Ofgem consults on shift to fixed balancing charges

Ofgem is consulting on proposals to recover balancing costs through a flat volumetric charge that would be set three months in advance and fixed for periods of a year.

The regulator said the move would remove some of the perverse incentives associated with the current charging arrangements and give suppliers predictability over balancing costs, lowering overall costs to consumers.

Balancing Services Use of System (BSUoS) charges are currently levied on large (more than 100MW) generators and demand in the form of a volumetric (per megawatt-hour) charge that varies based on the costs incurred National Grid Electricity System Operator (ESO) during each half-hour settlement period.

Ofgem said BSUoS charges over the year to the end of May averaged around £6.80/MWh but were highly volatile, ranging from -£6/MWh to £100/MWh.

Following its significant code review of residual network charges and embedded benefits, known as the Targeted Charging Review, Ofgem launched two successive taskforces to look at BSUoS charges.

The first was asked to examine how and whether the cost reflectivity of BSUoS charges could be improved to provide better forward-looking price signals. However, the taskforce concluded they do not provide any useful price signal and should therefore be treated as a cost-recovery charge.

On this basis, the second taskforce was asked to assess who should be liable to pay the charges and how they should be recovered. It concluded that BSUoS charges should be paid solely by final demand to remove distortions between different types of generators. It said they should take the form of a flat volumetric charge that is known in advance and fixed for a set period.

In April 2022, Ofgem approved the Connection and Use of System Code (CUSC) modification CMP308, which will shift liability for BSUoS charges solely onto final demand from April 2023.

The regulator has now issued its minded-to decision to approve a version of the CUSC modification CMP361 that would replace the current variable BSUoS charges with a flat fee that is fixed for 12 months with a notice period of 3 months.

The modification would provide the ESO with a ring-fenced reserve fund to allow it to manage the cashflow impacts of using a fixed charge to recover unpredictable balancing services costs. The fund would be built up over a period of five years through an additional charge on users.

The modification was originally proposed by the ESO, which led both of the balancing taskforces.

The particular version given preliminary approval by Ofgem (WACM5) was one of seven alternatives proposed by the working group for the modification.

The alternative versions varied by notice period (3 months to 12 months); fixed period (3 months to 12 months); whether or not there would be a reserve fund; the size of the fund expressed as the probability that charges would need to be adjusted within the fixed period; the length of the fund build-up; and whether annual contributions to the fund would be capped.

Ofgem said it is aiming to implement the modification alongside CMP308 in April 2023. The regulator has also given preliminary approval to the associated CUSC modification CMP362, which would make necessary updates to definitions in the CUSC to enable the implementation of both CMP308 and CMP361.

The regulator said the move to fixed BSUoS charges would remove the perverse incentive whereby users who are able to respond to expected price changes can reduce their exposure to BSUoS charges, even though this may not reduce balancing costs and leaves others who cannot respond to make up the difference.

It said flat ex-ante charges would also provide significant benefits to suppliers when setting their tariffs, reducing the risk premium they would otherwise build into contracts to account for potential periods of high prices.

Furthermore, Ofgem said the move will improve competition, focusing suppliers’ attention on cost items that are more fully within their control than BSUoS charges, which are currently “difficult to predict even for the most sophisticated operators,” whilst also reducing barriers to entry.

It said the inclusion of a reserve fund for the ESO would impose some additional costs on suppliers and consumers but these would be outweighed by the benefits of the additional certainty provided by reducing the risk of in-period adjustments to charges.

The deadline for responses to its minded-to decisions is 19 October.

Ofgem has additionally issued a call for input on the incorporation of the proposed changes into the price cap methodology.

Under the current methodology, variable BSUoS charges are calculated ex-post and recovered with a time lag. For instance, the costs recovered in the seventh price cap period covering October 2021 to March 2022 reflected the charges incurred by suppliers over the year to the end of June 2021.

Ofgem said moving from the lagged recovery of BSUoS charges to an ex-ante tariff would mean there would be a period of charges (January 2022 to March 2023) that would not be fully reflected and recovered through future price caps.

Depending on what happens with BSUoS charges during the period, this could lead to a surplus or shortfall in recovered costs. The regulator said there may therefore need to be a corresponding adjustment to the price cap as part of the transition.

Ofgem has proposed three potential options for performing this adjustment.

Option A, the “actual data method”, would have two stages. In the first, the regulator would use actual data for the years to the end of December 2022 to calculate any surplus or shortfall, which would be reflected in the price cap from period 10a, running from April to June 2023.

In the second stage, actual data for January to March 2023 would be used to calculate any further surplus or shortfall, which would be reflected in the price cap from period 11a, covering October to December 2023.

Under option B, the “float and true-up method”, the adjustment would be calculated using both actual data for the year to the end of December 2022 and a “float” for January to March 2023 based on forecasts from the ESO. This adjustment would apply to the price cap from period 10a.

When actual data for January to March 2023 become available, Ofgem would, if necessary, conduct a further “true-up” adjustment that would apply to the price cap from period 11a.

Under option C, the “deferred method”, Ofgem would wait to apply an adjustment until actual data has become available for the whole of January 2022 to March 2023. This adjustment would apply to the price cap from period 11a.

Ofgem said its initial preference is option A as this would rely entirely on actual, rather than forecast, data whilst also spreading out the adjustment over more price cap periods. The regulator said it is also considering whether to apply the adjustment over an even longer timeframe.

The deadline for comments on the proposals is 3 October.