Speakers: Patrick Hynes, Electricity Charging and Capacity Development Manager for National Grid, and Catherine Williams, Head of Commercial regulation at Ofgem
All Party Group on the Costs of Energy
14 July 2015 – meeting notes
Chair: Lord Palmer
Mr Hynes discussed network charging.
National Grid has a role of ensuring industry compliance with regulations and licences. Ultimately National Grid is looking to provide the best for consumers.
National Grid collect the costs of transmission assets on behalf of all transmission companies, covering offshore, the two Scottish companies and National Grid itself. National Grid is responsible for the charging methodology which has a locational element: the further away from the demand, the larger the charge because of the need for more infrastructure. The cost of charges is 3 – 4% of the end consumer’s duel fuel bill. These costs are rising because of the increase of renewable generation on the system, including new offshore cables connecting the islands and large scale windfarms.
National Grid also levies charges to recover the operational costs for system balancing and security of supply. We help others prepare proposals for changes to the methodology, which go through a governance framework and are then presented to Ofgem.
Transmission is a natural monopoly. Ofgem in an economic regulator. We set the maximum amount transmission owners are allowed to recover. The current price controls for transmission owners were set in 2013 covering a period of 8 years. Network costs are recovered through Transmission Network Use of System charges (TNUoS). In the current year £2.6 billion has been recovered. This recovers 7-8% of capital cost on an annual basis. The day-to-day balancing charges are recovered through Balancing Services Use of System (BSUoS) which are about £825 million a year.
The investment in the transmission system is driven by the amount and location of generation. The two Scottish transmission operators will spend around £7bn. Ofgem has to look at how the money is to be recovered from users of the system. We think it is fair that the costs are recovered from users based on how much they drive the costs of the underlying investments. We talk about cost reflectivity, meaning linking the costs a generator creates to their tariff. Cost reflectivity is a fundamental principle to transmission charging, providing the best outcome for GB consumers.
This signal to a generator (about the costs they impose on a transmission network) gives a way to take into account the cost of the network, when deciding where to locate. Transmission network charging arrangements have an important role to play.
Questions and comments
Lord Palmer: How does this work in the Islands, what happened previously? How does this affect the Winter Fuel Payments?
The Islands are not covered by the current pricing methodology because they were never connected by transmission lines. We have a methodology ready for when the Islands were connected.
The Western Isles and Orkney both have a low voltage transmission link, and Shetland is not connected to the main transmission system. Going forward there is scope for large renewable production in these areas which will require larger scale links.
From a network costs, it is about location. DECC are responsible for the Winter Fuel Payment.
A key problem in energy costs is the lack of transparency, how can we get the man in the street to trust what is going on? Transmission costs are often blamed for prices staying high. Newer companies such as Ovo make their bills clearer, whilst National Grid used to do that with a calculator on their site.
Ofgem/National Grid: There is a general question on the transparency of bills. However, not in relation to transmission (network costs) which is publicly available information. The information available may not be in consumer’s language. 3% – 4% of the consumer bill is transmission, whilst 20% of the average bill is transmission and distribution costs together. Green subsidies are also included in bills.
What are the transmission capex in the next 20 years in both the domestic and industry bill?
National Grid: £110 billion for capital costs, taken out as an annuity based on a rate of return set by Ofgem. New assets are coming on, which increases the overall base level, but other assets are depreciating at the same time. I don’t have the full details, but I can give you more details directly.
Ofgem: This is a challenge; we have recently seen an unexpected increase in the growth of solar PV, which has reinforced the rapid pace of change. As an industry we do need to respond to that. We recognise the need to change, on lots of things. It is quite a fundamental shift. Where we look at large scale investments we need to scrutinise those really carefully. We also need to look at changes in renewable subsidies; there is quite a paradigm shift.
Who is taking this forward, there does not seem to be an alliance between National Grid and DNOs?
Ofgem: We recognised this, the issues are greater than one party can solve. There are interesting questions for which we do not have immediate solutions. We are working with DNOs on this.
