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COVID-19-driven changes to electricity Third Party Charges

Laura  Woolsey Laura Woolsey Analyst
24th June 2020

The impact of COVID-19 on the energy sector has been a hot topic for the last few months. As we progress further into the UK’s lockdown period we are now beginning to piece together the wider picture of effects across energy Third Party Charges (TPCs).

These impacts are expected to be felt across many of the charging elements encompassed within TPCs and relate to more than just demand reduction which has taken the spotlight as a major feature of the lockdown period. These impacts will also vary in both size and timescale across the various charges and therefore, to appreciate the full scale of effects resulting from the COVID-19 outbreak, all charging elements must be considered individually. This article consequently examines COVID-19 impacts across a range of electricity charges included in TPCs.

The impact of demand reduction
The impacts of reduced demand from COVID-19 have been felt across the energy sector, and is an important determiner for many non-commodity charges as it is the basis over which costs are spread, with lower demand resulting in increased charges.

Where this occurs, these charges are typically levelised across the entire demand base. Therefore, despite falling business demand and rising domestic demand, the impact to all user types on a p/kWh basis is in most instances identical. Lower net demand results in higher costs for all users on the network.

Furthermore, the impacts from COVID-19 on demand may not be localised to 2020-21, but could also run into the longer term. The 2008 financial crash saw a 5% decline in annual UK electricity demand between 2008 and 2010, and a 10% decline between 2008 and 2014. An economic crash following the COVID-19 outbreak may result in a prolonged period of lower demand in years following the outbreak.

Wider consequences of COVID-19
The impacts of COVID-19 are not limited to demand reduction. It is also expected to impact a range of other relevant items such as network revenue recovery, operational costs of managing the network and the roll-out of smart meters across GB. The impacts across levies will be different and felt across a range of timescales. The full impact of the outbreak can be better understood by looking at individual charging elements, as explored below.

How are network charges affected?
Compared to other charges, Transmission Network Use of System (TNUoS) and Distribution Use of System (DUoS) costs will see a rather delayed impact from COVID-19. Reduced total demand due to the COVID-19 lockdown measures is expected to result in a decrease in recovered revenue for networks in 2020-21. The total allowed revenue for network companies in each charging year is set by Ofgem, and so under-recovery will result in an increase to charges in a future year. However, this rise won’t be felt until 2022-23.

DNO revenues are expected to be the most significantly impacted as the low voltage and high voltage charges have a significant volumetric component to them. The impacts on transmission charge recovery are more uncertain. Non half-hourly user charges, including domestic and non-domestic, are levied throughout the year on a peak charging basis – these are likely to be impacted by COVID-19. However, half-hourly settled customers are levied on their consumption over the three peak periods in the winter months – therefore the impact on revenue recovery will be dependent on the wider economic impact of COVID-19, or if lockdown measures persist or are reintroduced this winter.

Network companies have brought forward proposals to allow most monthly network charges to be paid at a later date, with no additional security cover required, in order to support suppliers and shippers facing cashflow challenges due to the impacts of COVID-19. The scheme is for parties without an investment grade credit rating, who for three months could claim relief (up to £1.6mn for electricity suppliers, and £1mn for gas shippers, per network licensee) for up to 75% of eligible monthly network charges. The proposal is one of a number of measures emerging across TPCs to limit the impact of COVID-19 on industry parties.

Unlike transmission and distribution network charges, a more immediate impact is being felt in Balancing Services Use of System (BSUoS) costs. Much of the increase in BSUoS charges this summer will reflect the higher costs associated with balancing the system during the lockdown period - £453mn will be recovered by National Grid Electricity System Operator (ESO) for services to support the balancing of the system during low demand periods brought about from the pandemic. However, it is likely that much of these additional BSUoS costs arising from COVID-19 will be deferred into 2021-22, as per code modification CMP345 Defer the additional Covid-19 BSUoS costs.

The impact on renewables and capacity levies
Renewables and capacity levies are expected to be impacted to different extents and across a range of timescales.

Each year, the Renewables Obligation (RO) represents a hefty a burden on electricity suppliers, as the £6.3bn scheme (for 2019-20, equivalent to £23.61/MWh in GB) could be effectively paid in one go at the end of August/ beginning of September depending on individual suppliers’ strategies to meet the obligation. But the scheme works differently to other TPCs. BEIS sets the RO target on suppliers six months before the start of any compliance period, on a Roc per MWh basis, essentially fixing the cost to consumers. This means that if customers consume less, as they have amid the COVID-19 pandemic, it does not impact the £/MWh cost on their bill. Instead the supplier just needs to source fewer Rocs or pay less in the buy-out. Nonetheless, it still means that suppliers are required to stump up significant amounts of cash at a time when customers may be struggling to pay their bills.

In respect of the Contracts for Difference (CfD) scheme, the impacts of COVID-19 have resulted in an under recovery of costs to cover generator payments in the current quarter (April - June 2020). Costs are recovered from suppliers through a £/MWh levy rate set by the Low Carbon Contracts Company in advance of the quarter in question. The levy rate for this quarter is not sufficient to cover CfD scheme costs with lower power prices resulting in higher top-up payments to generators, and with the lower charging demand base compounding this. As a result, BEIS agreed to provide a one-off interest free loan to cover the shortfall in costs with suppliers not needing to repay these additional costs (currently forecast around £67mn) until Q1 2021-22 (April - June 2021).

Feed-in Tariff (FiT) costs are also going to be heavily impacted by the current outbreak. FiT costs are recovered from electricity suppliers through quarterly levelisations, and an annual reconciliation. A combination of extremes in sunshine hours and low demand resulting from the COVID-19 outbreak are expected to drive FiT costs up to an all-time high for Q220 (April – June), and low demand is expect to continue to impact FiT costs into Q320 as well.

Like other schemes, the charging structure of the Capacity Market (CM) alters the relative impact of the COVID-19 outbreak on consumer bills. CM charges are (presently) based on the previous winter’s peak demand. The greatest impacts of the COVID-19 outbreak on demand reduction fall outside of this period. CM charges are thus less directly affected than other charging elements by recent changes, but some suppliers may now be forced to recover a fixed cost from a smaller demand base. CM costs would also be affected by any long-term changes to demand levels that last through the upcoming winter period.

Where are we now?
Initial transmission system demand (ITSDO) data from National Grid ESO has shown that power demand has plummeted for the first two months of this quarter, due the UK’s lockdown restrictions. Average daily power demand was 0.56TWh across April and May 2020 compared to the 0.69TWh during the same period last year. The impacts of this reduction are already being felt across many TPCs with more impacts likely to reveal themselves further down the line. As we have seen, several measures have already been taken to protect consumers from sharp rises in costs. However, due to the scale and length of the impacts resulting from the COVID-19 outbreak, and the industry’s various methods of cost recovery, the effects on TPCs are likely to be felt for many years to come.

Our Third Party Charges Forecast service projects annual TPC costs out five years. Please contact l.woolsey@cornwall-insight.com or d.starman@cornwall-insight.com for further information, or questions on COVID-19’s impacts.