A whole new world

John Parsons, networks portfolio manager at BEAMA, takes an in-depth look at Professor Dieter Helm's Cost of Energy Review and what it could mean for the networks.

A whole new world

Whether you agree with its conclusions or not, the Cost of Energy Review lays out a clear, and at times sobering, review of the development of the electricity sector over the last 50 years and its present complicated structure. For those of us who have been arguing that we need radical change it certainly offers that. It covers all aspects of electricity supply but I’m going to look at the proposals for networks which are probably more far reaching than for other areas, even if they have received less attention.

The review takes a good look at the development of network regulation since privatisation. The review concludes that, with the increasing level of change and innovation, it is simply impossible to accurately predict allowances eight years hence. Anyone who has monitored the annual outturns for ET1 and ED1 will have sympathy for this view. If follows that periodic reviews are unworkable, cannot control costs efficiently and should be abandoned. ET2 and ED2 would be scrapped and ET1 and ED1 rolled over until a new arrangement was in place. Regulation would largely be replaced with a market approach with National and Regional System Operators (NSO and RSO) established as public bodies to identify the need for network development and, where they did, open up the work to tender. The review argues that in future, load growth may equally be addressed by traditional reinforcement, local generation, storage or DSR and it would be the job of the RSO to set up an auction between all options to find the cheapest solution. Network maintenance could similarly be auctioned off to the lowest bidder. Other distribution network operators (DNOs) and private contractors could compete with the incumbent to win the work. With the demise of periodic reviews, Ofgem would lose much of its role and could be bundled up with other regulators to focus on consumer protection.

 

Going through changes

So what would this mean? It can be expected that the incumbent DNO would have an advantage in bidding for work given their knowledge of the network, skills base and local presence. However, they would be vulnerable to competitors introducing innovation and so would probably have to try to keep up with them and be early adopters themselves. This pressure, plus an open market for cost effective solutions to network constraints, would certainly open up the industry to innovation. It would make the UK a very attractive place to develop new business models and products, fitting well with the government’s Clean Growth Strategy objectives.

It might not be a very comfortable world. The proposals would effectively break up the DNOs into an asset, plus operations and contracting services. A DNO that lost its contracting services would have little more than its asset base. Given that the network companies look to outperform their TOTEX allowance to boost their income, losing that could be very difficult, especially as, the review points out, most networks have heavily geared balance sheets. It is a little chilling that the review refers to the special administration process and the protection in place for consumers. However, aggressive DNOs could look to expand and grow their activities. Given the convergence of generation, distribution and supply, the review also proposes creating a single licence to cover all these activities, which would make it possible for DNOs to diversify their services. The market would also open up to new entrants, bringing innovation along with them. It’s going to be a difficult world for the RSO to manage with multiple contractors and service models, all of it having to hold together and keep the lights on. 

 

Informing the debate

There will be many parties strongly against these proposals and many challenges and risks if they went ahead. But there is a strong argument that the arrangements we have now are simply inadequate to produce the changes needed so they must change, and not by a little bit. There seem to be three fundamental options; carry on as we are now with ever increasing complexity and cost and a likely failure to deliver the desired outcomes; nationalise the supply industry and go back to the Central Electricity Generating Board (CEGB) but in a much more complex and changing world than they ever had to contend with; or unleash the full force of the market and stand back. It’s going to be an interesting debate and the review provides an excellent basis to inform it. 


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