Ofgem call for evidence on an energy system cost allocation and recovery review

Our response

Consumer Scotland welcomes the opportunity to respond to this Call for Input on how energy system costs should be allocated and recovered. The cost of living crisis has stretched  the ability of consumers in Scotland to meet their energy needs.[1] The total amount of the typical consumer bill is lower than it was at the height of the energy crisis, but still above what it was pre-crisis in inflation-adjusted terms, which presents a range of affordability challenges for households. The make-up of consumers’ energy bill also presents a number of issues. We know, for example, that the standing charge is not popular with consumers and is regarded by many as being too high, although we also know that when the purpose of that standing charge is explained consumer views become more nuanced.[2]

Consumer Scotland has previously highlighted in our response to consultations on potential reforms to the standing charge[3] that piecemeal changes to bill structures are not the most effective way of protecting consumers. Many of the potential reforms to the standing charge could leave consumers worse off than they are at present, and risk redistributing the burden of system costs in a disorganised way. Add to that the radical changes the system is undergoing, and the potential for further evolution in the form of demand side flexibility, and we consider a comprehensive review is appropriate.

The launch of the energy system cost allocation and recovery review by Ofgem is therefore welcome and timely. It presents an opportunity to reconsider in a holistic way how system costs are passed through to consumers, to ensure this is done in as efficient a way as possible, and to make sure that the design of the charging system is fair and supports net zero ambitions.

In the following sections we provide feedback on the various parts of Ofgem’s call for input, and respond to some of the individual questions posed. Recognising the early stage that this work is at, our primary observation is in relation to how Ofgem takes this work forward. We consider it will be difficult to attempt to apply a set of principles to each individual cost component and to decide at that level what is the ‘right’ way to pass it through. Instead we recommend it would be more sensible and transparent to adopt a two-phased approach. The first should be bottom up and focus primarily on efficiency – how should a given cost category be recovered from consumers directly or indirectly in a way that assigns risk to the party most capable of managing it, and does not force different parties to pay for a system impact they have not created or contributed to? The second stage should look to apply outcomes-based principles – given the output of stage one, what adjustments need to be made to ensure that what parties are being asked to contribute is affordable and fair, supports net zero goals and economic growth, and is implementable in practice?

We would be happy to discuss the content of our response in further detail if that would be helpful, and look forward to contributing to this work as it evolves.

A changing system

It has been well-discussed that the energy system in Great Britain is undergoing a period of rapid and transformational change. The decarbonisation of the power sector and wider electrification of the economy hold the potential to reduce costs, improve energy productivity and economic efficiency, and strengthen Great Britain’s energy independence. In the short-term this change demands substantial investment in low carbon energy production and storage, and parallel investment in the energy transmission and distribution networks.

What has not happened in parallel is a holistic review to examine whether and how the cost recovery framework that has supported the operation of the energy system until now remains fit for purpose in a profoundly-changing environment. Programmes such as Ofgem’s Targeted Charging Review (TCR) and more recently its consideration of issues around the standing charge have examined this in part, but although ambitious in their own ways they are still relatively narrowly focused when viewed from a total system cost perspective.

This review presents an opportunity to change that. It is critical to revisit in a comprehensive way how system costs are recovered. There is otherwise a risk of adding further layers of complexity in charges, making piecemeal changes that favour or penalise different system users, delivering social or environmental policy through bills in an opaque way, and creating contradictory signals for consumers and businesses.

As the statutory advocate for consumers in Scotland, one of the foremost challenges we are concerned with is affordability. Consumers are under financial pressure, and energy bills are a significant contributing factor to this.[4] This is not just a current problem, however. We also need to consider the needs of future consumers. Decarbonising the energy system and supporting economic growth are among the best ways of helping consumers over the long term. In doing so we can reduce the extent to which future generations are exposed to climate-related price volatility and make the system more resilient to external shocks, most notably from global gas prices. Energy system charging arrangements can play a significant role in helping or hindering these efforts.   

