RIIO2 will include a rethink of innovation incentives

As Ofgem collects its thoughts on the structure of the next network price control, Kersti Berge says the regulator is mindful of the principle that innovation ought not to need artificial incentive programmes.

As we prepare for the next set of energy network price controls from 2021 the need for the companies to develop and use innovation will be greater than ever.

The energy sector has already gone through rapid changes. The networks will have to manage many uncertainties in the coming decades including how much demand for capacity there will be from new technology such as electricity vehicles. For gas networks, new sources of gas such as hydrogen and potential changes in how heat is delivered could affect the way the networks are used, and what their actual role is in the future.

Encouraging innovation is something that is very important to Ofgem and we support it when it brings benefits to customers. Funding packages to encourage innovation have been an important part of the RIIO (Revenue=Incentives+ Innovation+Outputs) framework that we use to set the price controls. These controls determine how much energy networks can spend on operating and investing in their networks.

“Ultimately we expect network companies to develop and use innovation as part of their normal working practices, without having to rely on these programmes.”

We have already signalled that the next set of price controls from 2021 for the gas distribution and energy transmission companies will be tougher, with a lower cost of capital and lower returns. 

We are also talking to stakeholders about what has worked well, and what has worked less well on innovation funding. The result of those discussions may be a rationalisation and simplification of the innovation incentive programmes in the next price controls. Ultimately we expect network companies to develop and use innovation as part of their normal working practices, without having to rely on these programmes.

We are also focussing on getting better value for money for customers on network innovation and getting new solutions into wider use. With that in mind, it is important that network companies take note of our decision this week about applications to use the Innovation Rollout Mechanism (IRM) for the 2015-2023 electricity distribution price control.

The IRM allows electricity distribution networks to claim extra funding to roll out proven innovation so that it becomes ‘business as usual’. However, they can only have extra money for using technology or approaches that are genuinely new, and not already funded through their price control.

There were a number of requests for funding through the IRM and we have agreed to provide Scottish Power Energy Networks (SPEN) £8m for using new equipment which should reduce instances where generators have to trim their output at times of constraints (when the network is under strain). Although other companies use similar equipment to the system that SPEN wants to use, it is groundbreaking because it is more complex and it will help to manage constraints on the high-voltage network in Dumfries and Galloway. However, we rejected a further request by SPEN for £36.8m funding because other technology it wanted to use was already being funded elsewhere in their price control, or being used by other electricity distribution network operators (and funded through their existing allowances).

All network companies must look at how they can innovate and roll out new solutions cost effectively for customers. We therefore welcome UKPN’s decision to withdraw its request for £33m of IRM funding for equipment which seeks to avoid unnecessary grid reinforcement. UKPN has since decided to recover the cost of this equipment from its existing price control allowances.

The point I want network companies to take from this is that they should continue to drive innovation as the energy system transition progresses. But in doing so they must take every opportunity to improve the value for money that customers get from it. We also want to see more evidence that network companies are collaborating on innovation projects as this will help them to come up with solutions which benefit the whole energy system.  This is important as the companies are now developing their new innovation strategies, and we are building up to announcing the winners of this year’s Network Innovation Competition. We will give companies every encouragement to develop and roll out innovation so long as it is genuinely new, is not being funded already through their price controls, and brings benefits to consumers.