Iain Wright: Why it’s a mistake to see UK Grid Charges as an anti-Scottish conspiracy

Iain Wright, who has worked in the energy industry in Scotland and Ireland for over 30 years, argues that it is a mstaken view among some independence supporters to see the national grid charges as a conspiracy against Scotland, and instead we should be looking at changes to the methodology of the energy regulator if we want change 

SOME independence supporters on social media regularly claim that unreasonably high transmission charges levied on electricity generators in Scotland, compared with those applied to generators in England, are evidence of a plot by Westminster to undermine the development of our renewables industry.  These charges are also cited as a major contributor to the closure of Longannet Power Station.  These arguments are based on copying (eg) Table 1.5 from National Grid’s Statement of Use of System Charges (see fig 1), that break the GB transmission system down into 27 zones.

Fig 1. Table 1.5 from NGC’s UoS charging Statement Applicable from April 2015

As Scotland is covered by generation zones 1-12, a cursory examination will reach the obvious conclusion; that the numbers are higher at the top of the table; ie Scotland.  There is therefore clear evidence, it is argued, of a deliberate bias against Scottish generators, who are being deliberately ripped off.

Underpinning this generalised sense of unfairness, there are two underlying complaints;

·         Pricing is directed by Westminster

·         National Grid makes excessive profits by ripping off generators in Scotland

The first point is easily answered; the assumption is wrong.  National Grid’s licence requires the company to agree a charging methodology with the industry Regulator (Ofgem) by whom charges derived from application of these principles must be approved.  It is therefore the regulator that is directly responsible for system charges in Scotland and that is being challenged by both Scottish Government and industry to introduce a more appropriate charging methodology. However, because National Grid is only allowed to recover a fixed amount of revenue, a solution that improves charges in Scotland will of necessity result in higher charges for generators in the south.  Any change taking place within this type of constraint will create losers as well as winners, so it is quite likely that one or more of the former would go to court to seek to overturn any change.  The outcome of any litigation would not be a foregone conclusion.

So who decides how grid charges are made up?

Three things must be borne in mind when thinking about National Grid transmission charging;

·         Charges are about recovery of network costs

·         Neither energy/environmental policy nor social good are considered within the methodology

·         The network owner’s allowed revenue is largely based on the investment in its wires, so the Regulator's focus is on least cost delivery of required infrastructure in order to avoid unnecessary investment increasing the cost to customers.

The net result of these is that the network owner is paid to provide the cheapest infrastructure that will allow demand for electricity to be met.  Anyone, whether a customer or a generator, who chooses to locate somewhere other than at an ideal (in network terms) place, must pay the cost of expanding the network to meet their requirements.  This opens up a whole other area of discussion around the relationship between economists and the real world that is outwith the scope of this article, but suffice it to say that this is the Regulator’s approach right now.

“Anyone, whether a customer or a generator, who chooses to locate somewhere other than at an ideal (in network terms) place, must pay the cost of expanding the network to meet their requirements.”

So what is the basis of the approved transmission charging methodology?  The essential inputs to coming up with a workable solution are an understanding of how the system works, how much it costs to maintain and develop and the mathematical/economic expertise to deliver a coherent answer to the question.  The Regulator has a choice of either employing expensive consultants to develop the tariffing methodology on the basis of an external view of system operation and cost estimates, or a “free” system operator with access to real life information.

Electrical systems are extremely complex to operate for a variety of reasons, to do with physics, customers and the tendency of mechanical systems to break unexpectedly. Transmission companies the world over therefore employ lots of extremely clever people to make sure the lights switch on when required and stay on for as long as required.  The Grid operator has actual operational understanding of power system physics and obviously has the best information on costs, so the choice of a “free” genuine expert over a paid consultant to do the analysis is a no-brainer for the Regulator.  Clever and informed engineering people can solve difficult problems without blinking an eye.

So National Grid can be relied on to provide an accurate and elegant solution that addresses every building block of a comprehensive charging system and delivers the exact amount of revenue allowed by the Regulator. They will do this to meet the requirements given to them, but the question is whether the Regulator is asking them to answer the correct question. 

What’s the decision and is it equitable?

Minimising overall network charges (and therefore the financial return earned by the network owner) means providing price signals (ie charges) that encourage people to connect at places having the lowest investment cost impact on the system.  In practice this means that connection and usage charges are based on the cost of adding an extra Megawatt (MW) of additional capacity at each part of the system.  The unfortunate consequence of this approach is that charges increase the further north you go.  Part of the calculation involves use of what National Grid calls an “expansion constant”, which is a £ per kW per km charge.  So there is a pretty good argument that the approved methodology is also based on the distance between generation and demand; a concept that is specifically rejected in EU law.

“There is a pretty good argument that the approved methodology is also based on the distance between generation and demand; a concept that is specifically rejected in EU law.”

Although this “additional MW” approach will generally incentivise efficient allocation of investment in the economy and is not controversial from the perspective of an economist, it does not take account of externalities; other relevant issues and social impacts that are difficult to quantify.  It also contains an inherent assumption that the starting point (ie the current system) is ideal.  However it is quite hard to make this case, given that the current network was mainly designed 70 years ago when all power stations were big and built on coalfields and most demand was from industry and located in Birmingham.    

