More joined up?

In her latest column exclusively for Utility Week members, former Ofgem executive Maxine Frerk casts her eye over the regulator’s decision on the methodology for the electricity distribution network price controls.

Amongst the deluge of energy policy announcements in the last few weeks, Ofgem put out its decision on the Sector Specific Methodology for RIIO ED2.

Making clear this was all joined up, there were various references to the prime minister’s 10 Point Plan, the Climate Change Committee (CCC)’s 6^th Carbon Budget and the Scottish government’s Climate Change Plan.

When I led RIIO ED1 we kept government well at bay on the basis that network regulation should be outside political influence. But given the challenges of net zero it feels absolutely right that there should be closer working, even in this area.

The recently published ministerial letter setting out the government’s priorities as context for ED2 helps make that process more transparent. But how aligned is the thinking in reality?

My reading of the ministerial letter is that government has been encouraging Ofgem to be more supportive of strategic investment. In particular the letter highlighted the importance of appropriate investment to enable timely connection of new low-carbon technologies such as electric vehicles (EVs) and heat pumps. It talks about the benefits of early investment and of a “touch the network once” approach. And while Ofgem’s stated goal has been to deliver net zero “at lowest cost to consumers”, the ministerial letter talks instead about “enabling the investment necessary for net zero at the same time as ensuring value for money”. A small but significant distinction.

The challenge of how to tackle strategic investment is then, unsurprisingly, at the heart of Ofgem’s ED2 decision but in practice remains largely unresolved. Ofgem notes rightly that in electricity distribution the uncertainty around future pathways impacts a large number of small projects and hence its aim is for an automatic volume driver – provided it can come up with one that works and does not create perverse incentives for companies to over-invest.

Designing the right incentive isn’t easy but it’s still disappointing that Ofgem hasn’t managed to make more progress on this crucial piece of the jigsaw. It suggests that the mechanism could be some form of capacity volume driver alongside a utilisation metric but there is clearly more work to do.

Part of the problem would seem to be a continuing schizophrenia in Ofgem as to what good looks like in relation to strategic investment. There’s an assumption that with smart EV charging and flexibility, network upgrades to cope with EVs can “mostly be avoided”. In contrast Ofgem suggests that “where the endpoint is more certain”, such as on off-gas grid heating, the companies should take a longer-term cumulative view and plan accordingly. It’s not clear that either extreme is right.

Uncertainty remains on transport and heat

On EVs, the CCC was clear that the scale of upgrades required can be reduced (but not eliminated altogether) through effective use of smart charging and that it is expected to be more cost-effective to proactively ensure that networks are able to cope with increased demand, rather than to wait until demand outstrips capacity. There is also an important distinction between private and public charging points and an ongoing debate around the technology solution for smart charging. The problem cannot be simply assumed away.

And with heat, while it may be fairly clear that heat pumps will be the dominant solution off the gas grid, uncertainty remains around the extent of energy efficiency improvements, how far heat pumps can be smart and flexible and where district heating might be a better solution. Understanding the range of potential demand impacts and how best to manage that uncertainty is important for heat too.

In both cases Ofgem is right to be demanding “persuasive evidence” from the companies on what is needed. Ofgem has to avoid writing a blank cheque to the DNOs for new capacity but equally it feels wrong to over-emphasise utilisation when there is significant uncertainty and an imperative to facilitate connection of these new loads. The independent panel review of Electricity Engineering Standards – also published this month – acknowledged the economic benefits of loading up the network where you can but argued that once reinforcement is required the marginal cost of adding significant additional capacity to futureproof the network and reduce losses means this is generally the right approach.

Clearly though smart charging and flexibility have a vital role in keeping the costs of the transition affordable. In its Forward Work Plan Ofgem announced a new Full Chain Flexibility work programme which will look at the range of barriers and incentives to delivery of flexibility. Given this new work, Ofgem has put on hold its Access and Forward-Looking Charges Review, a major overhaul of network charging that has been criticised for not doing enough for flexibility and distributed generation.

A bit like Boris Johnson cancelling Christmas, this is the right answer but it would have saved a lot of heartache if Ofgem could have come to that decision earlier.

Preparing the business plans

In 2017 when it kicked off the Access work Ofgem was clear that timing would need to be co-ordinated with RIIO2 and the plan until recently was that DNOs would at least have a minded to decision on which to base their business plans.

Having failed to deliver that, the DNOs are left having to prepare their plans on the basis of current charging arrangements which will then need to be unpicked later. The access charging arrangements are a crucial driver of the company plans as they will clearly influence the likely level of demand for new connections, the price signals that drive flexibility (and smart charging) and also whether the costs of reinforcement are included in allowed RIIO revenues or recovered through individual customers.

A final issue given prominence in the ED2 consultation was whether company plans should be based on national or local forecasts. As Ofgem now acknowledges, you need both. There needs to be some central steer on the range of scenarios to be considered at a national level – which Ofgem has now said it will provide in the new year – but you also need local projections taking account of the range of local and regional factors that will shape demand, with varying degrees of reliance put on them depending how well-developed local climate plans are, for example. The Energy Networks Association is then being asked to reconcile the sum of DNO regional forecasts with the national picture. This all makes sense but leaves the companies heavily reliant on the scenarios that Ofgem has promised to develop.

So, despite having a longer run-up than gas distribution and transmission, it still feels as if the DNOs will be trying to prepare their plans against a shifting regulatory framework with decisions still due on strategic investment, access reform and the central forecasts that companies should use.

In addition, Ofgem has understandably said it will hold off from providing a view on finance issues, including the cost of capital, until after the Competition & Markets Authority water decision in February. It is inevitable that energy policy will keep shifting and Ofgem’s approach of adaptive regulation recognises that. However, draft business plans are due on 1 July and there is an expectation in some quarters that they should not change too much after that – which feels unrealistic given how much still remains to be decided by Ofgem in the months ahead.

The Sector Specific Methodology decision is an important step in the ED2 process even if, on a number of the big issues, there is still more to do. Tonally the document sends a clear message that Ofgem is working alongside government to ensure net zero is delivered. It’s now for the companies, working with their stakeholders to provide the evidence as to what that entails in practice.

Maxine spent 15 years at Ofgem, latterly taking on responsibility for all aspects of the regulation of distribution networks. Since leaving Ofgem she has been working as an independent consultant for a mix of regulated company and consumer / community group clients.