Memorandum submitted by Electricity North
West Limited (ENW)
1. EXECUTIVE
SUMMARY
1.1 Since privatisation DNOs like ENW have
halved their work forces, halved their costs and doubled the quality
of supply enjoyed by customers. This performance is direct evidence
of real strength in strategic and innovative thinking and implementation.
1.2 The key question for the future is whether
the longer-term security and climate change goals can be achieved
purely through market forces via the current structural model,
or whether an element of central planning is required? The levels
of uncertainty are leading to a paralysis of necessary investment
and therefore to rely on market mechanisms alone is doomed to
failure. There needs to be a decision made on the broad generation
mix and strategic direction to achieving the 2020 targets as a
stepping stone towards the 2050 targets. This requires the explicit
identification of the "controlling mind"—clearly
a role DECC must take on.
1.3 Decisive leadership from DECC is of fundamental
importance to the effective translation of policy into practice.
We can see that a consensus on the generation mix and appropriate
strategic direction is forming, it is now necessary to move the
whole weight of the industry behind a clear statement of the strategy
all must implement.
1.4 If this occurred ENW could immediately
start work on over £100 million of investment using existing
technology to relieve constraints on new renewable generation
in Cumbria and on operating regimes for community CHP in Manchester.
We would also undertake trials of new technologies to develop
"smart grids". All of these investments would result
in an increase to the average domestic customer's bill in the
North West of approximately £1.50 per year.
1.5 Changes in the regulatory framework
are also required to enable us to follow this direction including
the continuing facilitation of private finance for these investments;
enabling direct and ongoing commercial interaction with customers;
and improving the regulatory incentive framework for DNOs.
1.6 DNOs have an enduring relationship with
every building with electricity and a meter in their region. As
licensed and regulated organisations with a clear regional remit,
the DNOs could become vehicles for delivering a wider range of
public policy objectives relating to sustainable development and
have a key role to play in the move to a low carbon economy.
2. INTRODUCTION—WHO
WE ARE
2.1 Electricity North West Limited (ENW)
holds the Distribution Network Operator (DNO) licence for the
North West of England, serving 2.3 million customers. We are an
asset owner with a network worth £8 billion and do not have
financial interests in supply or generation. We have established
an innovative business model whereby we own and manage the network
assets whilst our service provider United Utilities operates,
maintains, constructs and repairs these assets on our behalf.
Today's customers benefit from the increased focus of our service
provider on operational efficiency whilst tomorrow's benefit from
our separate focus on the longer term issues of asset stewardship.
2.2 Our focus on the future has encouraged research
and innovation within the organisation. We are fully committed
to R&D investment under the Innovation Funding Incentive and
are the only DNO that has utilised its full allowance. Our approach
to managing the potential peak in the replacement requirement
of our ageing asset base has been recognised as industry leading,
including the award of the Institute of Engineering and Technology's
Innovation in Engineering Award, 2007 for asset management.
2.3 Our proven ability to innovate is a
key skill that needs to be expanded and supported by the regulatory
framework in the future.
3. OUR VISION
FOR BRITAIN'S
ELECTRICITY NETWORKS
3.1 The key question for the future is whether
the longer-term security and climate change goals can be achieved
purely through market forces via the current structural model,
or whether an element of central planning is required?
3.2 We recognise that there are a wide range
of possible options by which the nation might achieve the 2020
targets, exemplified for example by the results of Ofgem's Long-term
Electricity Networks Study (LENS). The competitive markets have
provided the platform for these options to emerge; however there
is no certainty regarding the way forward and significant doubt
over whether solutions will be available in time. This uncertainty,
coupled with the restrictions of the current regulatory approach,
is leading to a paralysis of necessary investment. Reliance on
market forces as the driver of generation and demand patterns,
can not guarantee to deliver the timely provision of infrastructure
or ensure that the solution achieves the Government's 2020 targets.
3.3 The changes required in our electricity
networks are potentially greater than the post war rural electrification
programme. To make a change of this magnitude in the short timescales
available requires the identification of a unifying strategic
direction for the GB energy industry. To rely on hope and market
mechanisms alone is doomed to failure.
3.4 Fortunately, we can see that through
the efforts of many in the industry, DECC and Ofgem an appropriate
direction is forming. However, it is now necessary to move the
whole weight of the industry behind a clearly stated, preferred
option if we as a nation are serious about achieving targets.
This would not be to the exclusion of other options, but would
rather act as a rallying point and as a route along which we could
positively facilitate the required developments. There needs to
be a decision made on the broad generation mix and strategy for
achieving the 2020 targets as a stepping stone towards the 2050
targets and for this to happen requires the explicit identification
of the "controlling mind".
3.5 Our view is that this role must taken
on by DECC, thus maintaining the independence of Ofgem in its
primary role as economic regulator. DECC may need to bring in
skilled and knowledgeable expertise from across the UK energy
sector to help them in this task. We also see the need for consistency
in the overall approach, requiring DECC to provide stronger guidance
to Ofgem and to other sectors such as buildings, industry and
transport. Decisive leadership from DECC is of fundamental importance
to the effective translation of policy into practice.
