Degrees of separation: the future of DSOs

Earlier this year, Ofgem issued a call for input on the future of local energy system institutions in which it proposed four possible models, ranging from the internal separation of distribution system operation (DSO) functions within distribution network operators (DNOs) to the creation of a series of regional system operators. The regulator is now evaluating the responses before issuing its conclusions early next year.

Utility Week previously explored the views of DNOs on the proposals. We now take a look at what others have been saying.

“We are, in the ED2 price control process pushing very, very hard for a focus on effective DSO activities, whether they’re separate or not,” says Rachel Fletcher, director of regulation and economics at Octopus Energy.

“What really matters to us is that the DNOs are making much better use of flexibility than they have historically, and that the right incentives are in place to encourage DNOs to consider flexibility first before traditional reinforcement.”

Octopus has been at the forefront of the development of domestic flexibility, launching Britain’s first half-hourly domestic energy tariff – Agile Octopus – and winning contracts for more than 150MW of capacity in recent tenders by Western Power Distribution and UK Power Networks.

Fletcher says the “real prize” on offer from fundamental institutional reform is in the facilitation of flexibility markets: “The one thing we should seriously consider is creating a single market platform that would deliver flexibility both at a national and local level.

“So rather than each DSO having its own local market and using different platforms to procure and dispatch services, and then on top of that the ESO (Electricity System Operator) having its own platform, why not create a single market platform?”

“There’s obviously a lot of work going on in the Open Networks project to harmonize the DNOs flexibility specifications,” she acknowledges, “but we don’t have anything close to harmonization. And on top of that, as an industry, the skill set that we’re most scarce in is digital and data management.

“The path we’re going down at the moment requires seven plus teams with those skills so why not as an industry create a single market platform?

“Why not start asking the DSOs and the ESO to work together on a single market platform rather than using legislation to change roles and responsibilities in that way?”

This idea of separating off market operation fits most closely with the last of Ofgem’s four proposed models, with DSO roles being dispersed between organisations, depending on which would be best suited to fulfil them.

On a related note, Fletcher questions whether the Energy Networks Association (ENA), which is leading the Open Networks project, is able to deliver the changes that are needed: “I’m sure the ENA are doing their very best in running the Open Networks project and we are thankful for all the progress made so far, but as these local markets develop and grow there is a more fundamental question about whether a trade body is the right organisation to drive and govern progress.

“They lack authority over their members so there’s a risk that things move at the pace of the slowest whereas Ofgem have got the ability to crack the whip a bit.”

“We think there’s probably quite a lot that could be done with a bit of leadership from Ofgem in terms of forcing the pace of some of the things that have been talked about for years within the Open Networks programme, including issues of primacy between the ESO and the DNOs,” she adds.

“At the very least, they could be upping the pace on the standardization of flex products and the transparency of those requirements.”

The search for consensus 

Fletcher says discussions around primacy between the ESO and DNOs have been going for about a decade and are still yet to be resolved: “Some of these issues you could discuss until the cows come home and I’m not sure you’re going to reach consensus across the industry on these things. At some point, you need the regulator to step in and say, this is just the way it’s going to be.”

She welcomes Ofgem’s plans to introduce ex ante incentives around DSO functions for the ED2 price controls beginning in April next year, but says “what we’d really like is continued regulatory attention on performance within the price control period, and for Ofgem to be convening, annually perhaps, meetings between the DNOs and relevant stakeholders to discuss whether we’re getting the progress that is really needed.”

In addition to market operation, Fletcher says another function for which there may be case for some form of separation is around network planning, in particular in relation to decisions over the future of gas distribution networks.

Although Ofgem’s third model envisioned the creation of a series of regional system operators that would take on some or all of the DSO functions as well as cross-vector planning roles, Fletcher said the call for input failed to address this issue directly.

“It does feel to us that in that area of planning, and that function of planning, there is a need to at least rethink it,” she explains. “A, there’s a good argument for having more separation between the network owner and the network planner, and B, there seems to be quite a lot of value in thinking about who has got the authority to make these multi-vector decisions and how these decisions are made.

“A decision about switching off gas, I’m not sure you would ever just hand over to an energy planner because that feels like quite a political decision. But you could see how if you had a local energy planner – a local FSO (Future System Operator) equivalent on the planning side – then they might be able to provide technical advice to a political decision maker, for example, or that could all sit with the FSO at some point down the line.”

Fletcher says the changes she would most like to see could be achieved with or without the wider separation of DSO functions from DNOs, which to a certain extent she regards as “putting lines on a piece of paper.”

Having said that, Fletcher does think this could still be helpful “because when it comes to making the decision about whether your requirements are met through copper or they’re met through flexibility in one form or another, a neutral body – i.e. not the one that is owning – does seem to be a good way forward.”

She continues: “We’re already beginning to see some different degrees of separation within the DNOs and that direction of travel feels almost inevitable.”

Above all, Fletcher wants things to move quickly and does not want to see a repeat of the years-long saga of the separation of the ESO from National Grid, which has become a “running sore”.

She says if people continue to raise potential conflicts of interest as an issue then “you’d be better just biting the bullet and saying, let’s just do it, because otherwise we’re constantly going to be talking about this thing.”

Dr Helen Poulter, a research fellow at the University of Edinburgh focussing on local energy systems governance, agrees with Fletcher that market operation should be separated out from both DNOs and other DSO functions: “The bit I really struggled with in the call for input is why on earth the DSO is also the market operator.

“I think that the DNOs can become DSOs – they do system operating anyway, they do system planning anyway – as long as they’re told to think about flexibility first, but that can be put into codes, that can be put into incentives. That’s not a difficult thing to make them do.”

