Electricity distribution networks have urged Ofgem to give them the chance to prove they can effectively fulfil the new distribution system operator (DSO) functions they are developing before there is any decision on separation from their traditional role of building and maintaining infrastructure.
As part of their evolution into DSOs, distribution network operators (DNOs) are moving beyond a passive ‘fit-and-forget’ approach and starting to actively manage their assets as the electricity system operator (ESO) already does for the national transmission network. This includes procuring flexibility services to deal with constraints and defer or avoid more costly grid reinforcements.
In its sector-specific methodology decision for the RIIO ED2 price control released last month, Ofgem stated that it plans to launch a review of institutional arrangements in the electricity distribution sector in 2021 to establish whether there is a case for separating DSO functions from DNOs. It said the review will examine “the challenges for system operation at distribution level, the effectiveness of the current governance model and trade-offs between alternative models.”
“While work is underway to consider enduring governance models, we think it is right to embed appropriate measures to facilitate separability of DSO capabilities from the DNO,” it added. “Not doing so could lead to unnecessarily higher costs if in the future we decide that someone else should take on a DSO function or if there needs to be greater internal separation.”
Ofgem said it will develop the tools needed to enable such separation, which could include a DSO reopener, and set requirements within the price control around separability, interoperability and data standards. It said it will also require DNOs to identify the costs associated with DSO functions within their business plans and will map out their IT architectures, governance structures and processes: “This will aid our understanding of any current conflicts of interest, economies of scope between DNO and DSO, and separability and interoperability of systems and processes. We can then consider whether we need to enhance requirements around interoperability or require further separability of responsibilities.”
Responding to the decision, UK Power Networks chief executive Basil Scarsella said the company will set up their DSO functions so they are “ring-fenced” and “flexible”, meaning “if the government or Ofgem decide at some point in the future that the DSO should be separated, then it can be.”
But he also noted that the role is still “evolving”, there is no established model to follow and they still don’t know exactly what functions a DSO should have. He therefore argued that “the need for separation or otherwise should be addressed once the DSO role has been developed completely – it’s settled, it’s working.”
“Ultimately, if it’s better for customers then it should be separated and we will support it but that time is not now,” he remarked.
Patrick Erwin policy and market director at Northern Powergrid likewise said that whilst “we don’t think it’s mad for Ofgem to give itself the option”, it is “pretty crazy to us” to start making changes before the DSO role has been fully developed. “We’re going through this transition,” he added. “We’re not in a steady state.”
Erwin also made the case for why he believes the DSO role should remain with the DNOs, referencing the recent legal separation of the ESO from the rest of the National Grid.
“If you look at the electricity system – at the transmission owners and the ESO – you’ve got a short fat network with high levels of automation and there it is pretty easy to separate out operation and ownership, but there are already big costs of doing so.”
“If we look at the way the ESO is operating the transmission network today it is being more conservative in not breaking the network than the integrated National Grid was because it’s a bit like driving your friend’s car.
“If you borrow a friend’s car, or even if you hire a car without taking out all of the insurance, you tend to be a more cautious with it. Whereas if you know your car and you are comfortable, then you know when you can push it and when you can’t.”
He continued: “When you look at the distribution network, we’ve got a much, much bigger, much more extensive and much more complicated network.”
“And then similarly, we’ve got people who are embedded in the community who really understand the network and the community they serve, and again we think, that local and regional thing is very hard to separate between the DNO and DSO.”
“Before you break that up you’ve got to be really careful,” he warned.
Peter Emery, chief executive of Electricity North West, said: “Our position has always been that you can get the benefits of the DSO concept by still keeping the DSO within the DNO group. What you need to start doing is effectively changing the decision-making processes so that the DSO drives a lot of the decision making and the DNO then has to respond and compete versus market alternatives.”
He also raised concerns over how separate DSOs might be funded, arguing “the financial structure of those as independent organisations to us doesn’t make any sense at all.”
Emery said transparency over how they make decisions will be key: “If you’ve got transparency on DSO decision-making then you don’t need to separate the DSO from the DNO financial structure. But I think there’s quite a lot of work for the industry to do to demonstrate that this can happen, that decision-making will change and that consumers will benefit from that DSO approach.”
His comments were echoed by Phil Swift, chief executive of Western Power Distribution (WPD), who said: “If we can demonstrate independence of DSO and DNO decision-making within our overall business – by way of independent audit and scrutiny and backed by clear licence requirements – I would question why it is necessary to separate the activity and incur the potential costs of duplicating large parts of our capability, including IT costs in particular.
“It is really important to understand that the additional costs could outweigh the financial benefits that separation is believed to provide and this could apply equally whether it was WPD or a new third party.”
He said DNOS are “high-transaction” businesses with “tens of thousands of network interactions per year. No-one should underestimate the potential complexities of managing these interactions and the potential for associated network risks if the operation of these is separated and handled by entities with conflicting drivers.”
Swift continued: I believe that a top performing DNO will need to be supported by a top performing DSO, and vice versa. Both functions will drive efficiencies across the business and improve regulated outputs. This has been demonstrated by how advanced UK DNOs have been in implementing smart grid technologies and in taking significant leaps forward in carrying out DSO activities during ED1 with no specific reference to DSO in the original plans.”
He concluded: “I am confident that our actions and performance will speak for itself and demonstrate why we are best placed to deliver these new DSO functions and remain relevant for us during the energy system transition. We will continue to work closely with Ofgem but ultimately, it’s competition versus strong regulation of input and outputs – Ofgem and BEIS will make their choice.”