85.Networks’ governance and regulation determines, to some extent, their ability to connect new energy sources and balance the resultant system. We analysed the frameworks in which networks operated insofar as they help or hinder progress towards the goals outlined in preceding chapters, and focused on four aspects. Innovative solutions are crucial to reinforcing and balancing the networks, and so we scrutinised Ofgem’s programme of innovation stimulus. The distribution networks need to take greater responsibility for balancing the system, perhaps through the creation of Distribution System Operators. The role of National Grid as Transmission System Operator merits scrutiny at a time of significant change in network needs. Finally, a more joined-up or ‘whole-systems’ approach to energy is among the most iterated requests we received: we consider what this means and how it might be implemented.
86.We detail new technologies for networks to decarbonise and balance the system in previous chapters: a strong innovation programme is crucial to this pipeline of solutions. Ofgem provides considerable funding for network innovation. The RIIO price controls contain a package of support for trials of new techniques and technologies, known as Network Innovation Stimulus (NIS). This comprises:
These follow the Low Carbon Networks Fund (LCNF), a £500 million fund under the previous price control for similar purposes. This ended and was succeeded by NIS in 2015; much of our evidence therefore referred to the LCNF, which was widely praised.
87.Nevertheless, our evidence has highlighted three remaining difficulties in network innovation. Collection and dissemination of information from completed trials could be improved, and this would improve the impact of such testing. Successes of the LCNF and NIS are concentrated at early-stage development of new ideas, and lacking at end-stage rollout and commercialisation. We have also heard that the corporate structure and incentives of network companies make them innovation-averse, and we have taken suggestions on how this may be fixed. Network innovation is heavily funded and critical to developing the technology that networks need to adapt to modern challenges, and we must carefully scrutinise any flaw in the system.
88.Citizens Advice, while acknowledging the “extremely valuable work” of the LCNF, also criticises its collection and dissemination of results, noting “the projects often did well individually at documenting their work, but there is an urgent need for a central resource that pulls findings together”. Simon Moore, Policy Manager in Strategic Infrastructure at Citizens Advice, elaborated that “both the types of data being collected and the quantities of data being collected are very inconsistent between the different projects”. It is difficult to compare different types of data, or to compile accurate information when different sources provide different quantities of data, and so innovations become hard to evaluate. Mr Moore noted this as a particular issue at the consumer end of projects. Funding should aim to deliver at least some innovations with widespread potential, and standardised collection and dissemination of results would help achieve this. Citizens Advice also claimed that LCNF projects “tend to overlap in some areas and leave gaps in others”. This may be a problem with any system in which individual companies create their own projects for their own needs, as there is no central guidance to address shared issues and avoid duplication. However, improved information would highlight which fields are significant and untilled and which are exploited.
89.Successes in early-stage research and development appear not to be continued into commercial maturity. Technology Readiness Levels (TRLs) are a helpful tool to measure an innovation’s progress from concept to reality. The European Commission defines TRLs as follows:
Table 2: Technology Readiness Levels
Basic principles observed
Technology concept formulated
Experimental proof of concept
Technology validated in lab
Technology validated in relevant environment
Technology demonstrated in relevant environment
System prototype demonstration in operational environment
System complete and qualified
Actual system proven in operational environment
90.The ETI argues “in TRL 4–7, there has been a gap” and that the UK is “relatively heavy on investment at the front, low TRL level, but light on late TRL spend (pre-commercialisation)”. Dr Phillip Grünewald of the ICE and Oxford University emphasised the importance of this later-stage research:
The important thing is that this innovation does not happen just in the labs. The fundamental research is important and there is a lot that we can do in that area, especially on storage. The UK has the potential to be a real world leader, but it is important that we feed that through into demonstration and application.
