The capacity charge conundrum
Should customers who consume energy at peak times pay more? It’s a question Ofgem and Citizens Advice are taking directly to billpayers - presenting a series of new models for how energy is charged. Utility Week looks at the options on the table and whether they will provide customers flexibility or frustration.
The capacity charge conundrum
Should customers who consume energy at peak times pay more? It’s a question Ofgem and Citizens Advice are taking directly to billpayers - presenting a series of new models for how energy is charged. Utility Week looks at the options on the table and whether they will provide customers flexibility or frustration.
It’s a familiar conundrum. How can customers be meaningfully incentivised to change when they use electricity to increase system efficiency and reduce costs, without making it unnecessarily difficult for them? That is the challenge at the heart of the debate over capacity-based standing charges.
The bigger picture is to make electricity prices better reflect the cost that customers impose on the system at different times. One way to do that is to make those who use the most electricity pay a bit more if they’re using it in a way that puts greater demand on the grid - in other words, capacity charging.
Some countries have already turned this theory into pricing structure, including France, Norway, Italy, the Netherlands, and, to some extent, Spain and Slovakia, which use a mixture of capacity and volumetric charges.
Here in the UK, Ofgem and Citizens Advice have now put forward three types of capacity charges that could work for domestic energy customers. They will be put to customers through a series of Citizens Panels held across the country in October.
Under the first option, a customer’s electricity consumption between the 4pm to 7pm peak period would determine how much standing charge they would have to pay. Higher usage means higher standing charge.
The second type of capacity charging would look at a customer’s energy consumption in all half-hour windows over a full 12 months. This means a customer with a very high usage in any half hour of the year could pay a higher standing charge even if their average consumption is low.
The third option would base the standing charge on a customer’s total annual consumption. The higher the total consumption, the higher the standing charge.
Beyond the capacity-based charging, Ofgem and Citizens Advice have also included two other options: to continue with the status quo of having both unit rates and standing charge as they are; and to have a lower standing charge tariff with higher unit rates.
The 4 pm - 7 pm peak time is likely to be the best option for capacity-based standing charges depending on the exact design, according to Mark Williams, an electricity market specialist who recently joined the Heat Pump Association UK after serving as a senior adviser at EDF Energy.
He says: “It's the only one that really maintains the logic of what we are trying to achieve, which is to encourage some shifting of demand, and reflect the underlying economics of the system. It's in that peak window that you see the highest network usage and greatest need for firm capacity and system stress events.”
If done right, he thinks this model would be the best way to bring down unit rates as close as possible to marginal wholesale price, which would “really encourage” electrification. “Ideally, we would rather see policy costs come out of general taxation rather than energy bills, but this could be a good alternative if that's not possible."
Whereas, he says, the second option of a maximum half-hourly based capacity standing charge would have the “potential to be quite damaging”. For instance, if a customer "rationally and sensibly" turns on their EV, heat pump and battery to soak up all the cheap excess energy at 3am, they would be penalised under this model.
In this case, he says the customer would "be hit with a massive standing charge because they might have put their demand up to 15 kilowatts at its highest point”, adding: “It would completely undo various different flexibility signals. It would really hit people who have invested in electrification, so that would be really concerning".
He adds that this model would disincentivise people from participating in time-of-use (ToU) tariffs, particularly because they would send the “opposite signal to this capacity-based charging”.
For example, ToUs might increasingly send a zero or negative price signal to customers in the middle of the night for their electricity if there are abundant renewables on the system. While in such situations, customers should try and use as much electricity as possible, Williams argues that a capacity-based standing charge would discourage the customer from doing so. “It would leave them with a really high standing charge for responding to the signal from the flexible tariff. That's something that needs to be avoided.”
Meanwhile, he simply rejects the last option of total annual consumption-based capacity charges model for it doesn’t make any difference to customers. “It’s just taking a unit rate cost and spreading it across a year's standing charges,” he adds.
For instance, if a customer consumes an extra 1,000kWh costing them £100, that could either be paid at a 10p per kWh unit rate or could add that £100 on to the standing charge. Either way, Williams says, “It's exactly the same money being recovered for the exact same behaviour. I don't think it would really make any difference ultimately.”
Cost-reflective standing charges?
Marcia Poletti, head of European system change at Octopus, makes a similar argument to Williams that the “only option which could be somewhat acceptable is the one which focuses on peak-time consumption over the evening 4-7pm. This reflects expensive system costs and encourages customers to stay away from that”.
However, she tells Utility Week that “even [the best proposed option] is a really poor signal because we want cost-reflective signals rather than a blanket one.”
She explains that rather than applying a high standing charge across GB customers with high electricity usage during the 4-7pm peak time, charges should reflect the cost of serving demand in different locations. For example, she points out that if Scotland has excess generation between 4-7pm, that cannot be transported elsewhere, customers in the region should be encouraged to increase their electricity demand rather than being penalised with high peak-time charges.
