Ofgem have published their final decision on the Targeted Charging Review, but whilst this may mean lower electricity bills, it may put back the development of renewables projects by up to five years.

For at least the last three years, Ofgem have been looking at the way electricity generators and consumers are charged for using the electricity network. Their concern is that some generators (particularly smaller 'embedded generators') are able to avoid paying their fair share of the cost of its upkeep. They have now decided to reform the charges, to take effect from 2021.

Forward looking charges

There are two elements to the charges that electricity users pay. The first is forward looking charges that vary depending on where a user connects to the network and when and how much electricity they use at a given time. This can encourage users to be flexible in their use in order to reduce their own electricity bills and reduce network costs overall for the benefit of all users. Ofgem issued a separate consultation on forward looking charges last year which we reported on in our article Getting more out of our electricity networks. We expect them to issue their final decision on this in the next few months.

Residual charges

The second element is residual charges, to cover the costs of maintaining the network that are not covered by the forward looking charges. Residual charges are not designed to reflect how a user uses the network, but are meant to ensure that everyone using the network pays for its upkeep. However, they are not designed to cope with the way our use of the electricity networks is changing.

Embedded benefits

Embedded benefits is the generic term for the ability of generators connected to the distribution, rather than the transmission, network to avoid certain charges, and even to be paid by electricity suppliers for generating at a specific time. This gives them an economic advantage over generators who are connected to the transmission network which Ofgem thinks is distorting the market. 

What's the problem?

As we highlighted in our Energy Disruption report, we are seeing more and more businesses and households with their own generation, whether that be solar panels, wind turbines or back-up generators. More small-scale generators are connecting to the lower-voltage electricity distribution network and avoiding paying transmission charges, leaving the few that are left on the transmission network having to pay the lion's share of the cost of its upkeep.  

Targeting Charging Review Significant Code Review

Ofgem launched a Targeted Charging Review in 2017 and we have reported on previous developments in our articles, Ofgem minded to cut embedded benefits, Ofgem to cut embedded benefits from April 2018 and Ofgem's Targeted Charging Review means electricity charges will change.

Ofgem reached a 'minded to' decision in November 2018 which asked for views on:

• the best way of setting transmission and distribution residual charges, which are currently based on how much electricity consumers take from the grid
• whether to remove some of the remaining embedded benefits

Both these issues are covered by a Significant Code Review (SCR) which was launched in August 2017. The final decision to that SCR has now been published. For background see our article Ofgem's Targeting Charging Review means electricity charges will change.

Fixed residual charges

Ofgem has decided to impose a fixed charge on each class of electricity user, rather than base the charges on how much electricity they use – so like fixed telephone line rental. This would make sure that everyone makes a fair contribution.

Changing to a fixed charge means that some households who use the least electricity (for example those with solar panels and/or storage) will see their network charges increase from between £2 to £22 annually, although most households will benefit. Businesses that have invested in on-site generation will pay more than they do now, as they will not be able to offset any charges by running their generator at specific times. This removes one incentive for having on-site generation.

Embedded benefits

This is not the first reform of embedded benefits. The Triad avoidance payment (transmission demand residual charge) has already been reduced significantly – see our article Ofgem to cut embedded benefits from April 2018. This Final Decision removes two of the remaining embedded benefits and there is still potential to remove a third, depending on what the BSUoS task force decides.

Transmission generation residual charge

The current methodology for charging transmission residuals to generation currently results in larger generators (those over 100MW) receiving a fixed rebate (i.e. a negative charge) for being connected to the system. This is because the EU has set a cap on the average level of transmission network charges which generators should pay. Smaller embedded generators do not receive this rebate (negative charge), and are now at a disadvantage to larger generators. In the past, this different treatment resulted in a benefit to smaller embedded generators. 

Ofgem have decided to set the Transmission Generation Residual (TGR) to zero, in other words remove the rebate. This affects larger embedded generators.

BSUoS charges: payments from suppliers

Suppliers have to pay a Balancing Use of System charge to National Grid. It is based on a supplier's net consumption from the transmission system, so smaller embedded generation can offset this demand by generating electricity which travels up to the transmission network and be paid by suppliers for doing this and so reducing the supplier's BSUoS charges. Suppliers end up recovering the cost of these payments from consumers.

Ofgem are removing this benefit. This was a good source of income for distributed generation and the industry is arguing that removing this is holding up the move to Net Zero. Research from Aurora shows that full reform (i.e. setting the TGR to zero, removing the BSUoS payment from suppliers plus making all generators pay BSUoS charges) would impede unsubsidised renewable development by 2-5 years.

BSUoS charges: avoided charges 

Smaller embedded generators currently do not pay generation BSUoS charges, but all other generators connected to the transmission or distribution networks do.

Ofgem are still considering whether to make smaller embedded generators pay BSUoS charges and have set up a second task force to look into this.

Effect on generators

The renewable industry is not happy with Ofgem's decision.  Nina Skorupska, Chief Executive of the  Renewable Energy Association (REA) summed it up: "As Embedded Generation types such as onshore wind and solar become ever-more affordable and widely deployed, and fossil fuel generators come offline, the future grid charging and access regime will need to properly incentivise flexibility technologies - mainly energy storage and demand response. These reforms mean that businesses and homes which have taken responsible steps to install low carbon technologies will effectively pay more to use the wires needed to support the system."

Ofgem acknowledge there will be an adverse effect on the rate of return for generation, as shown in this table taken from the Final Decision:

Timeframe for implementation

The changes in this Final Decision will be implemented via modifications to industry codes.  Ofgem want the fixed charges implemented in 2021 for transmission charges and 2022 for distribution charges. The embedded benefits are to be removed 2021. It is up to the industry to propose Code modifications to effect these changes, but Ofgem have specified in detail what the modifications should contain and have stressed they will use their powers to require co-operation from the industry to get these modifications through by these deadlines.

Comment

There seems to be a dichotomy between Ofgem's remit to reduce consumer bills and make the networks as efficient as possible, and the need to decarbonise as rapidly as possible. The way residual charging and embedded benefits has worked up to now has been to incentivise smaller generation and on-site generation, albeit not all of this is renewable and Ofgem have a point that it has encouraged generators to run "out of merit" (i.e. instead of the cheapest and most cost-effective generators running first when more power is needed, embedded generators run when normally, if it weren't for the embedded benefits, it would not be as cost-effective for them to generate first).

Existing generation plants and those in the pipeline will need to look carefully at their revenue streams and take this decision into account. Ofgem are very clear that these reforms have been in the pipeline for a number of years and so investors should have been taking account of them in their due diligence, i.e. not relying on revenue from embedded benefits and lower residual charges continuing beyond the next couple of years.

It remains to be seen whether the next government will examine Ofgem's remit and change its principal objective (to protect the interests of existing and future electricity and gas consumers) to include the need to decarbonise as rapidly as possible.

Whether these reforms will help or hinder the rate of decarbonisation, only time will tell.