British Gas concurred that “there is a need to focus available funding on more commercial trials and better enabling routes to market”. Dr David Clarke of the ETI observed that later stages of development are more costly—giving an example of a design for a new wind-turbine blade which cost £1 million to research, £10 million to develop, and an estimated £100 million to bring to market—but noted “the final hurdle—the investment decision around the £100 million or whatever the number turns out to be—is more difficult in the UK”. Dr Jill Cainey of the Electricity Storage Network raised the point that “often with these innovation projects it is specified that it has to be completely new learning”, and consequently it can be difficult for networks to further develop others’ projects.
91.We accept that bringing innovations to commercial readiness is expensive, and likely successes are difficult to identify at an early stage. There have been some successes, such as the Consumer-Led Network Revolution’s demonstration of dynamic line rating and voltage control; we would like to see many more. The ETI contends that “failure to fund and develop timely demonstrations will result in consumers paying higher costs”. The UK’s aim should be to deliver network innovations with potential for export, and Sara Bell of Tempus Energy argued “we need a much clearer plan around what technologies could be exportable”. This would mean focusing on projects that fill gaps not just in UK but in European and international markets.
92.We heard that the culture and incentives of network companies are not conducive to innovation. UKERC noted that “for the most part, the network licensees are seen by their shareholders, i.e. by their investors, as low risk investments with unspectacular but safe returns”. Sara Bell told us:
Distribution networks are not known for their innovative approach. In the UK, most of them have been bought by infrastructure investors. That is really about parking cash that is earning a higher rate of return than it would at a bank. They are not in it because they want to innovate or want to drive a smarter energy system, and it is incredibly important to understand that.
Dr David Clarke agreed with Ms Bell, claiming “I just don’t think the DNOs, in a regulated environment, have the capacity to handle that scale of investment” (referring to his earlier remarks, given above, on the high cost of later-stage development). UKERC delved further into this cultural problem, arguing that “as a result of reduced R&D spending over the past 25 years, the network licensees have forgotten how to manage and report R&D”: this worsens the information difficulties outlined earlier. Professor Keith Bell, Co-Director of UKERC, noted “the culture is changing slowly” but “there is still a further road to be travelled down, in terms of changing the culture of the network companies towards innovation”.
93.These traits—risk aversion and limited access to capital and research methods—may preclude otherwise fruitful areas of investigation. UKERC claims that “only projects with a high chance of ‘success’ are commissioned, and negative or inconclusive results are at risk of being hidden even though they contain important learning”. Professor Bell added that “a lot of the projects have been kind of kit driven” and that “the next step is, to a large extent, back to first principles, back to the concepts, back to how you operate the system as a whole and how you interact with consumers”.
94.Innovation can be driven by need as well as creativity. Stephen Goldspink of Siemens Energy Management noted that some innovations “need to have the pull from the demand side to make it happen”. New connections and variable renewables will create new challenges for network companies to fulfil basic requirements of reliability, controlling costs and consumer satisfaction. Innovations that overcome these protect networks’ returns under RIIO.
95.A number of suggestions to solve these innovation problems were made. Phil Jones of Northern Powergrid advised Ofgem “to concentrate on system-wide innovation” rather than on distribution networks in insolation. Dr David Clarke argued for non-network companies, which are already involved with NIS in partnership with the networks, to be able to lead projects “so that you would get a broader cross-section and potentially alternative routes to market for the outputs”; Simon Moore agreed, noting “there are many ideas out there, which are not held within networks at the moment, which could have quite a strong bearing on the cost of networks over time”. Maxine Frerk of Ofgem was “keen” to “bring in more third parties as partners for the network companies”. The ENA “run a portal for companies who have an idea and want to find a network partner”.
96.We strongly support Ofgem’s commitment to network innovation, but feel there is room for improvement. Ofgem must collect standardised trial data to optimise learning from projects. Furthermore, it should allocate proportionally more funding to later-stage development, and seek opportunities to leverage other sources of funding to achieve project commercialisation. A stronger role for non-network companies in using Network Innovation Stimulus could also balance DNOs’ propensity for risk aversion in the short term, while counteracting it in the long run.
