Ofgem’s recent framework decision on improving its performance-based regulation scheme, RIIO, indicates that it may be ready to take a much-needed step toward levelling the playing field between supply-side and customer-side resources. However, it is not yet clear what the details will look like. According to Jan Rosenow of the Regulatory Assistance Project, a global group of regulatory experts, Ofgem should put a network regulation scheme in place that will maximize the role of energy efficiency, demand-side resources, and customers. The U.S. provides instructive examples of such an approach.
Gas and electricity network companies hold a monopoly position. Households or businesses cannot choose which network to use. Therefore, regulators set price controls, a ceiling on the amount companies can earn from the charges to use their networks.
These controls offer an opportunity to incentivise network companies to deliver the services consumers value and to advance the clean energy transition at least cost. In other words, price controls direct how and where the revenues collected through network charges are being spent. At more than €60 billion, electricity distribution revenues in Europe are serious money.
RIIO and the U.K.
The U.K.’s performance-based framework RIIO (Revenue = Incentives + Innovation + Outputs) is one of the most innovative price control mechanisms in the world. In its recent RIIO-2 framework decision, Ofgem, the U.K.’s Office of Gas and Electricity Markets, placed “giving consumers a stronger voice” at the top of its list of methods for developing a reliable, safe, secure network—one that fosters a low-carbon future.
The report shares the results of the agency’s consultation on how to adjust its network price controls program as of 2021 and 2023 for gas and electricity, respectively. In the process, the regulator put the last five years of its program under the microscope.
Like many regulators the world over, Ofgem recognizes the valuable role of consumers as we face exponential change in today’s power sector and strive for decarbonisation. Facing criticism over unexpectedly high network company profits, Ofgem strives to strike a balance between consumer costs and the need to create a “smarter energy system” that keeps pace with critical changes in the energy sector. Customer-side resources and energy efficiency are powerful instruments for meeting these challenges, especially if supported by the right policies.
Network companies well-positioned to deliver energy efficiency
Stakeholders voiced a broad range of views in the public consultation, particularly on end-use energy efficiency. The Regulatory Assistance Project urged Ofgem to consider a stronger role for network companies in providing solutions that encourage lower energy use by consumers and thus reduce or defer the need for investments in energy networks.
This is important because end-use energy efficiency, such as thermal insulation of gas- and electricity-heated buildings and more energy efficient appliances, brings environmental benefits such as lower carbon emissions and lower emissions from burning fossil fuels and leads to lower costs. Network companies, including system operators, are in a unique position to evaluate the cost-effectiveness of end-use energy efficiency from a network system perspective. They have the data to identify where efficiency savings might replace or delay the need for investments in network infrastructure, thereby saving consumers money.
Con Ed estimated that the effect of its systemwide efficiency programmes reduced capital expenditures by more than $1 billion.
To mention an old example of this approach, in the 1990s, the Holyhead Powersave Project reduced peak demand by 10 percent on Holy Island in Wales through energy efficiency measures including efficient light bulbs, draught proofing, and the installation of energy-efficient electrical appliances. The electricity supplier and distributer for North Wales implemented the project in response to growing demand that would result in the need for a new substation on the island. By deferring the need for the new substation by five years, the project resulted in an avoided investment cost of an estimated 500,000 euros.
Thankfully, the regulator took a serious look at the role network companies can (and should) play in delivering end-use energy efficiency. At a high level, Ofgem committed itself to creating a level playing field for demand-side and supply-side resources. This marks an important step in the right direction.
In its consultation response, the regulator states: “Where energy efficiency, alongside other supply-side options, has the potential to defer or mitigate the need for network investment, then there should be no barriers to network companies pursuing this solution.”
However, it is not clear yet what this will mean specifically for network companies and for RIIO. Ofgem will develop more specific methodologies for RIIO-2 by December 2018 to fill this gap.
US experience with “non-wires” alternatives
Fortunately, there is valuable experience on energy efficiency and network infrastructure from the international realm to provide guidance.
The longest track record of regulators working with network companies to integrate cost‑effective “non-wires” or “non-transmission” alternatives into planning and investment can be found in the United States, although there is a growing track record of network companies piloting similar solutions in the U.K. These alternative solutions include end-use energy efficiency, demand response, and distributed renewable resources.
Consolidated Edison (Con Ed), the electric utility serving New York City and its northern suburbs, leads the pack in this approach. In its ten-year forecast, Con Ed estimated that the effect of its systemwide efficiency programmes reduced capital expenditures by more than $1 billion. Similarly, the New England Independent System Operator has identified more than $400 million in previously planned transmission investments in New Hampshire and Vermont that are now deferred beyond its ten-year planning horizon due to energy efficiency.
Regulatory framework needed to realise network benefits of efficiency
In order for network companies to identify and realise the network benefits of energy efficiency and other measures on the customer side of the meter, regulators must put the proper regulatory framework in place. California’s recent introduction of a non-wires alternative requirement provides an instructive example of how such a framework might be structured. The requirement has several key elements:
- Regulators require network companies to identify any significant upcoming distribution system investment need.
- Once identified, each utility must solicit proposals to meet the need with portfolios of distributed resources such as energy efficiency, demand response, storage, photovoltaic panels, and other resources.
- Regulators then evaluate the proposals on a technology-neutral, least-cost, best-fit basis.
- If the most cost-effective proposal with the best value is superior to the distribution wires investment solution, the utility must enter into a contract with the winner.
- The utility is entitled to recover all costs of administering the non-wires solicitation and, as compensation for an effective solicitation, will be entitled to earn 4 percent on the annual contract cost of the non-wires alternative.
This is not a new approach. California’s non-wires requirement implements the “efficient reliability standardˮ developed by the Regulatory Assistance Project for the U.S. national regulators’ association nearly twenty years ago—a concept that is still entirely relevant today.
The expected impact of investment in non-network alternatives, including energy efficiency, is difficult to gauge, as it will depend on many factors. Instructive data on the benefits and potential scope can be drawn from discrete projects, including those listed earlier, where the savings resulting from investment in efficiency and other non-wires alternatives have been calculated in comparison to network-only investment.
Customer-side solutions for a transforming energy sector
Following the high-level commitment in the consultation response, Ofgem now needs to follow through on ensuring that energy efficiency and customer-side resources take a leading role. The agency will increasingly need to contend with electrification of the heat and transport sectors, further increases in distributed generation such as solar and wind, and greater uptake of storage and other technologies. Clearly, energy efficiency is one of the key ingredients to manage networks and make a success of the clean energy transition.
A version of this blog originally appeared in Energy Post.