The manner in which costs are allocated between and among parties has a significant bearing on both the totality of costs faced by each party, and the way in which the charges to recover those costs manifest on bills. For example, as part of the TCR, Ofgem placed liability for residual Transmission Network Use of System (TNUoS) charges and all Balancing Services Use of System (BSUoS) costs entirely on final demand. Previously these costs were shared between generators and consumers and as a result were paid both directly by consumers and reflected in the price at which generators offered their wholesale market output. By altering the allocation of costs, the TCR, all else being equal, therefore reduced the direct fuel cost component of consumers’ bills while increasing the variable BSUoS charge component, and changed the share of TNUoS residuals, previously recovered from generators, from one passed through to consumers in a volumetric way to a fixed charge. While in aggregate this may not have changed consumers’ total bills, and may in fact marginally decrease them in the long run, it has contributed to the significant increase in the standing charge, ultimately benefitting high users and harming low users.

Whatever energy system cost allocation approach Ofgem adopts should incentivise efficient investment and operational decisions by all market participants. This requires that both supply and demand side parties are appropriately exposed to the costs they impose on the system, and for suitable rewards to be available for those parties willing and able to optimise at a system level. However, where practical such rewards should not come at undue cost to those parties who are unable or unwilling to self-optimise. Accordingly, market design choices should aim to ensure that:

• risk is held by those parties best placed to manage it
• costs are borne by parties who have contributed to them
• action or inaction has fair costs and benefits attached
• the right signals are sent to the right parties at the right time

Consumers pay for the cost of the energy system. While the Cost Allocation Review cannot make categories of costs disappear, by following clear market design principles it can help to ensure the system is designed in as efficient a way as possible. Doing so will ensure the different parties have the right incentives to bear down on the costs they can control, reducing consumers’ final bills.

The nature of the energy system investment required to unlock the decarbonisation of the wider economy, and the impact of that investment on short-run marginal costs, means that the balance of costs that energy consumers face as billpayers is likely to change significantly, with fixed costs contributing to an increased share of the overall bill, relative to the system as it exists in 2025. As the economy electrifies, the charging base for each energy vector will also change. It is therefore important for there to be a sufficient set of incentives to support cost efficiency, creating an environment that encourages innovation and competition, and ensuring that all market participants are charged and rewarded fairly.

Fairness in energy cost recovery

Energy is an essential service, but the current level of debt and arrears in the gas and electricity sector suggests that it is one that has become unaffordable for many consumers.[5] This is particularly the case when considered alongside other the costs of other essential consumer products and services, which have been under significant inflationary pressure since 2020.

Despite gas and electricity prices receding from the highs of 2022-2023, the record level of indebtedness witnessed among domestic gas and electricity consumers in 2025[6] indicates that the financial support available to consumers has not been fully effective in avoiding the accrual and socialisation of additional costs. The expansion of the Warm Home Discount (WHD) and Ofgem’s attempts to create a Debt Relief Scheme (DRS)[7] are welcome.  However, with CPIH real-terms prices at the level of the default tariff cap remaining c. 25% above those seen in Summer 2019, and average non-domestic rates also substantially higher than they were at the equivalent point in real terms[8], there remains a broader policy problem to solve.

We therefore welcome Ofgem’s exploration of ‘progressive’ forms of energy pricing linked to income or wealth. Key to any steps in this direction will be the ability to effectively identify and reach those consumers in need of support. This has both a financial and an energy usage component, as some consumers with low income for instance may have high energy needs.[9] It is critical that datasets across the UK and Scottish governments (particularly HMRC, DWP and Social Security Scotland) are linked with energy industry data to make sure that any support can be targeted correctly. This is irrespective of whether the vehicle for any form of progressive measures is taxation or energy bills.

In recent years there have been questions about aspects of the costs recovered from energy bills, notably on environmental and social costs, and large business exemptions. The purpose of environmental levies is in essence to facilitate the energy transition and thus reduce future consumer costs and increase energy security. The purpose of social levies is to make the cost of energy cheaper for those who need support most, in essence helping to ensure universal access to energy. The exemptions provided to some larger businesses by exempting them from certain schemes and network costs are explained in terms of protecting economic growth, though this in practice passes costs from some larger businesses to domestic consumers and small businesses. In future, consideration should be given to whether these supports are currently being delivered in the most efficient and transparent way, and to more effectively communicate their purpose and benefits for consumers as a whole.

As well as considering how costs are recovered from different current groups of consumers, consideration should be given to the time horizon over which the significant investment in net zero-ready infrastructure is recovered. It will be important not to over-correct for past under-investment by placing unreasonable costs on current consumers. However, it is also important that the appropriate level of investment is made now, to avoid requiring future consumers to bear an unfair share of the cost. It is necessary therefore to have a clear view of the trajectory of both the costs and the long-term benefits of the net zero transition over the coming years.

