Ofgem proposes volume drivers for load-related expenditure by DNOs

Ofgem has proposed to introduce two new automatic volume drivers to manage uncertainty over required levels of load-related expenditure by electricity distribution networks as part of its draft determinations for the RIIO ED2 price controls.

The regulator said the uncertainty mechanisms, which would cover high-volume, low-value works that are relatively uniform in nature, are necessary to prevent asset stranding, while also avoiding the risk of underinvestment in new network capacity that could stifle the uptake of low-carbon technologies such as electric vehicles and heat pumps.

Ofgem said distribution network operators (DNOs) requested £3.2 billion of load-related expenditure in their business plans submitted in December, including £0.8 billion for primary reinforcement, £1.3 billion for secondary reinforcement and £0.8 for connections.

DNOs based their business plans around various different scenarios for achieving the UK’s 2050 net zero target, including some developed themselves.

However, Ofgem raised concerns over their use of scenarios and the evidence presented to justify requests for baseline expenditure, particularly as these represented a 120% increase over the annual average for the current price control period.

The regulator said it therefore reduced baseline allowance for load-related expenditure by 18% to £2.68 billion to align the plans with System Transformation scenario from National Grid Electricity System Operator’s (ESO) Future Energy Scenarios for 2021.

Ofgem said this would provide a consistent starting point across the DNOs to which in-period adjustments could be made using its proposed uncertainty mechanisms.

The regulator said it chose the System Transformation scenario as this is least the ambitious of the ESO’s Future Energy Scenarios, while still allowing the delivery of the 2050 net zero target: “This is not to say we consider System Transformation is the most likely view of the future, but instead it is the most appropriate scenario to use in order to protect consumers from higher costs than necessary while ensuring allowances are sufficient to enable net zero.”

To enable DNOs to quickly adjust their allowances in response to demand, Ofgem has proposed two automatic volume drivers for high-volume, low-value works that are more homogenous.

It has also proposed two re-openers: one for load-related expenditure that is not covered by the volume drivers – typically projects at higher voltages that are larger and less uniform – and a net-zero reopener to account for changes to the underlying assumptions for their business plans related to decarbonisation.

Volume drivers

The first of the volume drivers would cover reinforcement on lower voltage secondary networks, which is expected to be primarily driven by consumer uptake of low-carbon technologies, electric vehicles in particular.

Ofgem said it did consider managing this uncertainty using a re-opener mechanism to provide greater scrutiny of investment but concluded this would create a disproportionate administrative burden that could prevent networks from responding quickly and efficiently to increased demand.

The regulator said it considered two potential options for this volume driver: an output-based mechanism, whereby DNOs would receive set amounts for each device connected, scheme completed or new connection installed; and a capacity-based mechanism, whereby DNOs would receive set amounts for each megavolt-ampere of transformer capacity at substations and each kilometre of circuit.

Ofgem opted for a capacity-based mechanism on the grounds this would be more homogenous, give greater confidence in unit costs and would be less exposed to the risk of manipulation of volumes. In the case of transformer capacity, adjustments would be made based on the final capacity of the reinforced transformer, rather than the capacity added, as this would be more cost-reflective.

The regulator noted concerns that this volume driver could weaken incentives for DNOs to utilise flexibility services in place of reinforcement and therefore considered incorporating the procurement of flexibility services into the mechanism.

However, Ofgem concluded this could create risks of gaming, manipulation and windfall gains by companies. It said it would be more appropriate to put in place controls to ensure the volume driver used is efficient, and more generally make sure conventional reinforcement is only used when alternative options have been exhausted.

One of these controls would be a monitoring and review process, whereby DNOs would be required to report annually on metrics covering transformer utilisation, circuit utilisation, the growth of low-carbon technologies and broader load growth.

The regulator would set expectations of the threshold or trend that would need to be met to justify additional investment. The results would be reviewed annually and there would be a process to claw back unjustified spending.

Ofgem has also proposed to set caps on total expenditure that could be accessed through the volume driver, which would be calculated for each DNO based on a common scenario, namely the Climate Change Committee’s Balanced Pathway scenario. The caps would apply to the entire regulatory period but would be reviewed mid-period, with the option of revising or removing them entirely.

The second volume driver proposed by Ofgem would cover the reinforcement of low-voltage services, in particular the “unlooping” of cables shared between multiple properties. As with secondary reinforcement, the regulator said a volume driver is appropriate for this work as it is low value, with stable unit costs, and driven by the uptake of low-carbon technologies.

Unlike its proposals for secondary reinforcement, the regulator said this volume driver would be output-based, with DNOs receiving set amounts of funding per asset.

Given that unlooping is a lower-value, low-regret activity but can be very disruptive to consumers, Ofgem said this volume driver would allow DNOs to undertake work proactively on a street-by-street basis as well as responding reactively to customer requests, as they currently do.

It said both of the proposed volume drivers would be covered by the totex incentive mechanism, meaning efficiency gains would be shared with consumers.

Re-openers

Ofgem has additionally proposed a re-opener mechanism that would cover all load-related expenditure that falls outside of the scopes of the volume drivers. It said this would mainly be used for primary reinforcement at higher voltages, where projects are typically larger and more varied in cost and technical design.

It would exclude activities already funded through baseline allowances, and although flexibility services would fall within scope, Ofgem said the totex incentive mechanism should drive DNOs to fund them from ex-ante allowances.

The regulator said the window for submissions would open in year three of the price control in April 2025.

In line with the price controls for transmission and gas distribution, Ofgem also intends to introduce a net-zero re-opener to account for changes to the underlying assumptions for DNOs’ business plans related to the transition to net zero. These include changes to national and local government policy, new obligations arising from local energy plans, changes in the pace of uptake low-carbon technologies, and technological and market developments.

As with the net-zero re-openers for transmission and gas distribution, Ofgem alone would have the ability to trigger the mechanism at any time during the price control period, although stakeholders would be able to draw its attention to relevant issues.