Ofgem explores net zero planning models for local electricity networks

Ofgem has revealed it is exploring several different models for planning strategic net zero investments by electricity distribution networks as part its sector-specific methodology consultation for RIIO ED2.

The equivalent consultations for the other sectors covered by the RIIO2 price controls took place in 2018/19. The price control for electricity distribution will begin two years later than the rest in April 2023.

Ofgem recently published its draft determinations for these other sectors, stating that it had identified £10 billion of potential investment that could be approved during the course of the price controls as part of net zero reopeners.

The regulator said in its consultation for ED2 that this mechanism will be carried over to electricity distribution networks. However, it also said that regardless of the uncertainty over exactly when demand will materialise, distribution network operators (DNOs) will still need to make anticipatory investments for the rollout of low-carbon technologies such as heat pumps and electric vehicles as part of their baseline spending plans.

Under the current price control, DNOs have been provided with upfront allowances to invest in new capacity where they anticipate demand to exceed the existing capacity of their networks. “Within this allowance, we expected DNOs to manage the risk of forecast uncertainty,” Ofgem explained. “Where necessary, DNOs would be expected to spend more or less than their allowance if demand proved to be different from the initial forecast.”

To protect DNOs from significant forecasting risks, the regulator also included a re-opener mechanism so companies could apply for adjustments to their allowances if they exceeded them by more than 20 per cent. Ofgem said it does not expect this mechanism to be used as DNOs spending to date has fallen 39 per cent below their allowances, primarily to slower than expected uptake of low-carbon technologies.

But Ofgem said even if uptake had been higher than forecast it is not clear whether these arrangements would have brought forward more investment.  It said this partly due to concerns by networks that Ofgem would not increase their allowance if they made anticipatory investments and the demand they expected did not materialise, adding: “This risk is not offset by any material benefit to the DNO in the form of an output-related reward for making this type of early investment.”

Ofgem said a “different approach” is therefore required for RIIO ED2. It instead wants to DNOs to invest based on the “most likely” path towards achieving net zero emissions by 2050.

The regulator said this could be done on a centralised basis, with possibilities including:

• A single, central forecast scenario which the DNOs would be required to disaggregate on a regional basis.
• A specification of the forecast volume of low-carbon technologies that DNOs should plan to accommodate in each region.
• A requirement on DNOs to demonstrate how their forecast and investment plans are consistent with national policy in specified areas.

Alternatively, DNOs could each develop their own “most likely” view of the pathway to net zero in its region.

Ofgem said there are advantages and disadvantages to both. A centralised approach could lead under investment in some regions if they progress faster that others and the failure to take account of local needs and initiatives.

On the other hand, decentralised targets may be dependent on policy and financial commitments by national, devolved or regional authorities that may not materialise. There may also be misalignment between DNOs license areas and local and regional government structures and it would also put DNOs in a position of influence that they could exploit to game the price control.

The regulator has proposed four specific models on which it is consulting:

• Model A – DNOs would be required to base their investment proposals on a central forecast that aligns with the net zero target. Ofgem said this would be most appropriate if there is a high level of certainty as demand is being driven by national policy interventions and there is clarity on what form these will take.
• Model B – DNOs would again be required to base their investment proposals on a central forecast, but Ofgem would only include expenditure over which there is a reasonable amount of uncertainty within baseline spending allowances, with the rest being moved to uncertainty mechanisms.
• Model C – DNOs would work with local authorities and other stakeholders to develop a local energy plan. The investments required to achieve the plan would all be included within baseline spending allowances.
• Model D – DNOs would likewise work with local authorities and other stakeholders to develop a local energy plan. However, where questions remained over their need, scope or timing, investments would be moved to uncertainty mechanisms.

Ofgem said they are not mutually exclusive and that different models could be applied to different investments.

Chief executive Jonathan Brearley said: “Our proposals will help turn Britain’s streets green, putting in place the wires and technology for families to travel in electric vehicles and heat their homes and businesses with clean energy.

“The green energy transformation is not just about putting more copper in the ground. We need a modern, digital grid that uses all our energy assets as efficiently as possible”

“Local electricity networks will be at the forefront of eliminating harmful carbon emissions from the country, helping tackle climate change, so it’s vital they have the investment they need to do this whilst keeping costs as low as possible for consumers.”

The deadline for responses to the consultation is 1 October 2020.

Meanwhile, Citizens Advice has released new research conducted by Europe Economics exploring a number of potential risk-allocation models for highly anticipatory investments in the energy sector. Although the initial analysis was undertaken before the emergence of the coronavirus pandemic, adjustments were made to account of its impact.

Citizens Advice said the resulting reductions in energy demand may weaken the case for such investments and that consumers’ willingness and ability to pay may also be less. It said cost benefit analyses may need to incorporate different pandemic scenarios and the range estimates are likely to be wider.