. Such payments are believed to be preventing a level playing field between smaller EG and other forms of generation. For example, smaller EG is distribution-connected and therefore does not pay TNUoS generation residual charges (“TGR”). However, as smaller EG has increased over time, it has started to have an increasing impact on electricity flows on the transmission system whilst not being directly connected to it, resulting in increased costs for the grid. These costs are borne exclusively by transmission-connected users. To recover those increased transmission costs in an equitable manner, Ofgem is considering levying TGR charges on embedded generation as well. The other embedded benefits currently under review are the TNUoS demand and generation locational signals, and BSUoS demand and generation charges.

Charging Treatment of Storage

Currently, storage connected to the transmission network pays transmission demand charges when it imports electricity (during Triad periods), and also pays generation charges when it exports electricity back on to the network. At distribution level, however, storage only pays demand-related charges. Ofgem believes that:

• storage should be treated as generation for the purpose of setting all residual charges, and should not pay demand residual charges for either transmission or distribution; and
• it is appropriate for storage projects to pay ‘forward-looking’ charges that reflect the incremental demand and generation costs such projects place on networks.

Similarly, storage above 100MW currently pays both demand and generation BSUoS charges, therefore placing it at a relative disadvantage to generators. Ofgem has identified the following two potential approaches to resolve this issue:

• Balancing Mechanism Unit (“BMU”) Definition – define storage BMUs as either importing or exporting regardless of their actual activity in any settlement period, earning import or export credits to off-set its actions where power flows in the opposite direction; or
• Gross Charging – charge BSUoS charges for storage based on either its gross import or export, as opposed to net figures, irrespective of its actions in a settlement period, therefore placing it in the same position as generation.

Ofgem proposes that the contemplated changes should apply to storage co-located with generation but not to behind the meter storage projects located with demand, which will continue with the current charging structure.

Similar issues regarding network charging for storage were considered in the BEIS and Ofgem “A smart, flexible, energy system” (the “Call for Evidence”) consultation published last November (see our Law-Now here), for which a decision has not yet been issued. The Call for Evidence also highlighted the differences in treatment for storage and the resulting detrimental effects on the competitiveness of this technology.

Comment

Industry participants and market commentators have welcomed the more holistic and open-ended approach taken by Ofgem in this TCR, as compared to the process for the amendment to Triad payments. Experts believe that a comprehensive review of network charges was necessary to reflect in regulation the changes happening on the ground and set them on healthy foundations for future developments. Not least, the focus on storage and the regulator’s intention to put its charging regime on an equal footing with other technologies has been very well received and is representative of the central role that this technology will play in an age of increasingly decentralised, intermittent generation with reduced subsidy support.

More generally, it will be interesting to see how Ofgem will balance the interests of small versus large, and embedded versus transmission-connected generation in relation to network charges, and what effect any changes will have on the market. The TCR will be of particular concern to smaller EG whose financial models have already been shaken by Ofgem’s recent ‘minded-to’ decision regarding Triad payments and volatile market conditions. On the other end of the spectrum, TNUoS generation residual charges are currently quite low due to EU limits on transmission generation charges; however, with Brexit around the corner, these could change in the future.