National Grid: From a transmission perspective we have a close relationship with distributors; their roles are changing. They are becoming more active distributors and we are working with them on that.
Everyone trades at a single energy price at the moment, we may move to more local markets, in the future. We are mindful of investor confidence. Fundamental change does need to be coordinated. We would work with Ofgem and all the stakeholders involved.
Cost recovery is split between generation and consumption. Over a number of years there has been a move for consumption to bear more of that cost. That is related to a European Directive. What are the underlying causes of this trend and will that continue?
National Grid: The EU Directive does have to be complied with. It limits the revenue amount we can collect from generators to 2 Euros 50 on average. Prior to that there was a fixed split, now with the regulation the split is 80:20 (previously it was 73:27): the larger amount from the supply side. There is a lot of other work in EU about what the right split is and how that should be harmonised, but you need to look at all the arrangements, the rights and obligations enjoyed by the generator.
Does that give you cost reflectivity?
Ofgem: We feel it is very important that the generators have a cost-reflective signal. The recent work in Europe seems to be to harmonise closer to the GB regime. We are currently looking at a change in charging regulations which will drop charges to generation to 15% as a one-off change. We will look at that and consider how that affects consumers.
In relation to the price control mechanism, what is becoming evident is the issue of network resiliency and cyber security and investment made in international networks. How does the network deal with cyber security?
Ofgem: There is a specific provision on charges to upgrade critical parts of infrastructure, set out in the price controls.
Looking at demand-side-management, might it be embraced in the work you are doing and drive the price down? Could completely managed smart grids produce some interesting things to look at on costs?
Ofgem: When looking at the new world with smart goods and demand side reform we do need a holistic view, Ofgem are looking at this. There is interesting work in the UK, particularly in Shetland. We have been funding projects looking into the effect of these areas.
National Grid: Embedded generation will not always drive up the costs; it depends on where it is.
Innovation costs (which we fund) are set up in a mechanism which means best practice from one DNO is shared through all the DNOs. There will be a new system from 2016, which will all be centrally funded.
For demand-side-response, National Grid has been doing a lot of work with the industry. From a system operator perspective, this is valuable in running a system and reducing the costs to consumers. We are working with parties that can afford to explore that. If there are benefits and evidence, we will put that to Ofgem.
Lord Palmer: Did you have contingency plans had Scotland voted for independence?
Ofgem: There were plans but it would have depended on if there would have been a single energy grid.
National Grid: My understanding was there would have been the retention of a single energy grid. We would have evolved to whatever the framework was.
How do you finalise the transmission charge. It is frustrating commercially working with trade operators and not be able to give them prices because I am waiting for you? How hard is it to issue a charge and adjust it the following year if necessary?
National Grid: We recognise this is an issue. We are currently looking at the process. We could fix the price, however at 15 months ahead suppliers have not told us what they are going to take, so there will be forecasting errors. We have a working group looking at the benefits to consumers and large industrial parties and weigh those up against costs of managing forecast error. We will work with the industry and see how many months will be a correct time period. I encourage you to contribute to the consultation and submit evidence.
Currently consumers are charged through the Triad system. The more embedded generation we have and more Islanded systems we have, the more that charging strategy looks difficult. Is there any threat to the Triad system or indeed to the issue of embedded benefits to generators?
Ofgem: Pat: The system has been around a while. In our licence we have to keep the charging structure under review. There are moves to shift a lot more classes of demand away from normal meter arrangements to smart meters. This will allow for half hourly charging. Smart meters allow for reviews of the charging arrangements. We will need to keep the Triad system under review, although we have no plans at the moment to start a review, but we know there is a move in the energy sector that will require a review of Triad.
The industry has mixed views on embedded benefits.
Ofgem: Embedded benefits are linked to particular charging arrangements. As an industry we have looked at it several times. In the long run charging arrangements for distributor generators and the blurring lines between distribution and transmission will mean that some things will have to be looked at again.