Ofgem reacts to High Court ruling on transmission charges

Ofgem has rejected a set of code modifications that sought to clarify the application of a regulatory limit on transmission charges on generators following a High Court ruling on the matter.

The decision is the latest episode in a long-running dispute over the limit, which was initially introduced through EU regulation in 2010 and later transposed into UK law following Brexit.

The regulation states that average annual transmission charges on generators in the UK must be within the range of €0.00-2.50/MWh. However, the limit excludes “charges paid by producers for physical assets required for connection to the system or the upgrade of the connection”.

Among other things, the code modifications rejected by Ofgem sought to clarify the definition of “physical assets required for connection” within the Connection and Use of System Code (CUSC) after a previous set of modifications failed to correctly apply its interpretation of the connection exclusion.

Ofgem made the decision after a High Court judge ruled that the regulator had acted unlawfully in approving the previous modifications. In line with comments by the judge, Ofgem said it was abandoning efforts to create a generic definition of connection assets within the CUSC and will instead directly transpose the wording of the limiting regulation into the code to allow decisions to be made on a case-by-case basis.

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In March 2016, SSE proposed a modification to the CUSC, designated CMP261, that sought to apply an ex-post adjustment to transmission charges to maintain compliance with the limit, claiming the fees for 2015/16 had breached the upper bound by almost £120 million.

Despite being approved by the CUSC panel, the modification was rejected by Ofgem in November 2017. It explained at the time that SSE’s argument was based on a “narrow” interpretation of the connection exclusion, whereby it would only apply to charges explicitly classed as connection charges within the CUSC.

Transmission charges are divided between forward-looking charges, which are designed to reflect users’ impact on future network costs depending on where they are connected, and residual charges, which are intended to recoup the remaining sunk costs of the existing network. The forward-looking charges are further divided between wider locational charges, which are set for 27 zones across Great Britain, and bespoke local charges, which reflect the cost of local assets required to accommodate individual connections.

In applying the limit on transmission charges, Ofgem decided to adopt a “broad” interpretation of the connection exclusion, meaning “most, if not all” local charges would also be covered by the exclusion.

The regulator said the structure of the connection charges already defined in the CUSC and local transmission charges “demonstrates that they are all, in substance, very similar to each other”. It said there is “no reasonable justification for treating most, if not all, local charges differently from charges that are labelled as connection charges in the context of the connection exclusion.”

On this basis, Ofgem said the transmission charges for 2015/16 did not in fact breach the limit as SSE had claimed.

SSE and EDF lodged an appeal against the decision with the Competition and Markets Authority (CMA) in December 2017 but the appeal was rejected in February 2018.

As part of its significant code review of residual charges and embedded benefits, known as the Targeted Charging Review (TCR), Ofgem announced plans in November 2018 to shift residual transmission charges entirely onto demand, in part to remove disparities between different types of generation. The regulator confirmed the decision in November 2019.

In light of these plans and the lack of clarity over the application of the connection exclusion, National Grid Electricity System Operator proposed a series of CUSC modifications designated CMP271, CMP327 and CMP339.

CMP317, which was raised in May 2019, specified which transmission assets would be considered necessary for connection and therefore covered by the connection exclusion. It also established an adjustment mechanism to ensure continued compliance with the limit on transmission charges.

This was later amalgamated with CMP327, which was raised shortly after the completion of the TCR in November 2019 and enacted Ofgem’s decision to remove residual transmission charges from generators.

As the proposal document noted, the second modification was dependent on the first as residual transmission charges had hitherto been used to ensure compliance with the limit, becoming a credit to generators when average annual charges would otherwise fall below zero.

CMP339 was raised in April 2020 and provided a range of definitions for assets required for connection to support the numerous variations of CMP317/327 then being considered.

Ofgem approved the original version of amalgamated code modification CMP317/327, along with CMP339, in December 2020.

In its decision document, Ofgem stated that neither the original proposals nor the many alternatives it considered correctly incorporated its broad interpretation of the connection exclusion.

Nevertheless, the regulator said the modifications would work as a “stop-gap measure” to “avert an imminent risk of breach of the limiting regulation”. It said this would give time for National Grid to propose an enduring solution through further code modifications.

SSE appealed the approval of the modifications to the CMA in January 2021 but the competition watchdog rejected all six grounds of its appeal in March 2021. The company then sought a judicial review of the CMA’s decision in April 2021.

The High Court considered the legal challenge at a hearing across November and December 2021 before handing down its ruling in April. The court found in favour of SSE on the first of three grounds but rejected the other two.

In his judgement, Justice Swift said although he agreed with Ofgem’s interpretation of the connection exclusion and that transmission charges on generation may indeed fall within the limit on that basis, the modifications approved by Ofgem did not comply with the connection exclusion as set out in the regulation.

The judge said both Ofgem’s and the CMA’s decisions “proceeded from the premise that National Grid’s modification proposal did not properly reflect the connection exclusion. The premise was that National Grid’s proposal was over-inclusive to the extent that, depending on the circumstances of a generator’s connection to the transmission system, charges might be incorrectly included within the connection exclusion.”

He said Ofgem was effectively admitting this by asking National Grid to bring forward further code modifications.

Justice Swift said the fact that, under Ofgem’s narrow interpretation of the connection exclusion, the modifications would prevent a breach of the limit, did not outweigh their incorrect application of the regulator’s interpretation as there is no hierarchy between the two obligations in the regulation.

The High Court therefore quashed the CMA’s decision to reject grounds 1 and 2 of SSE’s appeal, both of which were covered by ground 1 of the judicial review. It also ordered the CMA to quash part of CMP339, specifically its definition of physical assets required for connection.

Furthermore, the court ordered the CMA to pay 65% of SSE’s legal costs and rejected Ofgem’s subsequent requests for a stay of order and permission to appeal the ruling.

At a relief hearing, Ofgem indicated that it would amend the definition of connection assets introduced by CMP339 over the following weeks. It said it would do this by either approving two new code modifications – CMP368 and CMP369 – that National Grid had submitted shortly after the court’s ruling, or through further code modifications.

However, Ofgem announced last week it had decided to reject both CMP368 and CMP369 on the basis that “none of the proposals relating to the connection exclusion can lawfully be approved.”

The regulator cited part of Justice Swift’s judgement that stated attempts to create a generic definition of connection assets are “necessary and useful, but only up to a point. The possibility will always remain that any generic definition might need to yield in the face of the circumstances of the case in hand.”

“All of the options before us seek to ascribe a generic gloss to the connection exclusion and do not provide for case-by-case assessment by reference to the words of the connection exclusion itself,” the regulator explained.

Ofgem therefore said it intends to request a further modification that would directly transpose the words of the limiting regulation into the CUSC.

Commenting on the High Court’s ruling in April, a spokesperson for SSE said: “We are pleased that the court has agreed with our position that the proposed changes to the transmission charging methodology for generators are based on an incorrect technical application of the rules.

“While we are disappointed not to have been successful on all grounds of our appeal, challenging regulatory decisions in the courts is always a last resort. Our key focus is on delivering the significant investment needed to deliver more clean, home-grown energy through our £12.5 billion Net Zero Acceleration programme, which will see us create 1,000 new jobs every year.”