In addition, the future of the gas system will be an important consideration for this work. With a shrinking base from which to recover gas system costs, and a system that is unlikely to be able to scale down at the same pace as fuel switching is likely to occur, there are a separate but related series of cost pressures facing gas consumers. While we consider gas should remain within the scope of this Cost Allocation Review for now, it may be that it needs to be considered separately subject to the outcomes of the UK Government’s work on the future of the gas network, which is expected to commence in the autumn.

One possible solution that Ofgem could explore is charging for energy system costs based on consumers’ capacity requirements. Currently, all households pay the same amount, regardless of the capacity demand they place on the network. This is potentially unfair on those households with a low system footprint, as they are in effect cross-subsidising those that have a higher impact on system needs. However as noted earlier, high use, including high peak use, does not necessarily indicate that a household is well off or capable of affording a higher energy bills, as some occupants may have, for example, complex medical equipment or other energy intensive infrastructure. So a capacity-based charging approach, if pursued, should be accompanied by broader measures to ensure consumers, particularly those in vulnerable circumstances, can meet their energy needs. While we think that capacity-based charging, we do not at this stage necessarily advocate in favour of it. Not least because it could have a negative impact on the incentives for consumers to install certain forms of low carbon technology, therefore harming the energy transition. This may be surmountable, however, by ensuring allowances or carveouts for EV chargers, for instance.  

The current debate on the perceived fairness of gas and electricity standing charges demonstrates that the concept of fairness is a subjective one. Ofgem research[10] confirms that consumers generally have low levels of awareness of the costs which contribute to an energy bill, the nature of those costs, or how they might change over time (all else being equal the fixed component of bills is likely to rise in the coming years). Armed with a better understanding of these factors, however, negative consumer sentiment was found to diminish.[11] It is therefore apparent that whichever approach Ofgem adopts with respect to energy system cost allocation, there is significant scope for better communication with consumers about the nature of cost drivers and the basis of charging. Indeed, faced with costs and benefits materialising over different timescales, without this articulation the arguments for the rapid transformation of the energy system in Great Britain risk being undermined, and consumer support for the wider transition to net zero could begin to fall away. While we do not necessarily want to see communications such as energy bills become longer and more complicated, it may be worthwhile exploring the extent to which suppliers, Ofgem and consumer groups could play a role in providing explainers of how energy bills are made up and why.

Inactive consumers

Notwithstanding the potential for market reform to sharpen the incentives on consumers to play a more active role in managing energy system cost efficiency, past experience of market participation suggests that many consumers are likely remain passive or dormant, with little or no interest in or capacity to seek out opportunities to be more fully engaged with the economic opportunities presented by a renewables-led electricity system.[12] Although it should be appropriately encouraged and incentivised, consumers cannot, and should not, be forced or required to become active participants in the energy market in order to achieve positive outcomes.

In the domestic sector, inactive consumers are currently protected from the potential to be penalised for their inactivity by the default tariff cap. However, the changing nature of price formation and the opportunities for suppliers and third party flexibility providers to drive consumer value through demand-side response (DSR) at times of scarcity or surplus could mean it becomes substantially more difficult to set an effective cap.

It is therefore critical that there is joined-up thinking across multiple strands of work – this includes the Cost Allocation Review, price cap reform, and DESNZ’ work on demand-led flexibility, default tariffs and social tariffs. By making sure there is a clear, amalgamated set of desired outcomes across these individual pieces of work there is an opportunity to ensure:

that consumers are rewarded for behaviours that help to reduce system costs

• those who can’t flex for reasons outside their control are not penalised
• that vulnerable and less well-off consumers receive the support they need to meet their energy needs
• that suppliers and other industry participants have space to innovate and compete

Areas for further research

As Ofgem’s work on the Cost Allocation Review is taken forward, we recommend that consumer research is carried out to explore consumers’ views of what they think a fair set of charging arrangements should look like. Careful thought will obviously be required to ensure this is pitched at the right level to allow consumers to substantively comment, but delivered appropriately it could help to inform some of the changes Ofgem and government might want to make moving forward. It would also helpfully illustrate areas where consumer views differ and where there may be misconceptions to ensure any future energy literacy efforts can take these into account. We have experience in the water sector in Scotland of deliberative research with consumers on the regulatory decisions in relation to charging, and would be keen to work with Ofgem to help shape the design of research in this area.

In the sections that follow we set out our response to some of the individual questions posed in the call for input.