4. THE STRATEGIC
DIRECTION FOR
DISTRIBUTION NETWORKS
4.1 The way forward for transmission has
been clarified to some extent by the recent ENSG report Our
Electricity Transmission Network: A Vision For 2020, which
focuses on the need for adequate network capacity to be in place
in good time to bring large scale generation from remote points
(including offshore) to major load centres. The energy generation
scenarios envisaged as the most likely in the ENSG report have
been signed off by both DECC and Ofgem.
4.2 The challenges for distribution are more
diverse and difficult to crystallise, which is why the determination
of an overall vision and direction is vitally important for us.
At the larger end of the scale, the issues are similar to transmission
in that they relate to the potential role of pre-investment in
network assets in order to facilitate the timely connection of
generation. However, they are harder to judge due to the greater
uncertainty over location and the specific impact each individual
generation project has on the local distribution network. The
wider technical challenge for distribution is to accommodate a
more even balance between local load and local generation, thus
reducing grid demand and allowing this to be met by low carbon
generation, primarily larger grid-connected sources such as nuclear
and offshore wind.
4.3 Energy efficiency, in particular zero
carbon homes, and new sources of space heating including CHP will
reduce the energy demand of buildings, although some technologies,
such as heat pumps, whilst reducing overall energy demand actually
increase electricity demand. Also the holistic GB energy usage
perspective indicates that new "low carbon" electricity
demands, such as for transport, will emerge to enable a reduction
in other fossil fuel use. Thus the pattern and direction of load
flows will change, both geographically and by time of day in ways
that are currently hard to predict. The corresponding network
changes are driven by the resulting balance of demand and generation
locally and will require a combination of investments, involving
both "traditional" asset-based solutions and an increasing
need for real-time information and control systems for the active
management of the network, the so called "smart grids".
If the "controlling mind" is able to exert some balance
between local supply and demand then the investment will be minimized
and connection accelerated. A review of the voltage limits in
the Electricity Safety Quality and Continuity Regulations (2002)
and a change of approach from absolute compliance to probabilistic
compliance will also ensure these costs are as low as possible.
4.4 If the "controlling mind"
expressed the direction with appropriate strength and clarity,
ENW could immediately start work on over £100 million of
essential investment. Subject to appropriate certainty of cost
recovery, we can instigate work now to relieve future generation
constraints in Cumbria now by replacing key circuits on our 132kV
network (£90 million), and remove potential constraints on
our 6.6kV networks to operating new generation in Manchester as
part of community scale projects (£15 million). This would
employ low risk current technologies and provide significant benefits
in terms of stimulating and accelerating the connection of low
carbon generation. However, because it cannot be guaranteed that
100% of this investment will be fully utilised, none of it is
possible under the existing regulatory framework. Once the basic
design of the feed-in tariffs is known we will be also be able
to identify other enabling pre-investments and evaluate the costs
versus the benefits.
4.5 A further category of investments are
the full scale trials of technologies and techniques where there
are as yet no clear market drivers to establish a definite need
(£4 million per annum for ENW). Again, as a nation, we can
not afford to wait for the emergence of what the market decides
are the "best" options. Essential developments are required
in relation to Active Network Management (ANM), and the implications
of demand side developments including electric vehicles. DNOs
need to be given the freedom to engage rapidly with all key stakeholders,
particularly other trade associations, government and regulators,
to select which specific developments should be subject to trials
on this scale.
4.6 All of these investments would result
in an increase to the average domestic customer's bill in the
North West of approximately £1.50 per year.
4.7 Another example of a "least regrets"
investment having universal benefit is smart metering. Such investments
must be made as soon as the relevant specifications are clear,
and as fast as equipment suppliers can gear up. This is an area
where the development of a common technical specification, operating
regime and data management/storage solution are all happening
now; however it is also an example of where a less fragmented
industry structure might well have moved towards a solution more
quickly than has actually happened. This is also an example of
how the decision by the "controlling mind" is required
before positive action begins. Impetus can be regained through
regulatory change by implementing an obligation on DNOs to provide
smart meters, allowing the activity to be contracted out to service
providers, in a similar fashion to the ENW business model.
4.8 It is also essential that we invest
now in the skills training, research and development of technologies
and techniques required to achieve our low carbon targets and
vision for the future. DNOs are proactively doing what they can
including the establishment of the new National Skills Academy
for Power. DECC should revert to fully funding the Centre for
Sustainable Electricity and Distributed Generation. This academic
centre was set up with DTI funding and has produced the most useful
research on networks in recent years.
4.9 We can determine what investment is
required in the distribution network in the North West to achieve
a certain approach to the required targets, and all other network
owners will be able to do the same for their networks, identifying
initially the "least regrets" things to do, once the
"controlling mind" specifies the broad direction. The
objective must be to ensure that sufficient clarity is given to
government policy to set the vision and direction, and to ensure
that network owners can respond to this directly. A change in
the regulatory approach is required to ensure these and other
investments proceed where there is agreement that they provide
universal benefits.