There is also an anomaly in EU market rules that mean the Irish and French interconnectors don't pay entry charges to the GB system.  If Scotland was a separate Member State from England (unlikely for a range of reasons right now), transmission charges for Scottish generators could be set at (eg) zero and Scottish generators would get free access to the E&W system.  On the other hand, the actual cost of the Scottish system, that has been massively expanded to support renewables development in the north of Scotland, would fall entirely on the bills of Scottish consumers.

Conspiracy or cockup?

Transmission charges for Scottish generators are the mathematical outcome of a regulatory requirement to protect the interests of final customers by minimising the amount of investment for which they have to pay.  National Grid’s charging framework is based on rigorous analysis of real data, to provide an answer to the question they were asked by the Regulator.  If the Regulator were to ask a different question, then National Grid would come up with an equally rigorous analysis that would give a different answer.  Indeed Ofgem recognised this and set up a review of transmission charging in September 2010 to ensure that charges supported development of low carbon energy, with a revised charging scheme coming into force from 1 April 2016.  Compare the charges in figure 1 above, with charges in the equivalent table, from the current year’s Charging Statement (figure 2).

Fig 2. Table 1.5 from NGC’s UoS charging Statement Applicable from April 2016

One of the questions being asked of the Regulator was why it made any sense to have a set of charges that directly fight against energy policy.  You put windfarms where it’s windy and hydro power stations where it’s wet.  So grid charges shouldn’t try to make developers do the opposite.  This was recognised as one of the defects in the previous charging methodology that had to be addressed.

Does Westminster have any influence?  The answer is “no”.  Few if any politicians would be bright enough to come up with the transmission charging scheme we have now, although they could revisit legislation to change the obligations placed on Ofgem to require alignment with a broader range of objectives.  The Electricity Act (1989) allows the Secretary of State to issue guidance to Ofgem on social and environmental matters, but this must be done in the full view of both houses of Parliament.  The process is described in Section 3B of the Act.

“You put windfarms where it’s windy and hydro power stations where it’s wet.  So grid charges shouldn’t try to make developers do the opposite.  This was recognised as one of the defects in the previous charging methodology that had to be addressed.”

Ofgem is a legally independent economic regulator operating within a fairly tight legal framework, although it still has a pretty wide scope for the exercise of regulatory discretion.  But it would be a bold regulatory step to move from an existing approach to setting cost reflective charges to a significantly different one that could also be described as reflecting cost, without pretty clear legal and analytical support. 

Ofgem’s final decision on the new charging methodology stated, “Following careful consideration of the evidence, including all the consultation responses, we find that our minded-to option set out in August 2013 and April 2014 is more cost reflective than the current methodology and best meets our statutory duties”. 

This is regulator speak for;

·         We have legal backing to do this

·         We gave anyone with an opinion the opportunity to have their say

·         The old method was indeed cost reflective but this new one is better

·         We think no-one can challenge this decision

It is quite clear that the old transmission charging regime was thought to represent the system’s underlying costs when it was introduced but, whether mainly as a result of lobbying, change of personnel in key positions, or new circumstances, there is now a different perspective on how system charges should reflect costs.  It certainly took time (5½ years) for the change to happen, but this doesn’t mean there was an official conspiracy to maintain high charges in Scotland.  A fair process involves detailed analysis and everyone to have their say before a decision is taken.  That way it cannot be successfully challenged in court (as the judge told RWE in July 2015).

Conclusions

Westminster is not involved in and could probably not care less about electricity transmission charges in Scotland.  It could have helped by amending electricity legislation to give a clear priority to the Regulator to ensure that electricity network charges were explicitly developed to take account of energy policy, but change happened even without that.

The Regulator had the power to change the charging methodology, but didn’t until it had sufficient weight of informed pressure and evidence to suggest there might be a case for change.  Ofgem has no explicit legal obligation to do anything other than what is currently done and risks judicial review proceedings by anyone losing out as a result of change.  So, unless doing nothing becomes untenable and the case for a proposed change is incontrovertible, the status quo will generally prevail.  Change will only happen as a result of sustained, coherent, technically‑informed pressure on Ofgem and nothing in the energy field can be expected to happen fast.

“Change will only happen as a result of sustained, coherent, technically‑informed pressure on Ofgem and nothing in the energy field can be expected to happen fast.”

Transmission charging is extremely complex and cannot be understood on the basis of looking at a single table from a complex document.  There are still apparent anomalies in the published charges, but anyone is free to analyse the published Project TransmiT documentation and propose appropriate changes.  So, even if you are utterly convinced that generators in Scotland are being overcharged, please accept that this is not the result of a deliberate Westminster policy to destroy our electricity industry.

Further reading

NGC The Statement of Use of System Charges

Statement of the Use of System Charging Methodology

Connection & Use of System Code (CUSC), Section 14

https://www.ofgem.gov.uk/electricity/transmission-networks/charging/project-transmit

https://www.ofgem.gov.uk/publications-and-updates/ofgem-welcomes-ruling-project-transmit

https://www.ofgem.gov.uk/publications-and-updates/project-transmit-decision-proposals-change-electricity-transmission-charging-methodology

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