Previously, Energy UK has taken a similar view in its response to Ofgem's cost allocation consultation, calling for cost-reflective pricing that varies by location.
“Energy UK would therefore encourage Ofgem to explore using an ex-ante subscription-based peak capacity charge for consumers, similar to what is currently used in France. Unlike in France, these charges could vary by location, ideally being lower the closer demand is to the main sources of generation,” it added in its consultation response. “Ofgem must coordinate the cost allocation review with the intention of making demand-side network charges more locational.”
The trade body’s head of retail policy, Ed Rees, tells Utility Week that the latest proposed capacity-based charges signal a move back to the Triad system. This was a mechanism that encouraged large energy users to reduce consumption during the three highest half-hourly periods of electricity demand on the transmission network during winter. It ended in February 2023.
“The Triad was a signal to reduce peak demand on the grid,” Rees adds, arguing that it was ultimately dropped because it allowed some customers to avoid their share of network costs.
“There’s only a narrow segment of customers who are technological energy geeks, who have the kit and the enthusiasm to manage the complexity.””
Marcia Polleti, head of European system change, Octopus
Unnecessary complexity for customers?
While the debate so far has focused on which option out of the Ofgem and Citizens’ proposed list is the best, Poletti thinks that the more important question is whether the list itself should be reconsidered. She says that if these options are presented to regular customers, who aren’t necessarily well versed in the GB electricity market, it could create complexity in their customer journey.
“Ofgem might want to consider the mechanism by which information is conveyed to customers, because there’s no need to hand that complexity to customers to manage, and have them tracking their usage over hours or days or over peaks,” she warns. “There’s only a narrow segment of customers who are technological energy geeks, who have the kit and the enthusiasm to manage the complexity.”
She adds that if customers are made responsible for shifting their electricity usage out of the peak hours or out of high standing charge period, they might “become unnecessarily worried about capacity charging and this might have a negative effect on how they interact with electricity in their home,” she adds. “They might decide, ‘I've got to turn the heating off in the peak time, or I mustn't put the heater on because I might go over my capacity charge’. We might get customers, particularly vulnerable customers, who are often coping with a range of other things, trying to also manage their electricity and their heating without creating any value for the system.”
Moreover, she argues that suppliers are already managing such price signal complexity for consumers through various dynamic and ToU tariffs. “Currently these options being explored by Ofgem and Citizens Advice’s don’t give customers [that] choice. If we want to ask customers how they want to be charged for electricity. I think the choice should be the right question to ask to customers,” Poletti says.
According to her, the questions that should be asked to customers are:
1. Would you like to have more complexity in the way you are charged for your electricity, if it made it cheaper for you?
2. Would you like to have your supplier have the option of creating simpler tariffs for you that would lower the cost of electricity?
3. Or would you like to be able to make a choice between the two – something simple and lower cost, or something more complex and lower cost.
“The key thing would be to clearly articulate the problem that Ofgem and Citizens Advice are trying to solve and then outline how the tariffs they proposed will encourage customers to change their behaviour,” she adds.
Another industry source tells Utility Week that, “If I was a customer and I was brought into a focus group to talk about this capacity-based standing charges, I’d be losing my mind”.
“You have got to make sure that the options proposed are considering a world where customer behaviours are automated; controlled either by supplier or third-party intermediaries. Currently, we are on the path to automation, but if we radically change how we pay now by putting the onus on the customers, it’s a step backwards,” they add.
“So, my starting off question would be if we carry on as we are what is going to go wrong? Because moving off a current path in a radical way is going to be difficult, so you’d want a pretty compelling reason to engage in that pain,” they argue.
Mary Starks, vice president of regulation, policy, and risk at Ovo Energy, also backs this concern. Starks tells Utility Week that “customers shouldn't face hard-to-understand price structures and complicated bills.
“Suppliers are best placed to absorb system signals in the background and translate them into simple, customer-friendly propositions like OVO's Charge Anytime EV plans, where drivers pay a predictable rate, plug in when they get home, and our automated technology does the heavy lifting."
Another energy supplier also raises similar concerns saying that “Any standing charge reform needs to be understandable, viewed as fair by customers, and avoid disproportionately affecting those who are least able to respond to price movement.”
They add that technologies that help customers avoid peak time energy usage should be made accessible to all households, “otherwise there is a risk that the cost for standing charges will inadvertently shift towards lower-income households who cannot afford these options”.
Commenting on these concerns, Tom Lowe, principal economic regulation specialist at Citizens Advice, says: “We look forward to hearing what consumers from all backgrounds across the country think about the different options for reform, and what people consider most efficient and fair.”
With household energy bills set to reach a three-year high in October, the question of how to reduce costs is becoming increasingly urgent. The conundrum over capacity-based standing charges may be complicated, but it could form part of the answer.
And for those involved in the conundrum, the pressure to solve it is becoming harder to ignore.
