Embracing change

Ofgem’s stakeholder engagement (and consumer vulnerability) incentive is a reward only annual panel assessment which applies to all network companies, across gas and electricity in both distribution and transmission.

All the networks have to present to the panel, led by Ofgem, annually on what they are doing on stakeholder engagements. The resulting scores are published annually, and there are financial rewards attached to this.

The panels for this year’s assessment took place in July and form part of assessments of the companies’ customer satisfaction performance.

Speaking to me at Ofgem’s head office in Canary Wharf, London, Kaul said: “If you are seen as being at the vanguard of stakeholder engagement then you receive a financial reward. It’s a discretionary reward so we don’t have to award it. It depends on the quality of stakeholder engagement and essentially the quality of the work that the network companies present to these panels and how they score it.”

The incentive is called the stakeholder engagement incentive (SEI) for gas distribution and transmission companies, but is called the stakeholder engagement and consumer vulnerability incentive (SECV) for electricity distribution operators (DNOs). While all companies must demonstrate strong engagement with their stakeholders in order to be eligible for a reward, the DNOs must additionally demonstrate how they are identifying and addressing customer vulnerability issues. In the SECV, the consumer vulnerability element is weighted at 25 per cent.

The existing incentives will stay in place until the end of the current set of price controls, with transmission and gas distribution price controls running from 2013 to 2021, while the electricity distribution price controls run from 2015 to 2023.

Kaul told Network the reasons why it is important to incentivise work that is being done in this area: “I think there was a feeling in RIIO1 when the framework was setup that network companies were quite insular.

“We wanted to reshape it so that it became a lot more outward looking. There were two things I think that were done at the time. One was that stakeholder engagement became a big theme in setting the price controls. We set up a process to try and assess how well network companies had reflected stakeholder feedback in their business plans. And then we set up these groups and panels on an ongoing basis to monitor how well they were doing with stakeholder engagement.

“I think broadly the signs are that that this has led to a shift in network company culture and their outlook. They are now much more engaged with their customers.”

 

Transparency

Some network operators would like to see greater transparency in the panel’s scoring system and decisions as they think this would help them identify more accurately how they can improve outcomes (you can see the latest results on page 14).

Kaul doesn’t disagree and says that Ofgem is prepared to listen to ideas about how to make the process more transparent and objective.

“Judging the quality of something is inherently subjective,” he remarks. “You can’t use a mechanical process so to some extent that is why it is a discretionary system that relies on an expert panel looking at what the companies are saying and then giving them a rating.

“We’re equally interested in whether using a panel based approach on an ongoing basis is the right way of going about things. Have we done enough in RIIO1 so that the culture is shifting and now you don’t need to keep rewarding people to talk to their customers as it’s just part of how they do business? We’ll be thinking hard in RIIO2 about whether we should carry on operating with a financial incentive scheme in the same sort of way.”

RIIO2 is never far from the surface during my chat with Kaul, who reveals more about the possible changes to the stakeholder engagement incentive in the next set of price controls.

“The kind of things we’re thinking about for RIIO2 are whether we continue to use a survey based approach to customer satisfaction as the lynchpin to how well network companies are serving their customers. And how do we reward that? Do we reward it on a financial incentive basis or a reputational basis? Even if we reward it on a financial basis, do we do it in an absolute or relative sense? Maybe it makes more sense to drive the maximum competition by creating a relative system that says if you’re in the top league you’ll get rewarded, if you are in the bottom league you’ll get penalised.

“It shouldn’t be the case that just because you meet an absolute target you get a sum of money, you should have some kind of comparison to your peers and how well they’re doing with customer services. Those are the sort of areas we need to think about for RIIO2, but the good news is that the culture seems to have shifted in the main and a lot more of this is business as usual.”

 

Price controls

The subject of RIIO2 is next on the agenda during my chat with Kaul so I start off by asking him why the default length of the next price controls will be five years instead of eight? 

“The main reason we’ve cut it from eight to five is because of the degree of change in the system,” he explains.

“In that 2021 to 2026 time period it’s going to be very difficult, even within a five-year control, to predict how the networks might be used and how the demand for their services may change. Even if it had been an eight or 10-year price control period, we would have had to put in some kind of half-way point to reassess the whole system anyway. So you might as well make it simple and reset it every five years.”

The energy regulator has proposed that the cost of equity range (the amount network companies pay their shareholders) will go down to between three and five per cent, from six to seven per cent currently. The three to five per cent range is the lowest rate ever proposed for energy network price controls in Britain.

“So far the only thing we’ve decided is the methodology for how we go about setting the cost of equity,” comments Kaul.

