Ofgem's Thinking on Network Charging

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Buried within Ofgem’s latest Future Insights paper on local energy is a section on network charging principles. While Ofgem makes clear that these papers represent emerging thinking and not established policy it is a slightly strange way to kick off the debate on what is probably one of the biggest regulatory challenges facing the sector – how to recover the fixed and sunk costs in the energy network as usage patterns change with the move to a low carbon energy system.

The paper rightly recognises that this is an issue where there are tensions between efficiency and fairness (but doesn’t make reference to other important charging principles like certainty, transparency, simplicity). The solution that the paper advocates is that network charges should reflect long run incremental costs with the fixed and sunk costs recovered in the least distortive way possible. The problem with this “least distortive” line is that it means you load costs onto customers with no choice (or where usage is essential) because then demand won’t change in response to the higher price (which is the economists’ definition of efficiency). What this ignores is the distributional impacts (which to be fair the paper does acknowledge) or the fact that we don’t necessarily want to maximise energy usage (which the paper doesn’t mention).

Applying these principles to the specific issue of how to deal with the threat of customers using microgrids to avoid network charges, the paper argues that network charges should be set to reflect the value to customers of the “insurance” grid connection provides but then says that charges should be lower for those with the choice of using a microgrid to minimise distortion. It is not clear why this second limb is needed or justified. The charges may end up lower but they don’t have to be – it all depends what value is attached to connection.

Looked at through a different lens, what would the network companies do if there weren’t any controls on their charges? They would charge what the market would bear. So for customers who have the option of a microgrid they would be looking to levy as high a standing charge as they could for the “insurance” value (but also the “option” value of being able to sell energy and other services back to the grid). The purpose of monopoly regulation is then to prevent the monopoly recovering too much, if the value placed on connection is actually higher than the overall cost.

My main point though is that this is a complex area that needs careful consideration. The Future Insights papers are a great way to get people thinking about wider trends but there then needs to be a vehicle through which the issues raised can be debated more widely – especially if they are going to stray into such vital policy areas as this.