Ofgem sending ‘wrong signal’ to DNOs

The lack of financial incentives for distribution network operators (DNOs) to improve their environmental performance “sends the wrong signal” to the sector, an industry expert has argued.

Maxine Frerk, a former Ofgem partner and director of Grid Edge Policy, raised particular concern over the absence of an incentive to reduce distribution losses, which she suggested may be seen by the regulator as conflicting with its drive to increase flexibility.

Frerk was commenting on the final determinations for the RIIO ED2 price controls which were issued by the regulator last week.

Ofgem is introducing three new financial output delivery incentives (ODIs) for five-year price controls beginning in April, bringing the total to seven.

In its final determinations, the regulator increased the upper limits of rewards for the existing Interruptions Incentive Scheme and the new DSO (distribution system operation) incentive by 50 and 20 basis points respectively to +1.5% and +0.4% of return of regulatory equity. However, the overall incentive package remains skewed towards penalties, with a range of +2.65% to -4%.

Although some DNOs have criticised the disparity between potential rewards and penalties, PA Consulting asset management expert Allan Boardman said this slant is understandable given how well they are already performing on some metrics.

“We’ve seen really good improvements over the last two or three price controls,” he explained, “whereas this time, rather than adapt incentives to find other ways to improve, it’s more incentives not to get worse.”

Boardman, who worked for a number of years at UK Power Networks, said on some areas of performance, such as supply interruptions, the “low-hanging fruit” has already been picked. He said the sector is coming up against the “law of diminishing returns,” meaning further improvements will become increasingly expensive to achieve.

His comments were echoed by Frerk who said that “it’s not unreasonable to say what we want, and what customers want, is them to hold their ground.”

“It’s not clear that customers do want to be paying more for better service,” she added. “We don’t want to let it slip, but it’s pretty damn good at the minute”.

However, referencing her role as an associate at the think tank Sustainability First, Frerk said “the bit we were always disappointed in is the lack of any financial incentives around the environment,” namely reducing energy losses on electricity distribution networks and phasing out the use of sulphur hexafluoride (SF6) – an extremely powerful greenhouse gas – for insulation in switchgear.

She said this “sends the wrong signal about the relative importance of that area.”

DNOs will be subject to so-called reputational incentives requiring them to publish annual environmental reports. Frerk said this is not sufficient, particularly given the difficulty in drawing comparisons between companies.

She continued: “The only thing the companies were talking about having a financial incentive on was their carbon footprint excluding losses.” Noting that energy losses “account for well over 90% of their carbon footprint,” Frerk said it is not enough to “just have measures that look at whether you’ve bought EVs or not. But everybody was keen to keep losses out of the picture, both the companies and Ofgem.”

“Ofgem has bought the companies’ line and they are very keen on flexibility and flexibility tends to increase losses,” she added.

“Our argument is that makes it more important, not less important, to look at losses and do whatever else you can, whereas Ofgem, I think, were worried that by shining a light on losses, it might discourage DNOs from going down the flexibility path which they see as being the bigger prize.

She said: “There are a lot of other things than you can do to reduce losses and you ought to be doing that all the more if you’re expecting losses to rise.”

Frerk said Ofgem has indicated it may produce its own mid-period report on environmental performance, adding: “By the end of the process our voice had been heard but you weren’t going to get any big change at final determination.”