Scottish Affairs Committee - A Robust Grid for 21st Century ScotlandWritten evidence submitted by Ofgem

Executive Summary

Ofgem welcomes the opportunity to respond to the Scottish Affairs Committee inquiry into “A Robust Grid for 21st Century Scotland”.

Our response focuses on the final question in the terms of reference—“How regulation of transmission system operators and distribution system operators impacts upon investment in Scotland’s electricity transmission network”. In particular we set out the key features of the framework of regulation that apply to the distribution network companies to which the vast majority of electricity customers, including all domestic customers, are connected. If the Committee would find it helpful we can provide more detail on the standards and incentives that apply to transmission networks.

Our principal duty is protecting the interests of gas and electricity customers, both present and future. We also have a duty to ensure that energy network companies are able to finance the efficient development, operation and maintenance of the networks while complying with relevant regulatory and statutory requirements. We do this through setting a price control on the networks.

The regulatory framework also seeks to ensure that customers across GB receive a good level of service from the companies. We have Guaranteed Standards in place which set a minimum level of quality of service the networks must provide to each customer. We place incentives on the network companies to improve the overall reliability of the network. There are special arrangements in place to encourage the companies to consider the needs of customers (mainly in rural areas) who are most susceptible to power supply interruptions and measures to assess and reward performance on network companies across the full range of their contact with consumers. We also have special arrangements in place to encourage the networks to innovate, particularly to accommodate low carbon technologies (such as heat pumps) and local generation.

We review the regulatory framework periodically and seek to update it and make improvements where necessary to sharpen incentives on companies to operate efficiently and consider the needs of customers. We are about to conclude our review of the framework for Electricity Transmission and are just beginning a review of the arrangements for Electricity Distribution.

We discuss each of the underlined features of the regulatory framework after explaining more about Ofgem’s role.

Ofgem’s Role

1.1 Ofgem is the Office of the Gas and Electricity Markets. Protecting consumers is our first priority. We do this by promoting competition, wherever appropriate, and regulating the monopoly companies which run the gas and electricity networks. The interests of gas and electricity consumers are their interests taken as a whole, including their interests in the reduction of greenhouse gases and in the security of the supply of gas and electricity to them.

1.2 Other priorities and influences include:

helping to secure Britain’s energy supplies by promoting competitive gas and electricity markets—and regulating them so that there is adequate investment in the networks;

helping Britain to build a low carbon energy network sector and other work aimed at sustainable development by, for example:

helping the gas and electricity industries to achieve environmental improvements as efficiently as possible; and

taking account of the needs of vulnerable customers, particularly older people, those with disabilities and those on low incomes.

1.3 Transmission network companies operate at higher voltages (132kV and above in Scotland) and transmit electricity from generators to distribution networks and directly connected large industrial customers. In Scotland there are two such companies SP Transmission and Scottish Hydro Electric Transmission.

1.4 Distribution networks operate at lower voltages (1kV to 132kV) and transmit electricity from the transmission network voltage levels to commercial, industrial and domestic customers. The two Distribution Network Operators (DNOs) in Scotland are SP Distribution, which serves two million customers in the South of Scotland via 63,000km of wires of which 31,315km are at low voltage, and Scottish Hydro Electric Power Distribution which serves approximately 740,000 customers in the north of Scotland and the Highlands and Islands, via 47,000km of wires of which 13,760km are at low voltage.

Price Controls

1.5 To carry out our role of protecting the interests of electricity consumers we regulate companies that own and operate the energy networks, through price controls. These determine for five years the maximum revenues network companies are allowed to earn by charging generators and energy suppliers for connection to and use of their networks to deliver energy to customers.

1.6 We are currently setting a transmission price control for 2013–21 (RIIO-T1). RIIO (Revenues = Incentives + Incentives + Outputs) is a new regulatory framework created by Ofgem, it is discussed later in this submission. As part of the RIIO process we are consulting on the business plans submitted by SP Transmission and Scottish Hydro Electric Transmission, for up to £7.6 billion of investment in the Scottish transmission networks in the period 2013–21. This will deliver essential upgrades to the Scotland’s transmission network at the lowest cost to consumers.

1.7 The most recent price control for electricity distribution networks, Distribution Price Control Review 5 (DPCR5) was implemented in April 2010 and covers the period until April 2015. Table 1 below outlines the charges for electricity distribution (DUoS) that are ultimately paid by customers as part of their electricity bill.