Question 1: What other examples or evidence from relevant sectors or international energy markets should we consider as part of our review?

In 2020, a report for the European Commission[13] proposed a suite of six principles by which to assess energy system costs. This built on the Council of European Energy Regulators’ 2017 guidelines of good practice for electricity distribution network tariffs.[14] The six principles were:

• Cost reflectivity: Tariffs paid by consumers should reflect the network costs that they cause, as well as any benefits they bring to the network, so that tariffs are non-distortionary. Decisions by users concerning connection and use of the network should not be influenced by non-cost reflective tariff components.
• Cost recovery: DSOs and TSOs should be able to efficiently recover incurred operational and investment costs, including connection charges and system service costs through the network connection and access tariffs.
• Non-discrimination: There should be no undue discrimination among network users. Tariff determination should be done on the basis of network costs caused or avoided due to the network user.
• Transparency: the methodology for calculating tariffs should be transparent and accessible to all stakeholders.
• Predictability: Tariffs should be predictable for the network users to enable their estimation of incurred network connection and access costs, and to facilitate investment decisions. This does not mean tariffs may not change, but rules for determining these should be clear and tariffs predictable, as far as possible.
• Simplicity: Tariffs should be easy to understand as far as possible, in order to support transparency and predictability, thus providing the adequate information for network users to take their investment and operational decisions.

While there may be limits and conflicts in applying these principles, we believe they provide a good starting point for considering how costs in general should be allocated and recovered.

Ofgem has already highlighted several useful jurisdictions it has studied in order to understand how charges are structured elsewhere. In addition to these we consider it would be helpful to look at France and Portugal.

France

In France, Enedis utilises load-limiting through the functionality of smart meters. In some respects, Ofgem’s forthcoming trial of reduced standing charges for consumers who are able to reduce consumption during periods of system peak demand attempts to achieve a similar result – rewarding consumers for taking actions in the interests of the system, but retaining households’ firm access rights. One apparent disadvantage of the approach under trial is that it does not differentiate between flexible and non-flexible sources of demand, and could – as was seen in the first year of NESO’s Demand Flexibility Service (DFS) – incentivise vulnerable consumers to reduce their usage when this could have negative effects for their wellbeing. Many of these consumers are particularly sensitive to price, but less able to call upon flexible sources of demand and therefore more reliant on self-rationing in order to reduce their energy use at a given time.

Response fatigue may present a challenge to sustained demand response through behaviour change alone – smart infrastructure is needed to make it as easy as possible for consumers to engage and allow for automation in many cases. This could limit the audience for sustained flexibility responses to more affluent consumers, unless access to the necessary devices is broadened, via grant funding for instance. And if rewards are benchmarked against a personal baseline, the charges faced by consumers will show a poor correlation with the costs imposed by consumption during periods of system peak demand. In this model, consumers with higher consumption during periods of system peak demand could potentially face lower levels of fixed charges than consumers who place lesser demands on the system at peak.

Portugal

In Portugal, capacity charges are used as a means of targeting a social tariff, with discounts offered to eligible low income and vulnerable consumers who meet conditions relating to income and/or the receipt of certain welfare benefits, and subject to a contracted capacity of no more than 6.9 kVA. While this is conceived as a means of targeting bill support at a subset of domestic consumers who may otherwise face what could be considered as a disproportionate share of energy system fixed costs, we note that in principle, the manner in which capacity is currently used could render some low income consumers with high essential energy needs ineligible. This is a risk that would appear to increase as the transition to electrically powered forms of space and water heating and road transport progresses. In the event that capacity charges form a component of electricity network charges for domestic consumers in future, it is therefore likely that any attempt to replicate the Portuguese model to target energy bill support is likely to need to rely on the chargeable capacity or relevant households, with appropriate capacity bands and safeguards in place to exempt consumers with high essential energy needs from a proportion of their true capacity costs.

In addition to considering best practice from elsewhere in relation to how costs are recovered, Ofgem should also look at how other sectors and jurisdictions communicate the make-up and rationale for bills to consumers in a clear and transparent way. Ofgem’s own research confirms that domestic consumers generally have low levels of awareness of the costs that make up their energy bill. However, armed with a better understanding of these, negative sentiment is found to reduce.[15] It is therefore clear that whichever approach Ofgem adopts with respect to energy system cost allocation and recovery, there is significant scope for a greater articulation of the nature of these cost drivers, and the basis of charging. Doing so aids consumers’ understanding of energy and can help to maintain support for strategic net zero goals. The Swedish example already cited by Ofgem is one to consider in this regard. Other examples include Australian breakdowns of how tax is spent, and the financial services sector where detailed breakdowns of mortgages and other financial product costs are provided.