97.Distribution Network Operators (DNOs) as they currently exist are network owners without a corresponding operator function. For example, the UK’s solar generation—mostly connected to the distribution networks—cannot be seen directly and is measurable only as a reduction in transmission-system demand. In chapter 2, we identified smart-grid technologies as crucial to low-carbon network infrastructure. These technologies could enable DNOs to move from a blind, passive role to one of responsibility for balancing energy flows at a distribution level as the TSO does for transmission: they would become Distribution System Operators (DSOs). UKPN said:
A DSO would undertake the conventional role of a DNO but would also make full use of smart techniques to create value for the wider electricity system, e.g. by undertaking an element of regional balancing and providing reserve and frequency response services to the national System Operator. Such services will become increasingly important to maintaining a stable balanced national electricity system as conventional ‘synchronous’ generation associated with coal and gas fired power stations gives way to higher volumes of intermittent renewable generation technologies.
98.The Electricity Storage Network argued that “a move to the DSO model is urgently needed as this would facilitate the development of innovative models for our future networks”. Tony Glover of the ENA claimed that “if DNOs were to become DSOs, it would ultimately reduce costs”; he did not envisage any short-term, transitional harms to consumers. The Minister concurred that “there will be enormous cost savings for consumers as a result of DNOs becoming more active in managing their part of the network”. On our visit to Copenhagen, we learned that some Danish distributers already have control-room functionality and can be considered DSOs: one project, EcoGrid 2.0 on Bornholm Island, is trialling a DSO in conjunction with DSR. RWE, a major supplier, recommended that DSOs be introduced before RIIO-ED2 begins in 2023—perhaps through “a RIIO-ED1 reopener”—“particularly because distributed generation has grown beyond expectations”.
99.It remains unclear how exactly DNOs would transform into DSOs, and whether they could be established without modifications to licence codes. Phil Jones argued:
It can happen naturally to a degree […] New pieces of equipment on a network would start to contribute to that almost automatically and nothing else would need to be done. But there would come a point where if the obligation is going to shift from National Grid, where it very clearly rests right now, on to, for example, my own company for that part of the world, then yes, there would have to be some changes to licences and legislation presumably. Certainly our licence obligation would have to change, and the codes that govern the way the industry works would then have to change and adapt to suit it. There is some quite dry, regulatory work to do eventually.
100.Andy Burgess of Ofgem told us “there is nothing to prevent the DNOs from becoming DSOs now, or at least the early stages of DSOs”. On the other hand, there are advantages to the universal responsibility that National Grid currently bears as a monopoly system operator—it is clear who does what. It would not be acceptable, in a new world of DSOs, for these lines of responsibility and accountability to be muddled. UKERC observed that “as now, the interactions between different items of equipment owned by different parties are likely to depend on appropriate technical standards”. This may imply that even early-stage DSO creation necessitates modifications to technical codes, at the very least. The Minister gave an account of networks’ current and future governance structure:
DECC would be responsible for looking at the structure of how the energy system works and the policy areas. Ofgem will look to DECC for policy steers on how they should then regulate and implement the topline policy, so Ofgem is then responsible for looking at the factors. In direct answer to your question, if and as we move away from DNOs to DSOs, it will be through Ofgem’s regulation of the system that they make clear to National Grid, as the national systems operator, and to the DNOs, as they become more like DSOs, as to where the boundaries lie. Obviously those will tend to be geographic. The national system operator operates the big highways and motorways of the grid and the DNOs look at the more local and regional. Ofgem will be regulating both and then of course National Grid manages the day to day operations of the system, so the expectation is that more system operation at the distributed area is going to add to National Grid’s ability to manage the system more efficiently and, therefore, cheaply.
