Market Insight Report Non-commodity costs update

With wholesale energy costs falling for much of 2023, on average businesses looking to renew or sign new energy contracts have seen lower prices than in 2022.

However, a significant proportion of energy bills is made up of non-commodity costs (NCC), sometimes also referred to as third party costs. These costs have a large influence on customers’ bills and could affect affordability.

NCC cover a range of expenses including recouping the costs for delivering gas and electricity through the national grid and local distribution systems to end users. They also include charges for providing subsidies to renewable generation and to ensure there is sufficient and steady supply of energy during peak times.

In this section of the Q3 report, we will examine what has happened to a representative energy cost stack over the last four quarters. Then we will highlight new developments for a selection of NCC and discuss the potential impact of these on customers’ bills.

Non-commodity costs are rising

Subsidies to support renewable generation are solely levied on electricity bills rather than gas bills. Also, the costs associated with maintaining and balancing the electricity system are higher than the gas transmission network. As a result, NCC are heavily influenced by electricity NCC.

That said, let’s look at the cost stack for gas and electricity in Q3 separately. For gas, there are several observations worth noting. The commodity element (wholesale costs) remained at 81% for the second consecutive quarter ¹. Consequently, the non-commodity component remained also unchanged at 19%.

Business gas and electricity cost stacks Q4 2022 to Q3 2023

Non-commodity is divided between metering and network charges. These costs declined by the same percentage quarter-on-quarter (QoQ) resulting in an identical configuration as the previous quarter: 3% and 16% respectively.

The decline in network charges was primarily driven by an 18% fall in National Transmission System (NTS) costs. These charges cover the expenses related to the physical movement of gas from the point of entry to interconnectors, where gas flows into local distribution networks ².

Lower demand for gas in the summer months including lower demand for electricity generation, contributed to the decrease in NTS costs. On 1 October 2023, National Gas Transmission released the final NTS charges for the next year. This was set at 0.0533 p/kWh, a 43% increase from the previous year ³.

Turning our attention now to a representative business electricity cost stack, this shows the ratio between commodity and NCC moving from 58/42 in the previous quarter to 54/46 in Q3.

 QoQ fluctuations underpinning the cost stack movements

• Wholesale (commodity) costs declined by 11% decline (for more detailed insights, please see the wholesale section)
• Environmental charges rose by 8% driven by a 53% increase in Contract for Differences (CfD) charges
• Network costs increased by 3% driven by an 11% increase in Distribution Use of System (Duos) charges
• Metering costs saw a 2% increase

Let’s look at the latest developments for a selection of NCC.

Environmental and Social Schemes

Renewables obligation (RO)

The renewable obligation scheme is a government initiative requiring electricity suppliers to procure a proportion of their supply from renewable sources. These encompass wind, solar, hydroelectric power and other sustainable sources. Energy suppliers must submit renewable obligation certificates (ROCs) every year as proof of this mandate.

The scheme opened in 2002 in the UK ⁴ however has since closed in 2017. The government’s main scheme for supporting large scale renewable generation was replaced by Contracts for Difference (CfDs), as the RO scheme is set to close in March 2037.

In 2011, the government first introduced Fixed Price Certificates (FPC) which was set to commence from 2027. The intention for FPC was to address volatility arising from ROCs prices, especially as projects transitioned to CfDs. However, this volatility is set to emerge in 2030s, putting the FPC initiative on hold.

Non-commodity costs in Q3 2023

In July 2023, the government issued a call for evidence emphasising the advantages of the FPC, including price and revenue predictability ⁵ and mitigating the risk associated with supplier payment default and mutualisation ⁶. The call for evidence closed on 9 October 2023.

Contracts for Difference (CfDs)

CfDs is the government financial scheme between low carbon electricity generators and The Low Carbon Contracts Company (LCCC) (government-owned company) . CfDs provide support for low-carbon electricity generation ⁷.

According to the Department of Energy Security and Net Zero (DESNZ) CfDs “protect consumers from paying increased support costs when electricity prices are high” ⁸. Instead, these costs are absorbed through government funding shielding consumers from the volatility or electricity market prices.

As wholesale prices have remained relatively low this past quarter, it is expected that CfD payment to the electricity generator will rise to meet the fixed price agreed in the contracts resulting in higher energy costs for consumers.

 The LCCC determined Q1 2024 ⁹

• Interim Levy Rate (ILR) is £4.35/MWh
• Total reserve amount (TRA) is £559m

This is a 28% decrease in the ILR and a 29% increase in the TRA.

Energy Intensive Industries (EII) Levy

The EII is a compensation scheme that is part of the UK governments British Industry Supercharger (BIS) initiative. In essence, the BIS is a suite of strategic measures designed to promote British energy intensive industries towards enhanced sustainability and competitiveness both nationally and internationally.

Industries such as glass manufacturing, plastic products production and steel manufacturing are likely to see the greatest impacts.

According to DESNZ the BIS will include the following measures… ¹⁰

• 15% increase in EII levy exemption, now 100% exemption on ROs, CfDs and Feed In Tariffs ¹¹
• 100% exemption from Capacity Market charges ¹²
• EII Network charging compensation schemes to provide additional support and stability for EII parties contributing to their sustained competitiveness

Implementation of the EII is unlikely to be in place until at least Q2 2024.

Network Charges

Balancing Services Use of System (BSUoS)

National Grid Electricity System Operator (NGESO), National Grid Electricity Distribution (NGED) and UK Power Networks (UKPN) ¹³ have announced the arrival of new smart technology; Megawatt (MW) Dispatch service.

The advancement benefits both industry stakeholders and consumers.

Notably in the following ways…

• Cost Efficiency: MW dispatch service offers a cost-effective alternative to the pre-existing balancing mechanism constraint management process.
• Inclusivity: allows for greater participation and engagement therefore customers can benefit from its operational advantages ¹⁴.

Capacity Market (CM)

Following the implementation of phase 1 in June 2023, DESNZ has initiated phase 2 starting with a consultation of changes to the CM ¹⁵.

The primary objectives are as follows…

1. Enhance UKs energy security: support the resilience of energy infrastructure ensuring uninterrupted supply
2. Enhance scheme administration: streamlining processes, improving transparency and ensuring equitable participation
3. Align with net zero objectives: incentivising low carbon energy sources while reducing reliance on high carbon options

Transmission Network Use of System (TNUoS)

Ofgem, the regulator of Great Britain's electricity and gas markets, have appointed a dedicated task force to examine the strategic reform of TNUoS charges with special focus on investment and consumer impact.

In a latest report discussing reform options by Cornwall Insight ¹⁶, they propose two measures..

• Demand incentivisation: new credit scheme to stimulate demand connection in specified geographic areas
• Energy storage specific tariff: created to understand the costs and benefits of grid connected storage
  

The Ofgem task force is set to implement changes from 2025-2026.

Since the Targeted Charging Review came in, the residual element of DUoS (2022) and TNUoS (2023) has moved away from Unit Rates and into the Standing Charges, resulting in significant increases in customers' Standing Charges (and small reductions in Unit Rates).

The level of the increase depends on which consumption/capacity band a site has been designated by the networks.

Other changes coming in 2024 and beyond

New industry charges being introduced…

1. Hydrogen production levy: to support low carbon hydrogen production and set to commence in 2025.
2. Industrial Carbon Capture/Carbon Capture, Usage and Storage (CCUS): to support deep decarbonisation of industries that have no alternatives such as cement and chemicals industries.

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