Ofgem proposes £357m increase to ED2 allowances

Ofgem has proposed increasing upfront spending allowances for the RIIO ED2 price controls by almost £357 million to reflect planned changes to the charging arrangements for new connections to electricity distribution networks.

As part of its significant code review of network access arrangements, the regulator confirmed plans in May to lower charges for connecting customers by reducing or removing their contribution to the costs of reinforcing the wider network.

Demand customers will no longer be required to contribute to reinforcement costs and will only be required to pay for extension assets. Generation customers will still be required to contribute to reinforcement costs but only for the voltage level at which they are connecting.

The reforms, which are due to be introduced for the start of the ED2 price controls in April 2023, are intended to solve multiple problems. These include an incremental and reactive approach to investment by distribution network operators (DNOs) and a “free rider effect”, whereby customers wait for others to trigger reinforcements before requesting a connection so they can avoid incurring the associated costs.

In a new consultation, Ofgem said the changes would result in an increase in costs borne by DNOs, which were not reflected in its ED2 draft determinations published at the end of June.

As it is not yet clear how and to what extent customers will alter their behaviour in response to the changes, Ofgem said this increase in costs will partly be dealt with through uncertainty mechanisms in the price controls.

Ofgem said it continues to believe, and DNOs agree, that it is not necessary or worthwhile to introduce a specific uncertainty mechanism to manage the impacts of the changes to connection charges.

However, the regulator said DNOs have warned that the suite of uncertainty mechanisms proposed as part of the draft determinations would not adequately accommodate the increase in indirect costs such as for network design and engineering. It said it would therefore consider whether any tweaks to the mechanisms are necessary.

Ofgem has also invited DNOs to submit initial estimates for the cost impacts of the changes to connection charging, with a view to increasing ex-ante allowances in its final determinations.

These estimates, which the regulator received at the end of August, totalled £1.1 billion across all DNOs over the five-year price controls.

However, Ofgem said it does not yet have confidence that DNOs can accurately estimate how much more of connection costs will be paid through Distribution Use of System (DUoS) charges. It said it does not believe any upfront funding should be provided to reflect changes in customer behaviour as this impact has not been robustly quantified.

The regulator has therefore decided to provide ex-ante allowances for the first two years of ED2. Where these allowances and other baseline allowances are insufficient, DNOs will be able to unlock additional funding through the load-related expenditure re-opener windows, which are expected to fall in January 2025 and January 2027.

Ofgem has initially proposed ex-ante allowances of almost £357 million, with UK Power Networks receiving almost £127 million across its three licence areas and National Grid (formerly Western Power Distribution) receiving more than £110 million across its four licence areas.

The regulator has called for feedback on the proposed arrangements and given until 21 October to respond.