She says it makes “zero sense” for them to also act as market operators: “It could be done as part of the new FSO. If you go down the route where you have regional system planners, each of those could perhaps have a regional market. You could have either a few regional markets dotted around, or you could have it just from a central platform very much like it is at the moment with the wholesale market.”

Local variation

One issue she notes is the non-alignment of DNOs’ licence areas with national borders: “If you think about where the DNOs are based, you’ve got companies like WPD (Western Power Distribution), which is partly based in Wales and partly in England, and Wales have got a slightly different net zero strategy than England. The same thing happens in Scotland. You’ve got SSEN (Scottish and Southern Electricity Networks), which is in Scotland and southern England.”

“Having something done regionally or centrally for a distribution market makes a lot more sense than have a DNO which is trying to operate between these different markets, different rules, different focuses.”

“I think giving them more work, it becomes more expensive, and then that’s the customer paying yet again,” she adds.

More broadly, Poulter says there is enormous locational variation in net zero policies, not just between the different nations in Great Britain but also between urban and rural areas and between different local authorities, with those in larger cities often taking more ambitious positions.

She says there is a need for greater coordination in this regard and therefore prefers the regional system operators proposed in Ofgem’s third model: “What needs to happen really, at the local level, is we need a local flexibility market, we need regional system planning, we need government to start actually putting money into local councils so that they can come up with their local area energy planning, and all this stuff needs to happen.”

Poulter is least enthusiastic about the first model, in which there would be internal separation of DSO functions within companies. She says this is the “easy” option as it wouldn’t require any legislation but also wouldn’t solve the problems that need to be addressed: “What you need is certainty. And certainty doesn’t come from just doing something quickly. It comes from everybody knowing exactly what is going to happen and when.”

Maxine Frerk, an associate at the think tank Sustainability First and the chair of the Open Networks stakeholder group, is sceptical about the need for separation of DSO functions, asking: “Is it yet clear that we really need to separate out the DSO in a very strong way from the DNO?”

She continues: “Clearly for the ESO it’s been absolutely right to create an independent system operator but whenever you put those hard lines in it doubles the costs and makes everything more complicated so one shouldn’t be rushing to separate out the DSO unless you really feel that there is a problem with conflicts of interests.

“UKPN (UK Power Networks) have clearly decided that for them that’s the right step but other DNOs have argued very strongly in their business plans that there are benefits of remaining integrated.

“I think there’s a case for another layer but that’s about the local authorities and the local bodies joining up with the gas distribution networks and the DNOs.”

Frerk said this could be done without “going the whole hog” and fully separating DSOs and DNOs.

Conflicts of interest

Although not the only motivation, one of the key drivers behind Ofgem’s proposals was a concern over conflicts of interests between network ownership and system operation roles. Frerk acknowledges this is a valid concern but says: “I think they might be overstating it and it’s about understanding what the downsides are and how far you push it.

“You can tackle these things with varying degrees of solutions but it needs to be proportionate to the scale of the problem. Equally, making sure from the beginning that you’ve got something that could be split off when you get there makes sense because there are quite a lot of costs of unpicking National Grid when all the systems are intertwined.”

She questions whether Ofgem has currently got the bandwidth to start undertaking such a task at the distribution level as well: “Ofgem’s got so much on its plate. Is it really going to take on a big battle with the DNOs over this? I don’t know.

“I would have thought they are going to want to see how things develop so they’ve got the evidence to justify it if they want to do something so I wouldn’t have thought that’s going to happen a quick speed. They kick off all these balls that they haven’t got the resources to run with if you look at how much they are trying to do at the moment.”

Frerk believes the regulator’s concerns over conflicts of interest can be adequately addressed through rules, for example, requiring DNOs to put all of their projects to tender and assess flexible solutions using the common evaluation methodology developed as part of the Open Networks project.

Plus, she adds: “At the end of the day, we do still need to do some reinforcement. It’s not that flexibility is going to solve absolutely everything.”

Like Poulter, her biggest concern right now is enabling greater coordination with government, in particular local authorities, which may lack the resources and capabilities to develop comprehensive local energy plans and get fully involved with network planning.

Although Ofgem could help directly by granting DNOs the funding to help local authorities, Frerk says some of this issue is outside of its remit. She says the regulator therefore needs to be talking to the relevant government departments. However, says there is “no evidence that Ofgem has been talking to the other parts of government about what needs to happen.”

“The problem is that you need joined up government, not that you need a fragmented DNO,” she concludes. “Joined-up government is always hard to achieve but that has to be key to getting net zero delivered at a local level.”

Duncan Sinclair, a partner at the consultancy Baringa, likewise believes the case for the full separation is not yet clear, although it could make sense to hive off specific DSO functions: “A lot of the clamour for full ownership separation of DSOs seems to originate from nervousness about DNOs’ roles in operating markets.

“If independent ownership is deemed important, a nearer term objective could be to separate out the market operation function, rather than the full DSO.”

He says the same could also be said for coordination with national and local government and other network companies: “That doesn’t necessarily require a full blown regional system operator subsuming the DSO role, but a well-resourced new body clearly tasked with delivering effective local area energy plans in collaboration with the DSOs and other key stakeholders.”

Sinclair says some of the options presented by Ofgem are “quite radical” and would be “challenging to implement in the near term, not least given all the other reforms going on.”

For example: “One of the challenges facing Ofgem would be how to remunerate and incentivise a fully independent DSO.  It seems that we would need evidence from several years of operating successfully under functional separation first before that step could be considered.

“Working out who is ultimately responsible for keeping the lights on between an independent DSO and the DNO is another knotty problem.”

Even if Ofgem ultimately rejects these more radical options, Sinclair suspects one of the regulator’s motivations may have been to “move the centre of gravity of the debate and challenge the thinking of the DNOs who are less ambitious in this space.” None of the models it has put forward represent the status quo.