Electricity distribution structure of charges: Ofgem decision
Ofgem proposals (74 pages, PDF) to direct electricity distribution network operators through new licence obligations (12 pages, scanned PDF) to implement specific methods for setting the structure of access charges to their networks.
The main proposals are:
- Access for EHV demand and EHV generation should be priced using WPD's long-run marginal incremental cost modelling method, with an increment size of 100kW for both demand and generation.
- In estimating long-run marginal incremental costs, a notional demand growth rate of 1 per cent a year should be used, irrespective of actual or prospective growth rates for a distribution network area or the relevant network elements. This global assumption is only said to be appropriate if “applied in a modelling context of a long run charging model”.
- The long-run marginal incremental cost should be converted into an annual charge using a 40-year annuity, irrespective of when the notional incremental investment expenditure is estimated by the model to be required.
- In estimating the notional costs of meeting the notional 1 per cent demand growth and the notional increments, network capacity should be calculated by reference to thermal constraints only. Costs associated with fault-level constraints should be recovered through connection charges. But “this is an area we would expect DNOs to keep under review”. The document does not say what happens to the new “common distribution charging methodology” if such reviews conclude that fault levels are important in some companies' networks and not in others.
- If applying Ofgem's model and assumptions “is considered to produce 'excessive' charges that are considered to be in breach of competition law”, distribution companies should “discuss the matter with [Ofgem]”, and (unless the common methodology is fixed) “propose suitable alternative arrangements ... based on their best assessment of the long run incremental cost of providing capacity at that point on their networks”.
- The 1 per cent notional growth figure is set by Ofgem, but “distributors should keep this growth rate under review” and it should be reset at each quinquennial price control review. The document does not say on what basis these reviews should take place, given Ofgem's decision to ignore companies' information on actual or prospective growth rates in setting a global notional number, or what should happen when different distribution companies' reviews find that different growth rates would be reflective of their circumstances.
- For HV and LV network elements, unit costs should be based on a bottom-up cost model for a 500 MW increment covering all aspects of its HV/LV network that are not covered by connection charges. The cost should be allocated between classes of customers on the basis of estimated peak-time load.
The main missing elements are:
- “[Ofgem] encourage[s] DNOs to develop a common methodology for IDNO charging as soon as possible” and “requires DNOs to work with IDNOs on this area of work”. But “given [Ofgem's] concurrent powers under competition law” Ofgem does not think that it would be “appropriate” for it to “determine the methodology”. According to Ofgem, “there is clearly need for further industry debate and discussion before [Ofgem] can make a decision on a common IDNO charging methodology”.
- “[Ofgem's] decision is for common tariff structures from 2010” (subject to potential derogations) but “the details of tariff structures is to be developed by DNOs”.
- Modification and governance arrangements are referred to in the proposed licence conditions but are not specified. Ofgem expects distribution companies to work together to develop theses arrangements, and put forward a document for approval by 1 September 2009. And proposals from Ofgem's review of governance for charging methodologies “may supersede the governance arrangements [whose core features only are] set out in this document”.
Companies have until Wednesday 29 October 2008 to decide whether to accept the licence obligations to implement these proposals. Unless three or more licence holders object (i.e. EDF or any two ownership groups), Ofgem has powers (presumably subject to judicial review) to impose the licence obligations without a Competition Commission inquiry.
Quick comment. The document contains (Appendix 3) some terms of reference for consultants. It seems that Ofgem would like DNOs to procure (and pay for) these services, but the terms of reference envisage most reporting to be to Ofgem. The document also says that Ofgem has “committed to help DNOs develop” some spreadsheets which seem to overlap with those specified in the terms of reference. All very strange. Message to the person in charge of procuring this work: Reckon is interested in making an offer. Contact Franck.
Update, November 2008. Proposals rejected.
For further information or advice please contact Franck Latrémolière.
Filed under Electricity, Ofgem.
