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Ofgem launches code review in latest chapter of charging reforms

Ofgem has kicked off its review process to reform residual charging for both demand and generation across transmission and distribution networks with the launch of a significant code review (SCR).

The regulator is acting in response to its concerns and those of stakeholders that the current framework for residual charging may result in inefficient use of the networks. Ofgem believes that advances in technology and other factors have allowed some network users to avoid the cost-recovery charges used to cover the day-to-day costs of maintaining networks.

This is done by adjusting the timing and volume of their production and/or consumption of electricity to reduce exposure to the half-hourly calculated network charges, an action that Ofgem says other network consumers, such as small businesses or homeowners, are unable to do.

Residual charges are the ‘top up’ charges set to ensure that the network’s efficient costs, as determined through price controls, can be covered, after other charges have been levied. The main residual charges are the Transmission Generation Residual (TGR), Transmission Demand Residual (TDR) and the Distribution Demand Residual (DDR, also referred to as distribution scaling charges).

In addition, Balancing System Use of System (BSUoS) charges are currently a form of cost-recovery charge, so are similar to residual charges, however these will be considered under Ofgem’s strategy for regulating the future energy system.

The SCR will also not set out specific proposals to change other embedded benefits currently available to sub-100MW generation at the distribution level. However, this will be kept “under review” during the SCR with action possible ahead of the close of the review should evidence of distortions and consumer disbenefits arise.

The ‘ruthless’ embedded benefits reforms confirmed by Ofgem in June will see embedded benefits cut by as much as 95% by reducing TNUoS demand residual payments and introducing a new payment over a three-year phased implementation programme starting 1 April 2018.

The SCR will also focus on residual network charge recovery by reducing the burden on those less able to respond in ways which reduce their charges and may pay a greater share of network costs.

“Most stakeholders agreed that we should address the potential for current residual charges to fall increasingly on groups of customers who are less able to take action to avoid these charges,” the SCR states.

A “principles-based approach”

The review will focus on three areas, firstly reducing the perceived harm caused by distortions arising from residual cost recovery and in particular distortions to the signals created by the forward-looking charges, which incentivise efficient use of the network.

In considering these, Ofgem will look at the responses that a new system of residual charges could drive, and whether the effect of users’ response is likely to be harmful or beneficial to consumers’ interests.

It will also seek to counter distortions to competition between network users which it states have the potential to increase the overall system costs borne by consumers.

As well as the ‘fairness’ issue towards residential and microbusiness consumers in general and consumers in vulnerable situations in particular, Ofgem will also consider proportionality and practical considerations. This refers to the costs intrinsic to implementing changes, whereby Ofgem will look at whether new measures are justified by the estimated value to consumers of reducing distortions, and by achieving a distribution of charges that is considered fairer.

Ofgem will publish a residual charges working paper in the final quarter of 2017 before a draft impact assessment and minded to decision on any proposed changes is released in Q2 next year. A decision and impact assessment on new arrangements will be out within the following months before being confirmed with resulting modifications by early 2019, in order for new arrangements to come into effect from the 2020/2021 charging year.