With Ofgem set to publish draft determinations for the RIIO2 price control for gas distribution and electricity and gas transmission next Thursday (9 July), followed by its methodology for electricity distribution later in the month, this will be an early test of Ofgem’s new-found enthusiasm for decarbonisation.
In the Decarbonisation Action Plan launched by Jonathan Brearley on his first day as chief executive, the networks angle was central – with Ofgem talking about the role of anticipatory investment, energy networks being able to support 10 million EVs by 2030 together and development of an offshore grid.
Since then we have had Covid-19, which has created considerable uncertainty for the sector but has also created a growing consensus around the importance of infrastructure investment to support a green recovery. The Committee on Climate Change has argued that as a part of that green recovery “energy networks must be strengthened for the net-zero energy transformation in order to support electrification of transport and heating”. The National Infrastructure Commission has called for a greater emphasis on resilience while the department for business, energy and industrial strategy is clearly out and about touting for “shovel ready” projects to support.
With an Ofgem that seems readier to line up alongside government, rather than asserting its independence, these voices will be important. Indeed, Ofgem has established a formal Net Zero Advisory Group whose remit and governance is a bit opaque but whose membership includes these other government bodies, advising on the strategic trade-offs in RIIO.
What then might be the key tests of “green-ness” in Ofgem’s Draft Determinations?
The first and most obvious test is how Ofgem deals with the high-profile projects which, while costly, can obviously be badged as central to net zero and economic recovery.
I would expect Ofgem to be tough on the cost of capital (while awaiting the Competition & Markets Authority’s decision on water) and on efficiency but to be more generous in allowing these strategic investments to proceed. National Grid Electricity Transmission was looking for funding to support ultra-rapid EV charging at motorway service areas as well as for a project to build a transmission link along the east coast to reduce the cost and disruption of connecting offshore wind. SSE Transmission was looking for funding to enable it to accommodate 10GW of renewable generation in the North of Scotland, with mechanisms to fund more if required. The gas distribution companies were looking for significant innovation funding to take forward hydrogen projects.
For some of these major projects funding might come, at least in part, from government rather than RIIO and Ofgem may put some of the funding through uncertainty mechanisms if it is not convinced that the case has yet been made. However, that won’t necessarily stop them featuring them prominently in the RIIO press release as part of a green recovery package.
The next category – and a harder test – is how Ofgem deals with expenditure that is actually important for reducing carbon emissions in the near term but isn’t anything like as sexy. On gas distribution leakage accounts for around 95 per cent of the companies’ carbon footprint but in its methodology decision Ofgem moved away from having any financial incentive on leakage.
An important test is how Ofgem deal with this in draft determinations including its attitude on “repex” – the cost of the iron mains replacement programme mandated by the HSE. While traditionally badged as a safety programme this also helps with leakage and makes the networks hydrogen-ready so it should fit with the “green recovery” narrative. That said, the required access to customers’ properties makes it problematic in the short term at least and may mean that some of the more ambitious company plans are no longer achievable.
On the transmission side the equivalent is sulfur hexafluoride (SF6), a greenhouse gas with high global warning potential, where Ofgem is supportive of an incentive but transmission companies are also looking for funding for targeted SF6 asset replacement. On both repex and SF6 the sums of money involved are significant so Ofgem will be considering them carefully and the test is whether they are ready to support the less sexy but important spend in this area to tackle near-term carbon emissions.
And finally, perhaps the hardest test, is whether Ofgem has done the detailed work to really get under the skin of what the companies are proposing in terms of carbon reduction.
In the spirit of incentive regulation, it is essential that Ofgem has a clear framework for comparing what the companies are proposing in their Environmental Action Plans and their “science-based targets” for reducing their business carbon footprints.
In their business plans the companies all seemed to take different approaches to what they included in scope 1, 2 and 3 emissions and what they took as their base year, making comparison impossible as Ofgem’s RIIO2 Challenge Group highlighted.
Without clear and consistent metrics against which company performance can be tracked this won’t be an area the companies prioritise. Ofgem can talk about reputational regulation as a driver in this area but without robust comparative information stakeholders will struggle to hold companies to account.
These three tests – how Ofgem handles the big strategic investments needed to hit net zero, how it deals with the less sexy but important actions needed to reduce carbon emissions in the near term and whether it ensures there are clear and consistent metrics in this area – also apply to the methodology decision for ED2.
The draft determinations will be closely read by many in the sector. The press release on the day will probably tell us if they have met the first test on high profile infrastructure projects but it’s likely to require a careful read to work out if the green-ness is more than skin deep. I’ve cleared my diary.