The ED2 business plans: What’s not to like?

Maxine Frerk, director at Grid Edge Policy and a former Ofgem partner, gives her take on the draft RIIO ED2 business plans published by electricity distribution networks last month.

All of the distribution network operators (DNOs) have now published their business plans for ED2 (with UK Power Networks only publishing an executive summary which made my reading task a little easier). My overwhelming sense on trying to read and compare across was “thank goodness for Ofgem”. Without hours to really drill down into the annexes and detail it is hard to make meaningful comparisons. But I have tried nonetheless to pull out a few reflections.

The first is that the universal message across all DNOs is that this is about providing more for less. All of them are supporting huge anticipated growth in EVs and heat pumps with improved customer service – and most of them are doing it while at the same time reducing their share of customer bills, with Western Power Distribution (WPD) case holding bills flat and Electricity North West (ENW) proposing a small increase. What’s not to like?

The problem is that none of them really explain how they achieve this magic trick and one is left worrying that there is some sleight of hand going on – or that huge bill increases are being stored up for future consumers. The companies typically position this as being the result of innovation and efficiency savings but in practice that is a small part of the story.

Ofgem’s explanation would be that one reason it pushed down hard on the cost of equity is precisely because it knows that huge investment is needed to deliver net zero and keeping the cost of capital down is crucial in making that affordable. However, with the Competition and Market Authority (CMA) appeals running at the minute there is a risk that the cost of equity will end up higher than Ofgem would like. ENW did actually prepare their plan based on a slightly higher cost of capital which goes some way to explaining why they show an increase.

There’s also some complexity that Ofgem will need to unravel linked to the uncertainty mechanism for strategic investment. Ofgem has signalled that there will be some sort of volume driver but the details are not clear. The baseline plans typically cover what is seen as certain spend that would be needed in all scenarios with the expectation that the higher levels of outputs promised in terms of support for EVs will be funded through uncertainty mechanisms. The plans vary in how well they explain the bill impacts of different outcomes with UK Power Networks (UKPN) probably the clearest (a 10 per reduction for their base case and a 4 per cent reduction in their highest scenario) and ENW seemingly giving little thought to this huge area of uncertainty.

Ofgem will be able to work through the detail of that to ensure they are comparing like with like but we saw in transmission that they too have an interest in having a low headline bill impact and keeping quiet about what customers will probably end up having to pay once all the uncertainty mechanisms play out.

The third magician’s trick again sits squarely at Ofgem’s door and is around asset lives. As Northern Powergrid (NPG) set out in a recent interview, the move to a 45-year asset life reduces costs for current customers and pushes them up for future customers. This is a result of the “depreciation holiday” that results from shifting from a 20-year life to a 45-year life and also the fact that the longer companies have to wait to get repaid for the investment, the more we as consumers have to pay in total in interest / returns on that (just like on a mortgage). NPG are the only DNO calling that out at the minute but the Scottish and Southern Electricity Networks (SSEN) plan includes a graph running out to 2064 which shows revenues (i.e. bills) falling by a quarter through to the early 2030s and then doubling out to 2064. SP Energy Networks (SPEN) has a chart showing revenues falling in ED3 even if you hold expenditure constant. Customers in the short term may be gaining but future consumers are clearly paying a high price.

This is a complex issue but one that the CMA explored in depth in the appeal on ED1. Although a policy decision had been taken previously to move to a 45-year asset life, the Ofgem ED1 team were concerned about the inter-generational impacts and introduced transitional arrangements to mitigate the effect and to allow time for a rethink before ED2.

Centrica challenged that decision on the grounds that it pushed up bills for customers in the short term. The subsequent hearings only strengthened the Ofgem view that there was a problem and the CMA final decision endorsed Ofgem’s use of a transitional arrangement and noted Ofgem’s intention to carry out a review of the medium-term impacts of the policy. That review has not happened.

The worry, as highlighted in my paper for Sustainability First on inter-generational equity, is that all parties have an interest in focussing on the short-term bill impacts. It is vital that there is transparency around what the implications are for the longer term to judge if the outcome is fair.

What else is being delivered?

While the anticipated load growth and the impact on bills is the big story for ED2 there are other themes that echo across the business plans with different companies shining in different areas. This is one of the benefits of encouraging the companies to publish their draft plans which hopefully will help raise the bar across the piece.

Some of the particular highs and lows from my perspective are:

• UKPN’s plan to establish a legally separate DSO (distribution system operator) is a bold step. Ofgem has been clear that the networks must be neutral market facilitators and all DNOs are trumpeting their focus on flexibility – but questions will always remain around their perceived independence. I am sure Ofgem will be looking carefully at UKPN’s proposal as a future industry model.
• Visibility of what is happening on the low voltage network is central to the transition and smart meter data should be an important part of this. In the last couple of years all the DNOs have had their privacy plans approved allowing them to start collecting smart meter data. But how central it is to their business plan varies considerably with WPD having a whole section on harnessing the power of smart meters while SSEN fail to mention them at all.
• Climate adaptation is of growing importance and the Climate Change Committee recently highlighted the imperative for electricity networks to do more to protect their assets against climate impacts, recognising the growing dependency on the grid. All DNOs include continuing investment for flood protection but only SSEN really seems to be thinking about the wider impacts of climate change on their network.
• The growing grid dependency also flows through into a recognition that reliability requires increased focus. All the DNOs are looking to reduce interruptions and SSEN are proposing a 75 per cent reduction in the number of “worst served customers”. UKPN are looking at reducing the number of short duration outages which historically have not been measured. ENW are looking to improve reliability for their most vulnerable customers. If this can all be done without any impact on bills then we can expect customers to show clear support – what’s not to like. The worry, as flagged earlier, is the magic of how all this extra expenditure is delivered with a reduced bill.
• On the environment, all the companies have put a strong emphasis on the story around how they are reducing their own carbon emissions but again comparisons are difficult. WPD and UKPN have impressive sounding targets to achieve Net Zero by 2028 for the operational emissions they control. But dig a little deeper and it’s clear that these targets exclude losses and involve offsetting, which is a controversial issue. SSEN don’t have that sort of headline date but are clear that their SBTi targets include losses and the use of diesel generation on the islands which creates a particular challenge for them. They have also made links between biodiversity and carbon reduction with a novel proposal for seagrass restoration. Without a lot more digging it’s hard to tell who really is most ambitious in this space.
• And finally, there are a range of initiatives on the broader social agenda. UKPN have committed to introduce measures of social mobility and to make changes to their Articles of Association to embed an explicit public interest commitment (as Anglian have done in water). WPD have committed to supporting fuel poor customers to save £60 million through a clearly set out programme of activities with ENW proposing a range of new funds and initiatives to support vulnerable customers. SPEN have chosen to focus on Community Energy with a new fund and broader support.

So, with significant action across all plans on this whole range of outcomes and all without an increase in the bill, the overall sense remains “what’s not to like” – but also “where’s the trick?”.

At this stage the companies will hopefully be looking over their shoulders at what others are doing to help get their plans fully up to scratch. Ofgem will be giving some steers and will be using these comprehensive draft plans to start to think about the analysis they will need to do to properly benchmark them. In doing so it is vital that all parties are honest about the longer-term bill impacts and don’t just focus on the effects in ED2. Achieving net zero is an imperative but we need to be clear about the costs and to make sure that we are not leaving a large debt for future generations to deal with.