RIIO-ED1: Ofgem challenges DNOs to shave £1.4bn from eight-year business plans

The regulator is seeking £400m of savings from smart meters and smart grids - but can DNOs deliver?

“Ofgem announces £17bn investment for electricity network and cuts bills for customers,” trumpeted the press release detailing the draft determinations for the first phase of the new regulatory regime for power networks, RIIO ED1, on July 30. The release goes on to quote Ofgem chief executive Dermot Nolan saying: “this is the only part of the energy bill Ofgem directly controls.” As Ofgem seeks to appease public ire over rising energy bills, an average £12 a year per household over the next eight years counts as a major victory. But this means a further £1.4bn wiped off the DNOs’ business plans, in addition to £700m of savings the companies had already found in their redrafting of the plans.

This has provoked what counts as a storm of outrage in the polite world of regulated utilities. Two of the companies have openly spoken of their disappointment at the proposed settlements, and others are muttering behind the scenes. While companies would normally chafe at their regulatory settlements, there are quite specific disagreements about whether the DNOs can achieve the cost savings Ofgem has demanded. One particular area of dispute is around the potential savings from the smart meter rollout and smart grid solutions. Ofgem claims the companies could have saved nearly £900m more between them by planning better use of these technologies, and is clawing back £400m of that sum.

When the draft determinations landed, SSE shouted the loudest. The company, which has seen a 6.5 per cent reduction in its original bid, to £3.4bn, issued a statement: “SSEPD is disappointed with a number of elements within the draft determination including Ofgem’s proposal on efficient financing and its assumptions about the scope of further cost reductions across the industry.” In similar vein, UK Power Networks, which has seen the biggest proposed cut, of nearly nine per cent, to just shy of £9bn, quoted its chief executive Basil Scarsella: “A cut in expenditure from our proposed plan of some £600 million (nine per cent) over eight years is disappointing and will impact investment.”

The draft determinations include a six per cent cost of equity, lower than 6.3 per cent Ofgem initially estimated for the period, and the 6.4 per cent allowed to Western Power Distribution, the single DNO to be fast-tracked through the RIIO process. Ofgem is proposing various other measures to achieve “efficient funding”, which, together with other financial adjustments based on its benchmarking criteria, form the bulk of the proposed savings.

A further significant chunk of the savings – £400m of the £1.4bn – is expected to come from benefits arising from the smart meter rollout and smart grid solutions. Ofgem says the companies have failed to take proper account of these savings: “Smart meters will play an important role in enabling the DNOs to operate in invest in the networks more efficiently… DNOs need to maximise the benefits they can get form these meters – such as providing better outage and usage data – which the DNOs can use to operate the networks in a smarter way. The smart meter rollout will bring significant benefits directly to consumers as well as cost savings to DNOs. The DNO cost savings should be passed on to consumers who are investing in the rollout.”

Last summer, the ENA produced a report estimating the potential savings from the smart meter rollout as between £47m and £80m for the ED1 period, including £12m-26m arising from Time of Use tariffs cutting peak demand. Ofgem claims the companies have allowed for £27m of savings arising from the smart meter rollout, and claims that the potential savings are as high as £190m.

The disagreement here centres on when the benefits of smart meters will be realised, and how far DNOs can rely on effective partnership working. The completion of the rollout of smart meters is planned for 2020 – five years into the eight year ED1 price control. DNOs have been sceptical about the benefits of the rollout since it was decided that suppliers should lead it – a different model to the location-by-location approach led by networks in other countries. The ENA’s analysis concludes that the latest specification of smart meters, SMETS2, wipes £24m off the potential benefits for DNOs – an indication of what the lack of control means in practice.

Ofgem insists the benefits of the rollout should be passed back to consumers as soon as possible, ie within the ED1 period. The industry is more cautious, suggesting that the bulk of the benefits will come later, in ED2. Moreover, Ofgem believes that DNOs will see significant cost benefits through aspects of the rollout which are beyond their control, through partnership working with suppliers. Again, DNOs are more cautious.

In addition to the smart meter savings, Ofgem identifies two sets of savings from smart grid solutions. Again, it is seeking a return on investment for customers, this time for the Low Carbon Network Fund, which invested £500m in innovative smart grid solutions from 2009 to this year.

The first set savings, on required reinforcements to the grid, Ofgem puts at a potential £653m, or 23-25 per cent of forecast reinforcement costs. DNOs, it said, have bid for just 14 per cent.

The second set of savings arise from using the benefits of smart grids in other ways across the business. Electricity North West was the only DNO to factor in such savings, though Ofgem says it did not go far enough. Had the other networks taken ENW’s approach, a total in excess of £200m could have been cut, it said. It is clawing back £135m of these potential savings, as part of the overall £400m, with the rest to be made up from a combination of savings arising from the smart meter rollout and lower reinforcement requirements.  DNOs are left to determine this combination themselves.

DNOs are privately saying these savings are over-stated. In a carefully worded statement, the ENA said: “The development of smarter networks is a vital part of managing network investment and enabling an affordable, low carbon economy. Our report last year clarified the likely savings network operators may be able to leverage so that they can offset the need for more costly traditional network reinforcement and reduce customers’ bills in the long term. However, it is important this balance is right to ensure investment to maintain secure and reliable supplies.

“Once the roll out of smart meters is complete, it will help network operators to plan infrastructure need and manage the varying demands on the system such as distributed generation and low carbon technologies. Companies will be assessing all the factors in their Draft Determinations as part of their ongoing dialogue with Ofgem to better inform the final decisions on investment.”

For Ofgem, the potential savings form the smart meter rollout and smart grids are a welcome boon as it seeks to exert what little control it can over spiralling energy costs, and offer consumers a speedy return on investment. For DNOs, they remain a possibility on the horizon, with much of the control of the smart meter programme and its potential benefits out of their hands. As negotiations get underway ahead of the final determinations in November, these opposing views will have to be reconciled.