43.We explore in this chapter how effective incentives and benchmarks could be used more effectively to address the challenges of losses and leakages in the UK energy networks.
44.Energy is lost during transportation from production to consumption. Electricity distribution losses on average account for 8% of transported volumes, and vary between 3.1% to 10% for the individual DNOs. Loss reduction obligations and incentives for network companies feature across a number of RIIO price control codes such as health and safety (compliance with minimum legal requirements) and environmental impact (to reduce the carbon footprint of the network).
45.For charging purposes losses are dealt with in the electricity sector via the energy market rules. This means that generators and suppliers have their meters adjusted to account for losses. For gas, this is via a “shrinkage” cost defined by the network companies to account for variances between the energy entering a network and leaving it. We were encouraged to hear from John Pettigrew, Executive Director, National Grid, that gas distribution leakages had declined 20% in the last five years.61 The Government said the UK ranked alongside Sweden, Norway, Italy and Ireland in respect of losses on national energy networks.62
46.We received evidence from Citizens Advice Bureau on the impact of electricity leakages through the transmission network:
About 1.7% of the electricity transferred over the transmission network is lost. A further 5-8% of the electricity transferred over the [various regional] distribution networks is lost. These losses on the power networks account for approximately 1.5% of the UK’s greenhouse gas emissions. They also influence consumer costs as the greater the leakages, the more will have to be generated and consumed for the shortfall, leading to increased costs. 63
47.Jonathan Smith, Head of Trading and Pricing, First Utility, told us that consumer savings could be made by reducing losses:
From a domestic perspective the average bill is around the £1,000 mark. About half is the wholesale element, about £500. We have heard that losses are about 7% or 8% on distribution, 1% or 2% on transmission. That is 10%, so that is £50 in my estimation. That is a big piece we can try to reduce on consumer bills if we can find ways to reduce losses so we absolutely need to ensure the right incentives are in place to encourage that to happen.64
48.However, British Gas criticised Ofgem for how electricity distributors calculate their losses, arguing that the networks gain a windfall, while consumers lose out on a reduction in bills:
Ofgem has recently been considering whether to allow Electricity Distributors to restate [i.e. recycle] the level of their line losses in 2009/10. [However] if this were allowed to stand as originally structured, it would produce an overall penalty (and reduction in customer bills) of £140m. The networks have retrospectively restated the level of losses which has artificially improved performance. Ofgem recently decided to allow this, creating an overall reward of £269m. This will leave networks with a windfall gain of £409m at the expense of customers compared with the original scheme outcome.65
49.Ofgem stated that they had challenged network companies robustly on their stated losses. Maxine Frerk, Interim Senior Partner for Smarter Grids and Governance, Ofgem, said:
That is currently the subject of a legal challenge so it is hard for us to say very much about it. At one level we agree with you. We disallowed half of the revenues that they were claiming that they should have, and we have proposed what will be seen as handing about £161 million to customers as a settlement of this. We did not take their figures at face value, but we are being challenged for that at the minute so we cannot really say very much more.66
50.We were therefore concerned to hear that Ofgem pay network companies incentives to tackle energy leakages although the actual leaks appear not to be reducing proportionately with the incentives. The Government stated that there is a plan in place to reduce losses by transmission owners.
Ofgem introduced loss incentive mechanisms and is using the RIIO framework to strengthen this. As part of the RIIO-T1 price control, Ofgem has required Transmission Owners to publish a strategy for transmission losses and report to stakeholders annually on progress. 67
51.However, within electricity distribution, Ofgem recognise that DNO’s loss strategies have produced mixed results. In its draft discussions for the price control issued in July 2014 (applying to all the DNOS except Western Power Distribution which was settled early under the “fast track” process), Ofgem expressed disappointment with the current standard of the loss reduction strategies, and concern over whether they would meet the licence requirement. Ofgem has called on the DNOs to revise their strategies.68
52.The price control in electricity distribution (RIIO-ED1) planned for April 2015 will introduce a losses reduction mechanism consisting of four components:
53.However, under the proposed settlements, electricity distribution networks are presently required only to report on the actions they are taking to reduce losses; they are not subject to specific or measurable financial incentives for these actions.69
54.Citizens Advice Bureau highlighted that currently electricity transmission leakages are recovered from generators and suppliers on a geographically uniform basis–i.e. a flat rate without any reference to location.70 This means that there is less incentive for transmission companies to improve their infrastructure and reduce leakages.
55.While gas distribution leakages have improved, the current incentives to reduce energy losses and leakages are not fit for purpose, particularly for electricity networks. We were concerned to hear that Ofgem had paid incentives to network companies who had not reduced losses in proportion to those incentives. Consumers are losing out. We recommend that Ofgem develops explicit loss reduction targets and incorporates tougher penalties for network companies that fail to meet them. Introducing locational charges for leakages rather than uniform losses would encourage network companies to be more rigorous about cutting leakages.
56.Greater public scrutiny would also assist market performance, so we recommend that Ofgem publish the network companies’ performance against loss reduction strategies alongside the UK’s performance against international rankings of losses and provide a commentary on good and poor performers. This combination of information on individual and macro performance on loss reduction should help the market to hold the sector to account, which in turn can spur on energy efficiency and market effectiveness.