Network charges must provide strong price signals

The reforms to electricity network charges currently being considered by Ofgem should focus on providing the right price signals to create an efficient net-zero power grid.

They cannot at the same time be used as a means to reduce inequality or protect vulnerable customers – issues that should be addressed through separate specific policy measures – according to Ovo Energy’s director of strategy Toby Ferenczi.

Ferenczi was speaking to Utility Week following Ofgem’s recent decision to recover residual network costs through fixed charges on consumers – a single universal charge for all domestic consumers and banded charges for non-domestic customers.

Ofgem said residual charges are not intended to be cost-reflective or provide price signals to drive behaviour. It said fixed charges levied solely on consumers would level the playing field between different generators and prevent network users from taking actions to reduce their charges and avoid paying their fair share of costs.

It was for the same reasons that Ofgem decided in June 2017 to slash the residual element of triad avoidance payments to almost zero and replace them with an explicit tariff within the charging regime.

The payments were one of a number of favourable charging arrangements, collectively known as embedded benefits, enjoyed by smaller generators connected to distribution networks. They could earn the payments from suppliers in exchange for reducing their transmission charges and were able to do so because their output was considered as negative demand during the triad periods used to determine the charges.

However, a feedback loop emerged whereby the more people avoided the charges, the higher they became for others. This incentivised yet more people to avoid the charges, and so on.

Ferenczi accepts that price signals like this were “distorting the market” and “not necessarily aligned to network savings”.

But he says Ofgem is using a sledgehammer to crack a nut: “Rather than updating the pricing signal or putting in place more precise measures to stop the practices that they don’t want, there’s a lot of collateral damage from the approach that they’ve taken.”

Ferenczi says the changes the regulator has approved will undermine the business models needed to create a smarter, more flexible energy system, jeopardising billions of pounds of potential savings: “Unless we can get price signals of sufficient magnitude and granularity these models could dissolve or struggle to take off and proliferate.”

He says none of these savings were incorporated into Ofgem’s impact assessment: “We fundamentally disagree with the cost-saving argument that they’ve put forward, and actually, we think by removing any pricing signal altogether, they are encouraging inefficient use of the networks, which actually plays into the hands of network companies and could increase costs.”

Ovo is particularly concerned about the flattening of residual distribution charges, which are currently calculated on the basis of consumption within three time bands. Ferenczi says this provides an important source of value for flexibility, one which increasing numbers of customers are able to benefit from as smart half-hourly metering becomes more widespread.

Whilst flexible assets also have the potential to provide multiple grid balancing services, “very few are meaningful” in terms of the value they offer at the moment.

Ofgem made the decision as part of its targeted charging review (TCR) examining residual charges and non-locational embedded benefits. It is also examining forward-looking charges and network access arrangements through a separate significant code review.

“What we’re calling for is to have as strong and as granular signals as possible, both temporally – in smaller time blocks closer to real time – and locationally,” says Ferenzi.

“What the TCR decision does is it goes in the opposite direction. It removes a key pricing signal.”

He says Ofgem could still create sufficiently strong signals through the forward-looking charges but this will require the right division between of cost between the two sets: “They could definitely solve a lot of our issues by getting that ratio right.”

But, he adds: “It’s not disclosed what percentage is in which bucket. At the moment, our understanding is that a very small percentage is forward-looking, which means if you are collecting the vast bulk of network costs with no pricing signal, and you’ve only got a small pot of money with which to implement the pricing signal, you’re not going to get the behaviour change that you want.”

The forward-looking charges are intended to pay for new investments in the network, which users can therefore help to avoid by behaving in certain ways.

“Obviously, the value of flexibility increases the more renewables are on the system,” says Ferenczi.

“Are you looking five years ahead at what the needs will be or are you looking 40 years ahead at what the needs will be when you have ultra-high penetration of renewables on the grid,” he asks. “There’s a lot factors that could determine what percentage is in residual and what percentage is in forward-looking.”

He says the regulator cannot be neutral on what future it sees for the energy system: “We want Ofgem to have a clear decarbonisation mandate and be working to help promote scenarios of maximum decarbonisation.”

And he says it will not be able to create strong price signals without leaving some, perhaps more vulnerable, customers from paying more for the network than others. “You need to have separate measures for protecting vulnerable customers and those that can’t respond, but don’t let that impact having efficient network prices,” he argues.

Ferenczi is not confident Ofgem will end up at the right place, but even if it does, he says the long gap until a decision is made on forward-looking charges means “we now have an 18-month minimum period where we’ve got no visibility on what that will look like, yet we already know that we’re losing one of the key revenue streams for these business models.

“It sends a very bad message and will certainly affect some companies’ decisions over the period.”

Aurora Energy Research has previously warned that the reforms to residual charging could delay the advent of subsidy-free renewables by up to five years.