101.The benefits of Distribution System Operators (DSOs) seem near-universally acknowledged, yet there is no clear Government road map to their implementation. The Government should develop and publish a road map for DSO introduction, identifying future legislative and regulatory changes needed. The road map should include a plan to require small-scale generators to provide real-time information to DSOs. The relationships across DSOs and between DSOs and the Transmission System Operator must also be clarified.
102.We did not assume that the DSO should be run by the same company as the corresponding DNO. However, Tony Glover told us “we cannot see any practicable and cost effective way for the DSO not to be the DNO”. Andy Burgess said “in principle, we think it probably makes sense for it to be the same company, because you introduce an extra complication if you separate it out”. He cautioned, however:
The important things is to make sure that the monopoly DSO does not impede competition, that there is the right level of regulatory control over what markets it can be active in and, as far as possible, that we have competitive markets providing services, rather than the DSOs.
103.The evidence favours Distribution System Operators (DSOs) being run by the same companies as the corresponding Distribution Network Operators (DNOs), at least in the short-term transition to DSOs. However, DSOs are an extension of DNOs’ monopoly power, and Ofgem are right that this should be appropriately regulated. Given risks to consumers from accumulation of monopoly power, DECC and Ofgem should be prepared to review the governance of distribution networks as DSOs’ functions develop, and to separate distribution networks’ operation from their ownership if their conjunction proves to have a negative impact on consumers.
104.National Grid plc, a private company listed on the London Stock Exchange, and its subsidiaries have a wide variety of roles in ownership and operation of GB network infrastructure. They own and maintain the physical electricity transmission network in England and the gas transmission network in GB, act as Transmission System Operator (TSO) for both, develop, own and operate much of the UK’s interconnection, and play a role in administering Electricity Market Reform (EMR).
105.Dr Philipp Grünewald stated:
In general terms, I would agree that when an entity owns the electricity transmission network, large parts of the gas network, is responsible for capacity mechanism, whose subsidiary owns interconnectors and is the system operator, it stands to reason that there are some conflicts that ought to be addressed, because they just get bigger as we go forward.
106.Specifically, two potential conflicts of interest have been raised which would undermine the development of low-carbon network infrastructure. Firstly, National Grid has the power and incentive to encourage physical infrastructure development and then profit from it: this is known as ‘asset padding’. For example, Standard Condition C27 of the Transmission Licence requires the licensee (National Grid) to publish a Network Options Assessment report; this is “effectively saying what additional network investment was needed”. National Grid also reports on electricity capacity requirements for the Capacity Market. In both cases, National Grid could advocate more capacity than necessary in order to be allowed to build, then own, such assets. These are merely examples illustrating a wider problem of accountability: National Grid as TSO and transmission-asset owner is in the position of both benefitting from asset development and being in an influential position to recommend it. Sara Bell observed that “there is a fundamental difference between an infrastructure investor who wants to grow and grow and grow the asset and the role of cost-effectively managing a system that should be run in a most cost-effective manner”.
107.In response to the question of asset padding, Phil Sheppard of National Grid told us:
One of the clever pieces of regulation in RIIO is that we are incentivised around our total expenditure. That is a combination of revenue and CapEx. Therefore there is an incentive on National Grid as a [transmission operator], as it is with all [transmission operators], to find ways of not building and delivering an output that is part of the regulatory deal.
Citizens Advice argued, however, that “even if the efficiency incentive within each price control militates against overspending, there is still temptation to ‘pad your assets’, as this confers an advantage at the next price control”.
108.The second potential conflict of interest concerns National Grid’s role, through its subsidiaries, in owning interconnectors. EDF Energy contended that “there must be a clear process to ensure that potential conflicts of interest can be managed for National Grid, between its role as System Operator and its commercial interests, such as the development of interconnection.” National Grid uses interconnector imports as backup in event of narrow system margins. Moreover, interconnectors are eligible for the Capacity Market. Again, National Grid could overstate capacity requirements, which would generate a higher clearing price in the Capacity Market—perhaps for its interconnectors. The fundamental issue here is that National Grid could act in a way that inefficiently advantages interconnection over other balancing tools, such as storage and DSR.
