Ofgem confirms plans to flatten gas transmission charges

Ofgem has given the go-ahead to an overhaul of gas transmission charges that would reduce the current variation between different entry and exit points to the network.

The modification to the Uniform Network Code would also remove a discounted short-haul tariff for gas users located close to import terminals that is intended to discourage them from bypassing the transmission network by installing their own pipes.

A number of industrial firms have warned that they may be forced to go off-grid to remain competitive with international rivals.

Transmission fees are split between capacity charges – which grant users the rights to flow gas onto and off the network but are payable regardless of whether they are exercised – and commodity charges, which are paid on actual flows. Both sets are further divided into entry and exit charges. The recovery of costs is evenly split between entry and exit charges.

The commodity charges are used to recover any residual costs that are not recouped through the capacity charges. The capacity charges vary based on the location of entry or exit. The commodity charges do not.

UNC678A would introduce a new methodology for setting the reference prices for different entry and exit points. Discounts are applied to the reference prices to determine the reserve prices for capacity auctions. The references prices are currently intended to reflect the long-run marginal costs for capacity at these locations.

The new methodology – dubbed the “postage stamp” model –would flatten the reference prices across entry and exit points, significantly reducing the locational variation in capacity charges.

Ofgem has already tried once already to overhaul gas transmission charges after concluding that they required fundamental reform in 2015. The regulator asked industry stakeholders to put forward proposals but in 2018 decided none were compliant with new EU regulations designed to harmonise the charges across the bloc.

In January 2019, National Grid Gas Transmission proposed a fresh modification named UNC678 that would introduce a “capacity weighted distance” model for setting the reference prices for capacity auction.

Under this model, the reference price for each entry point would be based on the capacity and distance to all exit points to which flows may occur. The reference price for each exit point would likewise be based on the capacity and distance to all feasible entry points.

Industry stakeholders subsequently submitted ten alternative versions of the modification, including UNC678A. Ofgem judged that only this and the original version would be compliant with the aforementioned EU regulations, which came into effect in 2017 and 2019.

In line with its minded-to decision in January of this year, Ofgem has now decided to proceed with the postage stamp model.

The regulator said the transmission network is already operating below full capacity and demand is expected to continue falling. It said the marginal costs of additional capacity are “on many part of the network, close to zero”, meaning a cost-reflective charging methodology is no longer necessary.

“In our minded-to decision, we noted that distance is often a driver of incremental costs of networks,” the regulator explained. “However, in a meshed network largely operating below capacity with expected declining demand, we think a fair approach to cost recovery should be based on the level of access to the system irrespective of individual location.”

It said network charges based on the capacity weighted distance model would “incentivise network users to bring gas onto the national transmission system at entry points closer to demand centres, without any significant cost savings.”

UNC678A will also remove, without a replacement, the optional commodity charges available to network users close to entry points. The tariff is designed to discourage networks users to build their own pipes to avoid transmission charges.

Ofgem recognised the benefits of avoiding bypass of the transmission network but said none of the proposed replacements contained within alternative modifications were compliant with EU regulations. It said the discounts they offered were too large and would therefore “give rise to an ‘undue’ cross-subsidy”.

However, a group of industrial firms in the Tees Valley area have warned that the removal of the short-haul tariff will harm their international competitiveness, with some seeing a 25-fold increase in their charges.

They said their costs will increase by millions of pounds each year at a time when they are already facing severe financial pressures due to the coronavirus pandemic and the uncertainties brought by Brexit.

“Ofgem’s proposed new charging structure will impose unfair and highly detrimental new costs on our Teesside facility, as well as other businesses in the region,” said David Hopkins, managing director of CF Fertilisers.

“Without a replacement for the current short-haul tariff, which is based on the fact that our business only uses a few kilometres of the national pipeline, Ofgem’s proposal will expose our Billingham Site and others to a 25-fold increase in gas transmission charges.

“We are currently operating in a very challenging economic climate.  As we seek to re-emerge safely from this crisis, it is vital that Ofgem works with government and industry to find a constructive solution to this issue quickly before the damaging new charging regime is implemented to the detriment of the Tees Valley economy.’

The changes are due to be introduced for the start of the new charging year in October.

Andrew Large, chair of the Energy Intensive Users Group, said: “Ofgem are out of step with other regulators such as the Environment Agency, who have taken a much more pragmatic view of the pace of regulatory change during the pandemic.

“Moreover, Ofgem’s proposals are botched. What is being introduced is only part of the package of reforms, and there is a consensus of a need to make other reforms as well, including a replacement for the current short-haul tariff. It is unreasonable for Ofgem to proceed in the middle of a pandemic with only half a reform, which is going to have such damaging effects on the competitiveness of energy intensive businesses. “

Nomi Ahmad, head of Sembcorp Energy UK, said the removal of the tariff would hinder plans to create a low-carbon industrial cluster in Teesside: “We have invested in Teesside for the long-term and are doing everything we can to develop Teesside into the UK’s leading low carbon energy and industrial cluster – bringing in more foreign investment and creating more jobs. This proposed course of action would jeopardise our growth plans for the area and hit Teesside’s existing businesses as well.”

Philip Aldridge, chief executive of the North East of England Process Industry Cluster (NEPIC), said the substantial increase in costs will mean the payback period for installing a private pipeline will be less than a year: “This change incentivises industry to pull together to build a private pipeline to go off-grid and avoid these costs altogether.”

Their cause has been taken up by local Stockton MP, Alex Cunningham, who added: “Driving through this change to meet EU regulations after we have left the EU, is illogical, especially given the severity of the regional impact for key manufacturing industry.

“It is an investment that regional industry shouldn’t need to make, cannot afford and that doesn’t benefit anyone – including the domestic consumer – to meet a legislative deadline that doesn’t even apply post-Brexit.”