To put it simply – this is a different way of collecting revenue for Transmission and Distribution companies.
How does it currently work?
Collectively all users of the electricity network contribute towards the £10bn worth of costs, made up of:
- TNUoS - Transmission Network Use of System charges (the cables built to transport energy across the motorways of the national electricity grid)
- DUoS - Distribution Use of System Charges (the A and B roads that get the power to their final destination).
- BSUoS - Balancing Services Use of System charges (the costs involved in ensuring that supply always equals demand second by second to avoid a blackout).
Historically, users paid their contributions to these three costs and there was no large financial incentive to avoid them. But as the costs have risen to such high amounts, an opportunity to reduce contribution specifically for TNUoS and DUoS charges by those able to started impacting a wider number of users adversely. How much users contributed towards TNUoS and DUoS was based on how much they used during peak charging periods (Triads and Red periods).
However, when someone avoids paying these costs, network companies do not recover less. In fact they have an agreement in place that actually means the network has to then collect this revenue from other users. This means that companies who are unable to avoid the peak times end up paying a larger proportion of the charges to make up for the shortfall created by the companies who are contributing less.
This is where the Targeted Charging Review comes in…
Take this example, a customer wants to use more energy at a certain part of the day but the network company knows that it will need to invest in the network at that time to ensure that energy reaches that customer site. What if the network company paid that customer an amount of money to not consume at that time? Well, then the customer would be financially rewarded and the network company would not have to pay millions investing in additional cables.
The TCR seeks to ensure that reducing demand at peaks doesn’t impact the contribution to the running costs that a network company needs to spend to just operate. These are employees, the offices, the vans they run, pensions, in fact any cost that would not change if a customer changed their consumption behaviour. Ofgem has termed this cost as residual. The part a customer can react to is called the locational or forward-looking charges.
As both the residual and locational charge is levied in exactly the same way, customers were able to reduce their contribution towards network costs and also inadvertently reduced their contribution towards those residual costs – again creating this shortfall.
The solution? To charge the residual charges in a fixed way that cannot be avoided.
If we take a look at TNUoS, a staggering 90% of the £3bn collected by the transmission operators is in fact termed as residual. Therefore 90% of the costs will become fixed (and triad avoidance won’t impact what you pay for this part).
The remaining 10% will continue to be collected from the triad methodology. Remember the network company wants sites to react to this signal as it would save them paying for additional cabling, which would be a more costly option.
For distribution companies where charges are levied regionally, the mix between residual and locational is much more varied. There is still a volumetric signal that distribution companies want users to react to, but broadly 50% of the costs are termed residual.
To make this slightly easier to understand – this following chart shows this split out by region.
You will see from this slide that the proportion of DUoS charges by region varies in the amount that will be collected though a fixed component once TCR is implemented.
Let’s take the Eastern distribution area on the left of the chart. 11% of the tariff will now be recovered on a fixed basis, the remaining 89% will be levied on the existing red amber and green methodology. Therefore, if a site can avoid the red rates (high cost periods) in this area, they will be rewarded by lower distribution costs.
Conversely, you will see at the other end of the chart is Yorkshire, almost 60% will be recovered through a fixed cost and 40% will now continue through the red, amber green methodology.
You may pick up that London is negative. This is because, despite the signal given to avoid the high costs red rate, sites have been unable or unwilling to react to it. Therefore, this distribution area ends up collecting more revenue than it intends to. To ensure that the final tariff does not overcharge users, there is a rebate applied to the distribution tariff. The main takeaway? Users in London are unwilling or unable to reduce their consumption despite being rewarded should they do so.
And what about BSUoS?
The cost of balancing the energy system (BSUoS) is paid by everyone apart from a group of generators connected to the distribution network. A decade ago, generators tended not to connect onto the distribution network so there was no issue. Because of out of date charging methodologies, this group of generators can now avoid paying their contribution towards BSUoS.
The TCR will fix this from April 2021 and they will now contribute like all other users connected to the network.
Still a work in progress…
You can see that charging reform needs to keep pace with how users consume and generate. Already Ofgem has launched another charging reform to accommodate more capacity onto the network given the ever-increasing electrification from EV’s and heat pumps.
Ofgem decided some rules that it would like network companies to follow when collecting the residual component of the TNUoS and DUoS charges. Delivering such a large change to how revenue is collected for network companies can be challenging. It can lead to some unintended consequences and behavioural change which need to ironed out over time. Ofgem made a decision to charge similar sized customers the same amount of residual costs. The intent and principle was to ensure all users pay a fair share towards running the network, which was absolutely valid. However, with every intent there needs to be a fair way of delivering that policy reform.
Remember all that this review is doing is that is carves up the revenue collected by the network companies so all users pay a fair amount.
This then causes winners and losers.
Imagine you had a site with a capacity agreement with your distribution company to draw 225kVa, you would pay £10,000 towards the running cost of this distribution network (DUoS). Now the company across the road from you had a capacity of 224kVa – they would only pay £3,000. £7,000 less for 1kVa lower capacity. You can see that Ofgem’s intent when turned into actual detail can still cause some distortions.
The same principle applies to TNUoS. In fact, for TNUoS this 225kVa customer site would only save £3,000 by reducing their Capacity by 1kVA. In total being just on the wrong side of the band could cost this customer an additional £10k in residual costs.
When is this happening?
- Smaller generators contribution towards BSUoS is expected to be implemented on 1st April 2021
- Suppliers will be charged residual TNUoS and DUoS using a different methodology from 1st April 2022
- Suppliers will need to recover all BSUoS from end customers no earlier than 1st April 2022.
It is also worth noting that whilst some BSUoS reform has been captured within the TCR, a further major reform has also been agreed by Ofgem. Similar to how TNUoS and DUoS has a residual component to its tariff, BSUoS in the future will be deemed as entirely residual. In fact it will mean that all end customers will pay all of the BSUoS costs. At the moment the cost is broadly shared with generators too. At the point BSUoS is moved to end customers, generators will reduce their wholesale cost simultaneously so that there should be a negligible difference to the final cost. This reform is currently on track to be implemented on the 1st April 2023.