109.Charlottte Ramsay of National Grid’s European Business Development responded that “European Business Development and all of the interconnector projects and companies that we run are wholly separate from the UK core activities, which means that the relationship we have with the system operator is the same as any other connectee into the system”. She concluded “there is potential for conflicts, and I think that they are thoroughly mitigated through the processes we have in place.” Phil Sheppard continued:
If Charlotte [Ramsay] came to visit me in Warwick, she would be treated as an external visitor and escorted to the meeting room. We would have the meeting, and then she would be escorted out. We are physically in different locations, with different security systems, and our [information] systems are all separate. In terms of that process, the governance is different. We have different boards. Our main board have all signed undertakings that they are never going to require or allow a licenced entity to breach its licence as a consequence of actions. There are a whole load of very thorough rules and regulations around that.
Stephen Goldspink similarly counselled against hasty action on National Grid, noting it “has taken considerable steps to silo its network operation and system operation” and that “there is a lot of mature experience” at the company. We would not want to lose that experience.
110.Maxine Frerk of Ofgem admitted “there is the potential for conflicts of interest, and that comes from their role as SO owning the interconnectivity, and also their role as SO owning network investment”. Nonetheless, Ofgem has powers to hold National Grid to account on “a spectrum between a conversation and ultimately taking enforcement action”, including “being able to impose financial penalties on them, up to 10% of turnover.” Ms Frerk continued “we would expect to pick up if there was something where the SO was taking some balancing action that looked odd to us in that context, and we could follow that up” and concluded that “we are confident that, at the minute, we are able to manage those conflicts, and that there are not any issues”.
111.There have been suggestions that DECC plans to separate the TSO function from National Grid. The Rt Hon Amber Rudd MP, Secretary of State for Energy and Climate Change, stated in her ‘reset’ speech that “there is a strong case for greater independence for the system operator”. In March 2016, The Times reported on documents purportedly leaked from DECC that proposed options for separating the TSO function from National Grid. It claimed that DECC’s preferred option was to create a non-profit Independent System Operator (ISO) overseen by Ofgem. The documents are quoted stating that “this option maximises independence of the System Operator both from market participants and the government. It is the approach taken by the majority of [other countries] and has been demonstrated to work well.” There are, for example, 7 ISOs in the USA, including one for each of the three largest states (California, Texas and New York). In Copenhagen, we met with Energinet.dk, Denmark’s TSO. Energinet.dk is a non-profit enterprise owned by the Danish Ministry of Energy, Utilities and Climate; it has both efficiency and social-welfare objectives.
112.Maxine Frerk told us:
The importance of having an independent system operator, in our view, is that it is independent of Government, as well as independent of National Grid. So if there were an ISO, we would expect it to be a licensed entity that we regulated in the same way as we regulate Grid.
113.Phil Sheppard cautioned against an ISO in the short run, noting that:
If you look at the models used elsewhere in the world, there is a whole raft of market rules that have to work with an ISO, because the incentivisation and the methodology of delivering value to consumers is very different. Injecting that sort of uncertainty into the UK market at this point in time seems counterproductive.
He contended that “at some future point [an ISO] may be appropriate, but certainly not in the short term or the medium term”. We agree with Mr Sheppard that the role of System Operator is complex and important, and should not be changed at a pace that would spook investors or outstrip the speed of appropriate regulatory development.