5. THE REGULATORY
CHALLENGES
Financing Investment
5.1 In this turbulent economic climate,
the regulatory framework and in particular the current Distribution
Price Control Review (DPCR5) covering 2010 to 2015 must provide
investors, of both equity and debt, with the confidence to make
the required funds available to enable investment programmes.
Whilst the utilities sector has been viewed as a reasonably low
risk investment in the past and has attracted comparatively low
interest rates, the current circumstances are likely to result
in higher financing costs with more restrictive debt covenants
for a number of years. The ability of DNOs to adequately finance
their activities over the medium term will be a significant challenge
for Ofgem to ensure in line with its statutory duties.
Industry Structure and Alignment
5.2 There are specific areas, typified by smart
metering and demand side management, where the separation of licensed
activities has created divergent objectives which would now benefit
from greater alignment. We believe that it is now important to
move away from the philosophy of "competition at all cost"
in areas where the financial benefits of competition for customers
are unproven, to improve co-ordination and simplicity on behalf
of customers. This does not require a change in industry structure,
but does require a change in attitude and philosophy on the part
of Ofgem and a focus on pragmatism. DNOs must be allowed to develop
direct and ongoing commercial relationships with users of the
network. Furthermore, policy goals can be achieved by mandating
obligations on the DNOs rather than waiting for market forces,
thus utilising the unique long-term relationship that exists between
DNOs and every household or property in the land.
Refocusing Incentives
5.3 In order to address the low carbon challenge,
Ofgem must explicitly recognise that the regulatory framework
needs to evolve to allow the network companies to promote and
encourage further DG development and connection. This requires
Ofgem to acknowledge its role in policy implementation, over and
above the requirements of legislation. We have been promoting
the removal of barriers to DG caused by the regulatory accounting
rules, allowing DNOs to focus on managing the network for customers
at the lowest whole life cost and also making the employment of
Demand Side Management schemes a more realistic possible alternative.
We are pleased to note that in Ofgem's recent DPCR5 policy document
they now recognise the need for these changes.
5.4 However, individual incentives do not take
account of the wider picture (for example, connecting renewables
in remote locations has the impact of increasing DNO losses).
A more holistic approach to incentive setting, that considers
the whole package of incentives and the interactions between them
and recognises the DNOs' role in terms of facilitating wider developments
is now required.
5.5 We believe that the way forward is through
evolution of the regulatory framework rather than revolution.
In saying this we do not underestimate the scale or pace of change;
it affects all sectors including domestic, industry, services
and transport in terms of heat, power and infrastructure. However
the fundamental need is for certainty of cost recovery in order
to continue to provide an effectively financed network, with alignment
between DECC and Ofgem objectives. We see this basic structure
as being overlaid with potential additional roles for DNOs as
a vehicle for delivering public policy objectives, alongside the
existing market arrangements.
6. THE FUTURE
ROLE OF
DISTRIBUTION NETWORK
OPERATORS
6.1 We recognise the need for DNOs to innovate
but suggest that this is an ongoing theme rather than anything
new. Since privatisation DNOs have halved their work forces, halved
their costs and doubled the quality of supply enjoyed by customers.
This performance is direct evidence of real strength in strategic
and innovative thinking and implementation. What we need now is
the right commercial environment and regulatory framework (as
well as customer demands) in order to foster further development.
6.2 As licensed and regulated organisations with
a clear regional remit, the DNOs could become vehicles for delivering
public policy objectives relating to sustainable development.
This is relevant where a relevant regional infrastructure owner/operator
is required, even if not directly involving ownership and operation
of distribution network assets.
6.3 DNOs can operate as strategic development
partners. Community energy schemes are most likely to succeed
where there is partnership between local authorities and the developer/owner/operator
of community heat. For CHP schemes, DNOs have a minor stake in
any projects via the electrical connection; however the involvement
needs to be at an earlier stage in the project development. Taking
a strategic view of the local potential requirements and supplies
of electricity and heat will highlight opportunities to provide
an overall lower-carbon solution at its minimum cost.
6.4 With regulatory approval, DNOs could
provide low-cost investment in heating and cooling assets including
their associated networks. This could eventually be under a licensed
framework, added to the regulatory asset base and paid for over
a regulatory asset life. The rationale for DNO provision of community
heat assets is that the viability of district heat community heating
with CHP schemes is strongly influenced by financing costs and
discount rate. Private ownership of heat networks without the
protections of licence obligations could lead to higher financing
costs and less consumer protection.
6.5 DNOs have the advantage that they have
an enduring relationship with every building with electricity
and a meter in their region. Unlike the gas or telephone networks
there is universal coverage of every dwelling and non-domestic
site. As well as the physical connection to each dwelling, DNOs
already administer the Meter Registration Service and bill electricity
suppliers for network services based on meter points associated
with that supplier. This relationship could be relevant to both
the administration and funding of ongoing financial incentives
corresponding to environmental benefits of low-carbon infrastructure
eg under a renewable electricity feed-in tariff, renewable heat
incentive or funding route for long payback energy efficiency
measures.
March 2009
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