Table 1

DISTRIBUTION USE OF SYSTEM CHARGES

	Scottish Hydro Electric Power Distribution Limited	SP Distribution Limited	GB
Average annual domestic electricity bill	£488	£474	£475
Average annual DUoS	£114	£86	£72
DUoS as percentage of average regional bill	23%	18%	17%

1.8 Technical standards require network companies to comply with certain standards when designing and maintaining their assets. Engineering Recommendation P2/6 is an Energy Networks Association document regarding Distribution System planning standards, which Ofgem require DNOs to comply with them, when they plan and develop their networks. Under the distribution licence Ofgem can provide derogations from this standard upon request from the DNOs.

1.9 Determining the appropriate level of revenue involves considering each DNO’s business proposals and assessing the level of efficient expenditure over the period. Price controls also include providing arrangements to deal with various changes that could happen over the price control period, such as the implementation of the Traffic Management Act.1

1.10 For DPCR5 Ofgem provided all DNOs with allowances for the costs associated with statutory work including tree cutting required under the Electrical Safety, Quality and Continuity Regulations (these are enforced by DECC, and monitored by the HSE). Scottish Hydro Electric Power Distribution received £106 million and SP Distribution £151 million to carry out their forecast operational activities at an efficient cost.

1.11 In return for the revenues that DNOs receive from customers during DPCR5, they are required, by March 2015, to have delivered an agreed package of output measures. If a DNO fails to deliver the agreed outputs Ofgem will claw back from the DNO the associated allowed revenues. These measures are based around the various assets’ overall health (eg what condition the asset is in, ranging from new to end of life) and load (eg how utilised is the asset, ranging from lots of spare capacity to fully utilitised).

Guaranteed Standards of Performance

1.12 The Electricity Guaranteed Standards of Performance2 define expected levels of performance that an individual customer should receive from their DNO. If these are not met and a range of exemptions such as exceptional weather events do not apply, the customer will receive a compensation payment, once they have claimed within three months.

1.13 For example, in normal weather conditions a customer who has been off supply for 18 hours or longer will receive a payment from their DNO of £54, and for each additional 12 hour period off supply they will receive a further payment of £27. The circumstances in which a DNO can claim exemptions from the Guaranteed Standards are outlined in the Statutory Instrument (No 698, 2010). There are other guaranteed standards and the ones specific to interruptions to supply are presented in Appendix A.

1.14 The Guaranteed Standards do not cover consequential loss that customers may experience as a result of a power-cut; instead they recognise the inconvenience caused by loss of supply, as it is not possible to guarantee a continuous supply of electricity.

1.15 The level of compensation has been set to act as a strong incentive for the DNO whose revenue per domestic customer is about 17% of the average annual domestic electricity bill, equivalent to about £72 per customer. A Guaranteed Standard payment of £54 to a customer significantly reduces the DNO’s income from that customer and acts as a powerful incentive to manage their networks so as to avoid having to make these payments.

1.16 When the Guaranteed Standards were introduced in 1991 they did not cover customers in the Highlands and Islands. However, in 2005 (SI 1019) Highlands and Islands customers were given their own standard. Where supply is not restored within 18 hours then the DNO has to pay £54 to each customer affected. The locations covered by this standard are given in Appendix B.

1.17 In 2010, as part of DPCR5, we increased the payment levels under the Guaranteed Standards to account for inflation and introduced two new standards:

the 5,000 customer standard, which applies where 5,000 or more customers are interrupted during normal weather. The DNO has 24 hours to restore supply, or is required to pay £54 to those customers affected, once the customer claims within three months; and

the rota disconnection standard, DNOs can use rota disconnections during a major incidence of constrained supply to deliberately disconnect customers on a rotational basis, so that the demand for electricity is reduced to the available supply. If a customer is off supply under these circumstances (ie subject to rota disconnection) for 24 hours or more, they will be eligible for a payment of £54, once the customer claims within three months.

Interruptions Incentive Scheme

1.18 Ofgem’s Interruptions Incentive Scheme (IIS) seeks to provide a penalty/reward framework for DNOs to improve the quality of service to all customers. This mechanism sets target performance levels for all DNOs based on the number and duration of power-cuts on their network, for interruptions of three minutes or longer. If a DNO is penalised under this scheme, the penalty amount is passed back to customers in the form of lower network charges.

1.19 These incentive rates are based on research that Ofgem conducted into both domestic and business customer’s willingness to pay for a reduction in power-cuts. This research provided Ofgem with detailed information on customer’s preferences when faced with power-cuts, and provided strong feedback that they placed value on speedier restoration when a power-cut happened. In response Ofgem increased the incentive rate on the duration part of the incentive to encourage the DNOs to restore supply even faster than before.