“We’ve got a fair amount of data that’s telling us if we were setting the controls today the cost of equity would be a lot lower than where we set it in RIIO1.”

Ofgem’s decision on the framework for setting the next price controls also confirms that new independent user groups and customer engagement groups will be set up by each of the companies to give consumers a stronger voice in how the price controls are set. For the first time open hearings will take place in the spring of 2020 where companies’ spending plans will be scrutinised.

“We want to make them pretty tightly structured,” notes Kaul. “For that reason, we have set up groups, and the purpose of those groups is to bring systematic user and consumer challenge to the spending plans.

“In the past we’ve done these things in a relatively transparent way. We publish plans on the website and do a lot of consultation. But it’s tough to engage people on what are quite technical issues. So in RIIO2 we’re going to try – though public hearings – to have a much more structured contest of ideas, arguments and evidence that is open to everyone. We’ll be saying to people: These are the areas of contention, this is why they matter to you, this is what the critics are saying – now come along and have your say.”

 

Innovation

Ofgem’s Network Innovation Competition (NIC) and the Network Innovation Allowance (NIA) are both funding stimuluses that have helped drive innovation across the sector. Whether or not they remain during RIIO2 in their current form is a question that’s still up for debate. 

“We’re still thinking about the particular form that it should take,” states Kaul. “So far the decision we’ve made is that some funding stimulus will continue to be required. It can’t all switch to business as usual. In the next decade there are going to be quite a few R&D challenges for our networks and they will have to evolve to meet the challenges.”

According to Kaul these challenges will include the rollout of electric vehicles, hydrogen in energy systems and active demand management.

“We also need to think about cyber security and how networks stay secure and resilient to much greater physical penetration than there’s been before,” Kaul continues. “These are areas that need some R&D spending and I think if there’s no innovation stimulus then the risk is that the R&D spending just vanishes. As to whether we still keep it in the same form, by running an innovation competition or giving an allowance to companies, we haven’t decided that yet.

“We will liaise with stakeholders to work out what they think is the best way of providing that R&D stimulus. We are also quite interested, and Network readers might have a view on it, as to whether we open it up to third parties. A lot of great ideas are coming from outside of the network sector. We don’t currently have the means to have direct third-party engagement in our innovation programmes. They do engage with us via the network companies, but I think it’s an interesting question about whether we should open it up to anybody – as long as the idea they have can be implemented on a network.”

 

Electric vehicles

Ofgem recently set out proposals to reform network access arrangements which will allow more electric vehicles to be charged from the existing grid.

Research from the energy regulator shows that more flexible use of the energy system will allow at least 60 per cent more vehicles to be charged if EV owners only top up outside peak demand times on the grid.

“Penetration [of electric vehicles] is still relatively modest. We’re keen to push for a reform of how network charging operates to facilitate the rollout of EVs,” states Kaul.

“The second thing we want to see is distribution companies doing more active management of demand in their area.

“These are things we’re doing to help the system respond better to the EV revolution. Ultimately, I think it will come down to the charging network. The question is who should pay for the rollout of the charging network across the country. Should the costs go on energy bills or should the users of EVs and manufacturers pay for the rollout of the charging network?”

 

Keeping networks safe

When asked about the cyber security of networks and the work that needs to be done in this area, Kaul provides an honest assessment.

“We take it very seriously. Ofgem along with BEIS has taken on a role as a competent authority on cyber security for enforcing the standards that are published by the Cabinet Office in the energy networks space. I think it will be a theme in RIIO2 which companies have to consider carefully.”

Ofgem will extend the scope for opening up high value network upgrades to the benefits of competition across the gas and electricity sectors in the next price controls. To signal its intent Ofgem has confirmed that National Grid can build the grid upgrade to connect the new Hinkley Point C nuclear power station. However, Ofgem will set the revenue National Grid can earn from the upgrade based in part on its experience in cutting the costs of connecting offshore wind farms to the grid by tendering the ownership of these links.

“We’ve essentially said to National Grid that they can build it out, but the price they get for building it out will be benchmarked using the cost of capital that we observe in the offshore transmission programme.”

 

Summary

Kaul is excited about the role that RIIO2 will play in the energy sector going forward. 

“Whether the networks like it or not the change is going to happen in the system. It’s already happening around them and although we can facilitate the change we’re not the drivers of it and the change will happen anyway. I think the choice the companies have is whether they embrace it or resist it. Where I think the price control can make a difference is in helping them become agents of positive change.”

Whatever happens it appears that RIIO2 is going to be a challenging settlement, but one that the networks will need to be ready for.

The Network Awards will feature a stakeholder engagement initiative of the year category. For further information visit https://future.networks.online/

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