Question 2: What options for amending domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?

One of the advantages of this review is that it provides an opportunity to undertake a bottom-up appraisal of energy system cost allocation and recovery, and address those areas where cost recovery is poorly aligned with the driver of costs. By removing fixed costs from volumetric charges and volumetric costs from fixed charges, there is an opportunity to better reveal the scale and nature of costs and improve consumers’ understanding of how their money is spent, and allow better value judgements to be made about whether those costs are reasonable and fair.

With growing calls for intervention on affordability, it also allows for informed debate about which aspects of energy system costs should most appropriately be considered for reallocation (either among other billpayers or between billpayers and taxpayers), and the reasons for those choices. This inevitably leads to better targeted support, and holds the potential for fuller market participation to be maintained (for example, in electricity demand flexibility) than would be the case if a blanket or volumetric discount were to be provided.

As an overarching point, Consumer Scotland encourages Ofgem to adopt a rigorous and bottom-up approach to cost allocation between and among parties on both the supply side and the demand side in the first instance, interrogating each cost item on its own merits. We also consider it important that the nature of the relevant cost drivers is appropriately reflected in the allocation of costs across different consumers and between fixed and volumetric charges, since ‘hiding’ the true nature of some energy system and/or policy costs by allocating fixed costs to volumetric charges (or vice versa) does little to support transparency and can create signals that conflict with wider sectoral aims.

Only once costs have been appropriately allocated between and among parties and across fixed and volumetric charges can a meaningful and informed debate be had about the distributional fairness of the quantum of those costs which should be recovered from different types of consumers. Ofgem’s domestic and non-domestic consumer archetypes provide a useful framework by which these impacts can be modelled and trade-offs assessed, while the Green Book provides useful guidance on the appraisal and evaluation of relevant options. This process should also involve or be led by government, or at a minimum be endorsed by them, as they have the central role in making distributional value judgements.

Overall, market design choices should ensure that:

• risk is held by those parties best placed to manage it
• costs are borne by parties who have contributed to them
• action or inaction has fair costs and benefits attached
• the right signals are sent to the right parties at the right time

On this basis, the blanket use of block tariffs (Options A3(i) and A3(ii) in Ofgem’s list) in a renewables-led electricity system appears to be problematic, as charges are dissociated from costs, and incentives no longer align with the availability of rewards. While they could play an enduring role in aspects of network charging[16] and may align more closely with cost drivers in other energy markets (notably, heat), it is difficult to see how they would support cost efficiency without adding such complexity as to undermine the objective of a charging regime that is simple enough for it to be implemented efficiently, and sufficiently understood. Nevertheless, we think it is valid to give these options consideration in future phases of this work.

The Call for Input notes that there is a “lack of a clear link to aggregate volumes in the drivers of the infrastructure investment needed in the system, where capacity tends to play a greater role”. This suggests that a cost recovery model that is overly dependent on the recovery of energy system costs through volumetric charges (Options A1 and A2) presents a challenge to the economically efficient recovery of those costs. Analysis previously undertaken by Ofgem in relation to the recovery of the firm costs arising from the Supplier of Last Resort (SoLR) process and, more recently, in relation to Ofgem’s proposals to require suppliers to offer one or more low or zero standing charge tariffs, also highlights significant distributional impacts in such an approach. Though in principle and in theory, these issues could be mitigated through the provision of additional, billpayer or taxpayer funded affordability support to negatively affected vulnerable groups, this would do nothing to improve the transparency of energy system costs or overall energy literacy, as a proportion of energy system fixed costs would remain ‘hidden’ in volumetric charges. The increased volume risk faced by suppliers in relation to their ability to recover the fixed costs of the energy system they face to supply their relevant domestic customers is also likely to manifest as additional costs on all consumers.

