Ofgem Targeted Charging Review: Decision and Impact Assessment

On 21 November 2019, after two years of deliberations, Ofgem published its decision on the Targeted Charging Review ("TCR"). Ofgem's decision has resulted in two distinct changes to the charging role of networks:

• Residual charges will be levied in the form of fixed charges (as opposed to the current model which is based on individual user electricity consumption from the grid).
• They will implement partial reform of the Embedded Benefits, removing the Transmission Generation Residual ("TGR") and instead charging balancing services charges for demand on the basis of gross demand at the Grid Supply Point ("GSP").

We provide more detail on the mechanism of both of these changes below.

Residual Charges

Consumers contribute to the working and maintenance of the electricity grid by paying both forward-looking and residual charges. Forward-looking charges reflect a contribution to future network costs, being applied at a particular time or location. Residual charges make up the remaining "allowed revenue" set under Ofgem's price controls. These currently account for around £4 billion a year, and are around 10-15% of a typical electricity bill.

The TCR reform of Residual Charges mirrors the shift in the way electricity is being generated in the UK. Historically, most users obtained their electricity from the grid, but now, with electricity being generated from a wider range of sources, including smaller scale and in-house generators, consumers on average take less electricity from the grid.

The effect of this charge is that certain users pay little to no residual charges whilst others pay higher residual charges to make up for the "allowed revenue" that cannot be recovered from consumers who self-generate electricity. In addition, it encourages consumers to invest in technology or change their behaviour in order to lower their own residual charges. Though this is a positive development, the end result, however, is that the total costs of the electricity network increase and are shared disproportionately between fewer grid connected consumers.

Under Ofgem's review, residual charges will become fixed charges for transmission charges in 2021 and for distribution charges in 2022. In practical terms, this means that some low-using consumers will see their electricity bill increase by around £24 per annum, whilst high-using (and non self-generating) consumers will see their bill decrease by around £40 per annum.

Ofgem reconciled these changes by focusing on particularly vulnerable consumers, and creating bands within which the fixed charges would be determined as follows:

• For domestic consumers, a single set of residual charges will be implemented within each of the 14 distribution licensed areas.
• For non-domestic consumers, there will be a single set of transmission residual charges, but a set of distribution residual charges for each of the 14 distribution licensed areas for each fixed charging band. These bands will be determined by voltage level (Extra High Voltage (EHV), High Voltage (HV) and Low Voltage (LV)), with further segmentation on the basis of agreed capacity for consumers whose data is available and on the basis of net consumption volume for consumers who are unmetered.

Overall, these changes are projected to result in £0.5bn to £1.6bn of projected consumer benefits. The estimated system benefits are even larger, ranging from £1.0bn to £3.2bn by removing existing distortions and appropriately balancing equity across bands with equality among relatively similar users in these bands.

Embedded Benefits

'Embedded Benefits' is the name given to differences in transmission and balancing services charging arrangements between Smaller Distributed Generators ("SDGs") and larger generators, below and above 100 MW respectively, connected to the transmission or distribution networks. Whilst these charges originally benefited SDGs, since 2017, the TGR (one of the Embedded Benefits) has become negative. This has resulted in larger generators receiving a credit by way of a tariff reduction, and a disbenefit to SDGs.

In order to counter this distortion, the TCR proposes implementation of partial reform of Embedded Benefits by 2021, and the creation of a Balancing Services Charges Taskforce (the "Second Taskforce") to submit conclusions to Ofgem by the end of June 2020. The reforms include:

• Setting the TGR to zero by 2020 (subject to compliance with EU Regulation 838/2010, which sets a range of €0-2.50/MWh for annual average transmission charges paid by larger generators).
• Charging balancing services charges on the basis of gross demand at the GSP, so that suppliers cannot reduce their liability for these by contracting with Smaller Distributed Generators and/or exporting on-site generation.
• Assessment of reforms to the generation balancing services charges, which are currently not paid by SDGs and on-site generators. The Second Taskforce is to assess who should pay balancing services charges, and how these should be recovered.

Overall, the reforms above are projected to bring net consumer benefits to 2040 in the range of £3.3bn to £4.1bn. The projected impacts indicated that there would not be a significant impact on system costs, with the effect ranging from no change to a net cost of £0.3bn.

Conclusion

The TCR is seeking to adapt to the electricity network adapts to the changing electricity landscape. Non-domestic customers with high levels of electricity consumption stand to benefit the most from the outcome of the TCR, however, Ofgem's long-term goal is to place charges to share the cost of the networks fairly amongst all consumers.

If you would like advice on how the TCR will affect you or your business, please do not hesitate to contact us.