1.20 Under the IIS scheme and subject to Ofgem’s review, DNOs can claim exemption for exceptional events that pass a defined threshold. If approved by Ofgem these events are excluded from the DNO’s performance. However, the structure of the IIS is such that DNOs should react to every event as if it were a normal weather power-cut, as there is no guarantee that their claims will meet the required thresholds.

1.21 If a storm event breaches a threshold amount a DNO can claim exemption, and is required to do so within 14 days. Ofgem reviews these claims, as part of its analysis of data on supply interruptions provided on an annual basis by the DNOs. The annual submission from DNOs on supply interruptions for 1 April 2011–31 March 2011 is due on 30 April 2012.

1.22 Table 2 below shows the reduction in the number of power cuts and the duration of power cuts since 2002.

Table 2

PERFORMANCE WITH AND WITHOUT STORMS
(APRIL 2002 TO MARCH 2011)

DNO	Without Storms	Including Storms
GB	22% reduction in power cuts 17% reduction in duration	21% reduction in power cuts 16 % reduction in duration
SP Distribution	25% reduction in power cuts 23% reduction in duration	29% reduction in power cuts 28% reduction in duration
Scottish Hydro Electric Power Distribution	29% reduction in power cuts 25% reduction in duration	23% reduction in power cuts 7% reduction in duration

Worst Served Customer Scheme

1.23 The Worst Served Customer Scheme is a mechanism introduced by Ofgem in 2010 to improve performance of DNOs in respect of customers who experience at least 15 power-cuts over a three year period. Ofgem introduced this mechanism as we recognised that these customers were not being covered as effectively as we would have liked by the IIS scheme.

1.24 A £42 million facility was provided for the five years to 2015 across GB. Scottish Hydro Electric Distribution’s share of this mechanism is £3.3 million, and SP Distribution’s is £2.6 million. This money will be reclaimed by Ofgem at the end of the price control if the companies have not used it, but it is up to the DNOs to decide how best to do this. We are aware that some companies have already carried out work under this scheme in the first year of the price control, and anticipate that others will do so during the remainder of DPCR5.

1.25 Our Worst Served Customer Scheme was developed in response to research with “worst served customers”. Our goal was to understand their experience and attitudes; explore awareness and attitudes to Guaranteed Standards; and to understand better their views on network investment. Seven focus groups were run in Great Britain, including Salen Village on the Isle of Mull in the area served by Scottish Hydro Electric Power Distribution, and Ardwell Village, in SP Distribution’s area. Most of the focus groups felt that service had declined over time, with the exception of Mull. There was also a feeling (except on Mull) that they were less well served than others and that contact with DNOs was generally felt to be poor, except by those on Mull.

1.26 As part of the RIIO-ED1 process we will return to this area and seek to incorporate any learning from the current price control and amend the scheme where necessary if required.

Broad Measure of Customer Satisfaction

1.27 Ofgem is also introducing the “Broad Measure of Customer Satisfaction”. This incentive aims to drive improvements in the quality of overall customer experience by capturing and measuring customers’ experience of contact with their DNO across the range of services and activities that DNOs provide.

1.28 This new incentive is intended to replicate the methods used by customer facing businesses in other competitive markets. These include three key elements: customer satisfaction surveys (on interruptions, connections and general enquiries); a measurement of complaints (unresolved and repeated complaints); and on DNOs engagement with stakeholders (stakeholder views on the DNOs’ approach to engagement and outcomes). We are currently in the pilot phase of this incentive, which will be fully implemented by April 2012.

Looking Forward—RIIO—Electricity Distribution 1 (RIIO-ED1)

1.29 RIIO (Revenues = Incentives + Incentives + Outputs)- is a new regulatory framework that provides a much greater say by network customers about what network companies need to deliver. It encourages more efficient investment and innovation through a stronger incentive regime. It also increases the price control period from five to eight years and seeks to encourage greater innovation in the electricity networks.

1.30 One of the key benefits for customers of the RIIO approach is the increased importance placed on stakeholder engagement with the network companies, building on our “Broad Measure of Customer Satisfaction” that we introduced in DPCR5. The aim is to provide customers with a greater voice on what they want and what results the DNOs should deliver over the eight year period of the price control. This development will create an important opportunity for rural communities to voice the kind of issues that they are facing and what type of customer service they would like. Under RIIO, we would expect companies to consider these concerns and respond if possible. There is scope for the DNOs to include schemes that address specific customer needs in their business plans if there is sufficient rationale for it.

Innovation

1.31 As part of DPCR5, Ofgem established the Low Carbon Networks Fund (LCNF). The Fund allows up to £500 million support to projects sponsored by the DNOs to try out new technology, operating and commercial arrangements. The objective of the projects is to help all DNOs understand what they need to do to provide security of supply at value for money as GB moves to a low carbon economy.

