Getting regulation right
Flexibility and the DSO business model was the topic of discussion at a recent roundtable hosted by Network and Oracle. With work now well underway on the second set of RIIO price controls, speakers were keen to talk about the impact of regulation on the transformation of networks.
11th February 2019 by Networks
Distribution network operators (DNOs) could meet the challenges of decarbonisation under the current model, one speaker explained. But doing so would be “horrendously expensive”, requiring huge investments in new capacity to meet peaks in demand.
To save money for consumers, DNOs must leverage flexibility to help maximise the usage of existing capacity, which remains plentiful outside of peak times, and take on the more active role of distribution system operator (DSO).
The common thread tying together much of the discussion was the importance of price signals and incentives, both in terms of how network companies earn money under the RIIO framework and how they recover these revenues from users through network charges.
Attendees said policy-makers and regulators must decide what exactly they want networks to do and then reward or penalise them accordingly.
They said the first set of RIIO price controls have worked well, mainly because of the strong incentives they offer. The shift to totex spending allowances has provided a financial justification for network companies to consider operational solutions to constraints as an alternative to building new assets.
Some thought it unfair that Ofgem has received so much “flak” from those who consider network profits excessive. Far from being a sign the price controls are overly generous, attendees argued they instead demonstrate the success of networks in responding to incentives.
They praised Ofgem for maintaining the core tenets of the RIIO framework for the second set of price controls starting in 2023 for electricity distribution and urged the regulator to avoid unnecessary “tinkering”, which they feared could create costly uncertainty.
Then again, they had plenty of ideas on how to make improvements.
They firstly drew attention to the absence of cross-sector incentives for actions that increase network costs but nevertheless benefit consumers.
“There is a risk that if you just focus on the network costs you ignore the opportunities for our customers,” said one.
“Sometimes having a more expensive network enables customers to have cheaper energy overall. We need to set up an arrangement which allows us to reflect that whole-system approach.”
Given the huge uncertainty over the future of the energy system, attendees also thought network companies should be compensated for providing optionality where valuable, for example, by oversizing assets when they eventually need to be replaced.
One noted that digging “the hole” typically accounts for 80 per cent of the cost of replacing an underground cable.
“Optionality value is absolutely critical to the case for flexibility and yet when you look at the regulatory arrangements they don’t reward or encourage optionality,” explained another.
They asked what level of network congestion should prompt reinforcements, and whether DNOs should be incentivised to keep it below a certain threshold.
The question also arose whether Ofgem could use innovation projects to test new incentive mechanisms before rolling them out sector-wide.
Several attendees highlighted the need to invest ahead of demand in preparation for the widespread adoption of electric vehicles. They accepted that Ofgem will not be able to provide large allowances in advance but said the regulator needs to reassure network companies they will be able to recover the costs they incur in due course.
On the topic of network charges, attendees had fewer specific solutions to offer but were clear on the nature of the problem at hand.
They said network charges will create price signals that form the foundation of many innovative business models.
They should provide clear incentives to users to minimise whole-system costs but without leaving those who are unable to respond – vulnerable customers in particular – to pick up the tab. They should also discourage customers from going entirely off-grid in order to avoid the charges.
It was suggested networks could charge users different rates for “core” and “discretionary” needs. There were also calls for customers to receive more information about what they are being charged for on their energy bill and how they could go about saving money.
Another subject that was touched on throughout the discussion was the importance of networks’ relationships with stakeholders.
There was agreement DNOs need to engage more proactively with customers rather than just responding passively to their needs. One attendee said networks need to step out from the “shadows” of energy suppliers, who until now have been the “face” of the industry.
Another claimed this change is already taking place: “One of the key aspects of RIIO is increasing stakeholder feedback and customer engagement.
“Stakeholder engagement is now hard wired in the business, and as a result it drives a lot of our work. Many of the things my team and I are doing now are a response to what customers said they wanted us to prioritise.”
Local energy schemes, particularly those being undertaken by large cities, were seen as an excellent opportunity for this type of engagement, bringing together numerous key stakeholders that networks might otherwise struggle to reach.
Views from the speakers:
“Optionality value is absolutely critical to the case for flexibility and yet when you look at the regulatory arrangements they don’t reward or encourage optionality. You could argue that early within a particular price control period they sort of do but later on, as soon as the optionality period bridges price reviews the value and incentive to the DNO is lost.”
Stewart Reid, head of DSO innovation, SSEN
“It isn’t a requirement to fundamentally change the technology because it has to do something different. Existing technology would work perfectly well. But it doesn’t meet the affordability challenge.”
Paul Bircham, commercial strategy and support director, Electricity North West
“One of the key aspects of RIIO is increasing stakeholder feedback and customer engagement. Stakeholder engagement is now hard wired in the business, and as a result it drives a lot of our work. Many of the things my team and I are doing now are a response to what customers said they wanted us to prioritise.”
Sotiris Georgiopoulos, head of smart grid development, UK Power Networks
“There is a risk that if you just focus on the network costs you ignore the opportunities for our customers. Sometimes spending more on networks enables customers to have cheaper energy overall. We need to set up an arrangement which allows us to reflect that whole-system approach.”
Nigel Bessant, head of network trading, SSE
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