While aggregate volumes correlate poorly with overall system costs, this is not true of the scale of peak demand. This is reflected in the current charging methodology for gas networks, where capacity charges are a feature in both transmission and distribution. However, though capacity charges (and for DUoS, exceeded capacity charges) currently play a role in electricity network charging for non-domestic consumers, domestic properties are treated equally regardless of their capacity requirements at times of system peak demand. Historically, there was logic to this approach as there was relatively little variation in peak demand between domestic consumers, and the data necessary to determine a given consumer’s impact on peak demand was not available. However, with the rollout of low carbon technologies such as EVs we may expect the former to change, and with the arrival of Market-Wide Half Hourly Settlement (MHHS) and with smart meters now in two thirds of British homes, the latter is no longer the case.

Although forward-looking charges already provide a price signal to demand customers to shift load away from periods of system peak demand, relatively few domestic customers are currently directly exposed. Typically, suppliers make assumptions about consumers’ demand and smooth costs over time. EVs, however, provide a strong incentive for consumers to seek out opportunities to limit their impact on system peak demand, and for suppliers to find ways to encourage them to do so, through more widespread uptake of time of use tariffs.  This also brings with it the potential for new demand peaks to be created outside the traditional weekday evening period. Should this transpire, the nature of demand driving the capacity requirements of the network is likely to be significantly different to today.

The Call for Input notes that placing “Greater emphasis on total capacity (maximum use) as a cost driver is [an] option [for cost allocation] […] that relates to the investment of the [electricity] system more directly”. However, it also highlights concerns that such a move could be perceived as a disincentive to the use of electricity to decarbonise heat, transport, and Industrial and Commercial demand. In contrast, electricity system cost allocation in Sweden is moving away from a consumption-based model to one more reliant on demand customers’ time-based capacity requirements, based on the view that a well-calibrated capacity-based charging model should incentivise demand flexibility and improve the economic efficiency of the electricity system.

In principle, there is no obvious reason why the same effects would not be seen in a well-designed capacity-based model in Great Britain. As the decarbonisation of heat and road transport progresses, significant differences in the demand-peak capacity requirements of different consumers are likely to materialise at scale. For example, consumers that use fuels other than electricity for space and hot water heating and/or who do not have access to their own EV charger are likely to have a materially different electricity demand profile than consumers more heavily reliant on flexible demand. Should electricity network capacity requirements come to be driven by the uptake of flexible demand, the current charging methodology therefore risks becoming distortive, insofar as it would result in a cross-subsidy between households with lower levels of peak demand and households with higher levels of peak demand. This would dampen the incentives for consumers to flex, increasing the need for network reinforcement and therefore system costs. More widespread use of capacity charges could help to overcome this issue by more accurately exposing demand customers to the long-run costs of their usage during periods of system peak demand.

Should Ofgem agree that there may be merit in exploring the further use of capacity charges as part of its review, as a general principle of fairness it may be desirable for any capacity charges imposed on domestic electricity consumers to include a floor – set at a level equivalent to typical baseline domestic peak demand plus an appropriate margin – below which a de minimis or zero capacity charge might apply. With appropriate data-sharing, consumers with high essential energy needs could be exempted from a proportion of capacity charges above this threshold. It may also be desirable to link any exceeded capacity charges imposed to the cost of procuring the interventions necessary to alleviate the relevant network constraint.

Taken together, such an approach could guarantee demand customers’ access rights, while incentivising consumers, suppliers and third party intermediaries to take actions to flex demand above the level of the floor in a way that reduces costs for all consumers. 

Question 3: How would changes to the underlying rules and approaches for allocating and recovering system-wide costs be expected to translate into the tariffs offered by suppliers?

Under any of the broad options for cost recovery set out in the Call for Input, to facilitate retail competition, and its intended consumer benefits, it is likely that energy suppliers will continue to require the freedom to design their tariffs in whichever way they consider best meets their commercial interests and customer needs. While recognising that some aspects of reform (notably those relating to the allocation of network costs between forward looking, capacity, and residual charges) could significantly influence the design of all or most retail tariffs, we consider the default tariff cap is the area most likely to be directly impacted by any reforms to cost allocation and recovery that Ofgem decides to implement upon the conclusion of this review . It is, for example, understood that to manage risk, many suppliers have amended their hedging strategies to follow the model designed by Ofgem for the purposes of setting the relevant allowances within the cap. Changing the way in which charges are passed through the system to different parties may change this.

In general, our view is that factors such as the smart meter and HHS rollout, combined with greater low carbon technology take-up and the means and incentives to flex demand that they provide, that will be the primary driver of tariff innovation by suppliers in the coming years.

It is important that this work on the Cost Allocation Review takes account of work happening elsewhere – eg Ofgem’s own price cap reform, and DESNZ’ work on demand-led flexibility and default tariffs.