1.32 In the price control it was recognised that Scottish Hydro Electric Power Distribution would have to replace the diesel power station on Shetland around 2013–15, due to its increasing operational and maintenance costs, along with incurring substantial environmental compliance costs.

1.33 The Northern Isles New Energy Solutions (NINES) project on Shetland is a three year trial by Scottish Hydro Electric Power Distribution Limited to create an integrated supply and demand solution for the island’s electricity supply. This project seeks to partially address the replacement of the diesel power station and introduce more environmentally friendly generation sources. This project is trialling a range of alternative solutions (including demand side response and storage) which could reduce the overall costs of replacing the power station. The funding required for this project, £15.33 million was approved by Ofgem and this came through the price control.

APPENDIX A

GUARANTEED STANDARDS OF PERFORMANCE SI 698 OF 2010

The Statutory Instrument can be found here:
http://www.legislation.gov.uk/uksi/2010/698/pdfs/uksi_20100698_en.pdf

Reporting code	Service	Performance Level	Guaranteed standards Payments
EGS1	Responding to failure of distributor’s fuse (Regulation 12)	All DNOs to respond within 3 hours on a working day (at least) 7 am to 7 pm, and within 4 hours on other days between (at least) 9 am to 5 pm , otherwise a payment must be made	£22 for domestic and non- domestic customers
EGS2*	Supply restoration—normal conditions (Regulation 5)	Supply must be restored within 18 hours; otherwise a payment must be made.	£54 for domestic customers and £108 for non-domestic customers, plus £27 for each further 12 hours
EGS2A*	Supply restoration: multiple interruptions (Regulation 11)	If four or more interruptions each lasting 3 or more hours occur in any single year (1 April—31 March), a payment must be made	£54 for domestic and non- domestic customers
EGS2B*	Supply restoration—normal conditions (5,000 or more premises interrupted) (Regulation 6)	Where a large scale event occurs, that is where 5,000 or more customers’ premises are interrupted by a single failure of, fault in or damage to a distributor’s distribution system, then supply must be restored within 24 hours, otherwise a payment must be made	£54 for domestic customers and £108 for non-domestic customers, plus £27 for each further 12 hours up to a cap of £216 per customer
EGS2C*	Supply restoration—rota disconnections (Regulation 8)	Where supply to a customer’s premises is interrupted as a result of rota disconnection on a distributor’s distribution system by a failure of, fault in or damage to that system, then supply must be restored within 24 hours, otherwise a payment must be made	£54 for domestic customers and £108 for non-domestic customers
EGS3	Estimate of charges for connections (Regulation 13)	Distributors must dispatch an estimate to the customer within either 5 working days or 15 working days (15 working days applies if significant work beyond a distributor’s fuse and service line are necessary), otherwise a payment must be made	£44 for domestic and non-domestic customers
EGS4*	Notice of planned interruption to supply (Regulation 14)	Customers must be given at least 2 days notice, otherwise a payment must be made	£22 for domestic and £44 for non-domestic customers
EGS5	Investigation of voltage complaints (Regulation 15)	Visit customer’s premises within 7 working days or dispatch an explanation of the probable reason for the complaint within 5 working days, otherwise a payment must be made	£22 for domestic and non- domestic customers
EGS8	Making and keeping appointments (Regulation 19)	Companies must offer and keep a timed appointment, or offer and keep a timed appointment where requested by the customer, otherwise a payment must be made	£22 for domestic and non- domestic customers
EGS9	Payments owed under the standards (Regulation 21)	Payment to be made within 10 working days, otherwise a payment must be made	£22 for domestic and non- domestic customers
EGS11* (EGS11A, EGS11B and EGS11C)	Supply restoration: severe weather conditions (Regulation 7)	Depending on category of event supply must be restored within 24, 48 or a multiple of 48 hours, otherwise a payment must be made	£27 for domestic and non domestic customers, plus £27 for each further 12 hours up to a cap of £216 per customer
EGS12*	Supply restoration: Highlands and Islands (Regulation 9)	Supply must be restored within 18 hours, otherwise a payment must be made	£54 for domestic customers and £108 for non-domestic customers, plus £27 for each further 12 hours

* Customers need to claim under these standards, for the remaining standards payments are automatic.

APPENDIX B

“Highlands and Islands” means the following Scottish local authority areas: the Shetland Islands, the Orkney Islands, Eilean Siar (the Western Isles), the Highlands (consisting of Caithness, Sutherland, Ross and Cromarty, Inverness, Nairn, Badenoch and Strathspey, Skye and Lochalsh, and Lochaber), and Argyll and Bute.

3 February 2012