Sunk network costs to be levied solely on demand

Proposal provokes criticism from energy trade body for undermining policy goals

The residual charges used to recover the sunk costs of the power grid should be levied solely on demand, Ofgem has said.

The regulator believes removing generators’ liability to pay the charges will prevent market distortions and help to create a level playing field between different types of generation.

However, Ofgem’s working paper on the change elicited criticism from the Association for Decentralised Energy, which says the proposals will have consequences that run counter to government’s industrial strategy and smart energy goals.

Payments for use of the electricity network are divided between forward-looking charges, which are intended to reflect users’ impact on costs due to investments in new capacity, and residual charges, which are intended to recover the sunk costs of the existing infrastructure.

At the moment, residual charges are levied on both generation and demand, but in an update to the significant code review which it commenced in August, Ofgem today (6 October) revealed plans to shift the entire burden to the demand side.

“Residual charges are intended to ensure revenue recovery and are not designed to incentivise specific actions by network users,” the paper states. “However, they can create significant opportunities for some users to avoid paying them if they are not well designed.”

Ofgem says the current charging arrangements allow some users to reduce their exposure to network costs by adjusting their production and consumption of power. Without reforms, those users which are able unable to do likewise will be left to pay for a growing share of the bill. They are likely to include small businesses and households in general, and more vulnerable customers in particular.

By enabling some network users to avoid the charges, the present arrangements also affect operational and investment decisions by generators – potentially adding to overall system costs.

Ofgem plans to end these distortions by removing generators’ liability to pay the charges. The regulator says this will level the playing field for different types of generation, for example, between domestic and interconnected generation and potentially also between metered and behind-the-meter generation.

It says this is preferable to either splitting the charges between generators and demand or charging only generators, since neither alternative would entirely remove the distortions which it is attempting to address.

The regulator also argues that loading the charges solely onto demand will be simpler than creating a new split system and would represent the least change when compared to the present situation as suppliers already shoulder the majority of residual charges.

The working paper includes potential mechanisms for the allocation of residual charges. The options still on the table are: continuing with the current arrangements; fixed charges per user; ex ante and ex post capacity demand charges; and gross volumetric consumption charges (although only for business customers). The last option would see customers charged for all electricity they consume, including power produced from behind-the-meter generation.

Net volumetric demand charges, net volumetric import and export charges, and peak import or export capacity charges have all been discounted as potential solutions.

Ofgem will now conduct further assessments of the options deemed to be viable.

Responding to the update, the Association for Decentralised Energy (ADE) warned that exposing behind-the-meter generation to residual charges would undermine the ability of businesses to help realise the government’s energy policy goals.

“We welcome consideration of new ideas to ensure all customers, including those with and without their own generation, are charged fairly to pay for network costs,” said ADE director Tim Rotheray.

“But at a time that the national electricity network costs have grown from £943 million in 2007 to £3.7 billion by 2021, we need to be doing all we can to incentivise behaviour that keeps network costs down.

“For Ofgem’s review to be done right, it needs to fully, carefully and methodically consider the costs and benefits that business energy users provide to all consumers over the long term by reducing their use of the electricity networks. Otherwise Ofgem will be asking business users to pay over the odds for networks they barely use, and industrial sites will see large, unfair increases in their electricity bills in contradiction with the aims of the government’s energy cost review.”

The regulator’s latest proposals for changes to the way residual charges are applied follows its decision earlier this year to drastically reduce the triad avoidance payments that small-scale distributed generators can earn by helping suppliers to reduce their residual transmission charges.