Question 4: What options for amending non-domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?

In principle we consider the first, bottom-up, phase of this work should be carried out in a way that applies equally across domestic and non-domestic markets. Only once this is complete should consideration be given to the assignment of costs across different types of consumer. Any cross-subsidies or exemptions for one or the other type of user should be transparent.

Question 5: Should we consider alternative methods for splitting network costs between domestic and non-domestic consumers? If so, what methods should we consider and why would these alternative methods benefit consumers?

The Call for Input sets out that the current allocation of network costs between domestic and non-domestic consumers is based on the respective proportion of demand in each sector, though the specific measures of demand vary between gas and electricity. Currently, electricity network costs are apportioned based on the aggregate annual volume of electricity consumed by domestic and non-domestic consumers, respectively, as a proportion of total demand. This results in c. 40% of electricity network costs being assigned to domestic consumers, and c. 60% being assigned to non-domestic consumers.[17] However, with capacity charges already forming a central part of gas network charging at both transmission and distribution level, the approach to apportioning gas network costs between domestic and non-domestic consumers is based on the respective aggregate peak capacity requirements of each sector, as measured in peak day kWh.

Despite forming the basis for electricity network cost allocation between sectors, the Call for Input notes that there is a “lack of a clear link to aggregate volumes in the drivers of the infrastructure investment needed in the system, where capacity tends to play a greater role”. This suggests that the current methodology used for cost allocation between domestic and non-domestic consumers is less well aligned with the relevant cost drivers in electricity than is the case in gas. Although the Call for Input goes on to note that placing “Greater emphasis on total capacity (maximum use) as a cost driver is [an] option [for cost allocation] […] that relates to the investment of the [electricity] system more directly”, it also highlights concerns that such a move could be perceived as a disincentive to the use of electricity to decarbonise heat, transport, and Industrial and Commercial demand. It is however notable that in Sweden, cost allocation is moving away from a consumption-based model to one more reliant on demand customers’ time-based capacity requirements, having taken the view that a well-calibrated capacity-based charging model should incentivise demand flexibility and improve the economic efficiency of the electricity system. It may therefore be worth exploring the opportunities for and challenges to the adoption of a similar model in Britain.

Question 6: What do you think of the five criteria we have proposed to assess and the descriptions we have provided for their scope? How should we balance the trade-offs between these?

While we agree with the five principles that Ofgem have presented, the way in which they are applied is important. We consider that some of these principles are better understood as the types of outcomes to be achieved for the energy system, rather than a set of criteria that can be applied to individual cost components. We consider they are best used as part of a second, top-down phase of this work, only after a bottom-up exercise to design a nominally efficient set of cost allocation and recovery arrangements has been completed.

Question 7: What evidence should inform our options assessment?

We would recommend carrying out research into consumers’ views of how they think charges should be structured. While challenging to pitch at a level that allow meaningful consumer input, our view is that this would be valuable to provide a basis for future policy changes Ofgem might propose. We would be keen to engage with Ofgem to discuss potential research in this area in further detail.

Ofgem should also ensure that data specific to Scotland is sought out as this work is taken forward. In Scotland there are a greater proportion of consumers that are not on the gas grid, and factors such as climate may mean that there are different impacts here than elsewhere. The same may be true of other regions. The Scottish Housing condition Survey is one such useful source of information.

Question 8: What are the main trade-offs between our proposed assessment criteria? What are the main positive interactions?

Ofgem should ensure that consumers’ interests are at the heart of this work. Of the five principles proposed by Ofgem, ‘fairness’ is the one that speaks most directly to consumers interests. While this is fine, and we are broadly content that the principles on the whole are sensible, we would not want to see the criteria used in a way that distracts from the purpose of this work as a whole, which is to ensure that the cost allocation and recovery arrangements are designed for the benefit of consumers. 

Question 9: Do you agree we should consider impacts up to 2035?

Yes, in general we consider this to be a reasonable timescale as any data and beyond this point is less likely to be reliable. However, it may be worth giving some consideration to longer-term impacts on the gas side. If the current rate of electrification continues and even accelerates then we will in the medium term see the fixed costs of the gas grid recovered from a shrinking pool of consumers. While not necessarily the responsibility of the Cost Allocation Review to resolve this problem it could helpfully shed some light on this issue, including the point at which it is likely to become critical

Endnotes