Electricity distribution networks will formulate their RIIO2 business plans based on centralised forecasts for demand provided by Ofgem, the regulator has announced as part of its decision on the price control methodology for the sector.
Ofgem said allowing distribution network operators (DNOs) to develop their own regional scenarios, as it was also considering, may result in an “inconsistency in approach” that could “undermine the delivery of net zero targets at a national level.”
“There are a range of different net zero compliant pathways that could be used to inform investment requirements on the distribution network,” the regulator explained in the decision document.
“Even when considering only a subset that are consistent with net zero targets, these diverge from each other due to different assumptions on drivers of demand. In the short term, these divergences may be relatively small, but over a longer-term period they differ to a significant degree.
“Without some form of centralised starting point, this could lead to individual DNOs choosing a forecast that is based on different assumptions than those that are adopted elsewhere.”
Ofgem said it will provide a common set of demand forecasts in its business plan guidance due to be published in January 2021.
These forecasts will include outcomes such as electric vehicle and heat pump uptake rates that are “consistent and reasonable across a range of different net zero compliant scenarios”. They will also reflect government targets and commitments such installing 600,000 heat pumps per year by 2028 and banning the sale of combustion engine vehicles by 2030.
The regulator continued: “We expect DNOs to apply these common assumptions on forecast demand in their investment planning.
“We consider that, where a DNO can show that these forecasts will lead to constraints on their network, during RIIO ED2, then there is a strong case for funding to be provided in baseline allowances to support intervention.
“Equally, where these forecasts are higher than the demand a DNO realistically expects for their region, we expect DNOs to adjust their business plan to reflect and respond to that. At the heart of our proposed approach is that DNOs should plan, and account for, key uncertainties in a transparent manner as part of their business plans.”
It said the use of a common set of assumptions should not deter companies from seeking input from devolved administrations, local authorities or other stakeholders.
Ofgem said these forecasts will “inevitable differ from the actual demand on the network, even in the short term” and so “it is not appropriate to rely solely on baseline allowances to provide funding for the investment required. Given levels of uncertainty, this approach seems highly likely to result in allowances which are either too high or too low, neither of which would be in the consumer interest.”
As most of DNOs’ work is likely to take the form of high-volume low-value projects, Ofgem said there is a risk that delivery could be slowed by an administrative re-opener process whereby projects are assessed on their individual merits. It said it is therefore considering creating an “automatic mechanism” to adjust funding in response to deviations from the central demand forecasts.
Ofgem said it is conscious of concerns that such a mechanism could be exploited by DNOs and so will not confirm what type it will use until it has developed its options further to ensure they include appropriate protections.
The regulator said it will initially focus on developing a capacity volume driver coupled with a utilization metric: “Of the different options we have identified, these two, operating in combination, seem to offer the most potential for enabling agile investment to support net zero, while protecting consumers against inefficient investment.”
It noted that although it is considering using an uncertainty mechanism to manage the risk of “relatively minor forecasting errors”, this would not be suitable to deal with “major changes in the profile of demand, such as those that might arise through a government decision of the future of decarbonised heating”.
Writing in a blog on its website, Ofgem deputy director for electricity distribution and cross sector policy, Steven McMahon, said the regulator expects to publish its final decisions on the financial framework for RIIO ED2 price control, including its working assumptions for the cost of capital, in early spring 2021.
“As with our approach to our RIIO2 price controls, we still expect to see lower returns for investors in RIIO ED2. This will mean less of consumers’ money going towards network companies’ profits, and more towards supporting the increases in network capacity required to deliver net zero.”
He said Ofgem has been exploring opportunities to “unlock investment” during the current regulatory period: “That’s why £80 million of shovel-ready projects have been accelerated to start in 2020, as part of our efforts to increase capacity to support new connections as well as preparing the grids for net zero.
“Work is ongoing with the networks through the Energy Networks Association (ENA) to develop further options to stimulate low risk, low carbon strategic investment to support net zero and future users’ needs in line with government climate change ambitions.
“Further information on these options is expected early in 2021.”
ENA chief executive David Smith commented: “In the last fortnight we have seen the prime minister’s ten-point plan and the energy white paper set ambitious net zero emissions plans that depend on network investment.
“Networks are responding to this by accelerating projects and by working with Ofgem to see what more can be delivered in advance of the next price control to support their communities ambitions.
“This work will also lay a foundation for the next distribution price control, RIIO ED2, remembering that distribution companies will submit their business plans to Ofgem in July 2021, in what is shaping up to be the most important planning horizon since privatisation.”
Ofgem recently published its final determinations for RIIO2 price controls for electricity and gas transmission, gas distribution and the electricity system operator, all of which are due to being in April 2021. The price control for electricity distribution will begin two years later than the rest in 2023.