114.The Minister explained the Government’s position:
We have been very clear from the Secretary of State’s reset speech last November that we would like to see more independence in the system operation. We are looking very closely at what the options are. Those range from “stick with what we have” to a fully independent system operator. We are looking at models elsewhere in the world and the Committee will be aware that in the States they have fully independent system operators. There are strengths and weaknesses of all models and there is a kind of possible “best of both worlds” or you might call it a halfway house, depending on your perspective, where you would have much greater independence but within the National Grid umbrella. We are looking at a number of different options and we will be making an announcement later this year on that, but, rest assured, we are looking very closely at what will be the best system to ensure that there are no conflicts of interest, that there is genuinely the empowerment to be able to meet the challenges of the changing energy landscape and that it will be very clear and very cost effective.
115.We recommend creating an Independent System Operator (ISO). Despite strong efforts by National Grid itself and Ofgem to mitigate the potential for conflicts of interest, it seems intractable and growing. Unnecessary asset development, or giving interconnectors an unfair advantage over existing and emerging balancing tools, could dilute the impact of other efforts to develop low-carbon network infrastructure. We note these concerns may also arise for Distribution System Operators in future. The Government should set out its intentions regarding an ISO as soon as possible, and consult on a detailed, staged plan for their implementation, so as to avoid injecting uncertainty into the energy sector. In particular, it will be important to act in a fashion that retains National Grid’s considerable technical expertise.
116.Whole-systems approaches take general energy objectives, such as decarbonisation or security of supply, and consider actions to meet these objectives across energy vectors (such as electricity, heat and transport fuels), rather than simply within each silo. Whereas individual-systems approaches to climate targets might look only at how electricity or heat may independently be decarbonised, a whole-systems approach would consider how energy supply and consumption could be shifted and balanced between these vectors. Dr David Clarke of the ETI illustrated the basics:
Probably the best thing is to step back a second from the detail of heat and gas networks and so on and say, “Well, we’ve got a set of CO2 targets for emission reductions to try to reduce CO2 by 80% by 2050”. If you look at that the other way round, that says you are emitting 20% of the CO2 in 2050 that you do today. Logically—no great analysis—where would you keep using fossil fuel? Where would you allocate those CO2 emissions if you had to, that remaining 20%? It would be in transport—various forms of transport, on-road, off-road, marine, aircraft in particular. By the time you do that, with a bit of industry emissions as well that you have to accept and probably a tiny amount of power sector emissions, your 20% has gone—you’ve used it.
117.There are concerns that DECC and Ofgem do not currently adopt this whole-systems approach. Sara Bell told us:
The challenge with the energy system is always that we have taken a very siloed approach. Even within DECC, generation sits in one department, demand sits in another, transmission networks in another, and so on. There are very few people with the expertise to look across the whole area, so naturally the optimisation between all of them is not done. For example, when we brought in the feed-in tariff for solar we did not ensure that there was the right incentive to use the solar power on the premises, so distribution networks had to start installing voltage regulation technology. If we had had a joined-up policy, the whole policy could have been implemented more cost-effectively.
Ofgem agreed that a whole-systems approach was “critical”.
118.One mechanism to implement whole-systems thinking would be the creation of a system architect—an organisation responsible for long-term planning of the energy system with a whole-systems approach. Several stakeholders voiced support for such a system architect. Dr Clarke noted:
The overall system design needs to be at a national level. It does need to be considered, and we need to consider it as engineering, economics and consumer acceptance. […]
You then need to recognise that local implementations will be completely different from place to place.
Ofgem felt a system architect would be a step too far: Andy Burgess said “it is about having coherent system architecture rather than necessarily having a single architect”; Maxine Frerk noted it would be “a new body in what is already quite a complicated landscape, with different responsibilities shared between what we do, what Grid does as SO and what Government does”. DECC’s Future Power Systems Architecture project, undertaken by collaboration between the Institution of Engineering and Technology (IET) and the Energy Systems Catapult (ESC), seeks to address some of these questions.
119.Implementing a whole-systems approach could produce better solutions for the kinds of challenges discussed throughout this report. We note Ofgem’s concerns regarding a systems architect, but believe the Government should take any proposal from the Future Power Systems Architecture group seriously, and look for opportunities to work across silos and departments in the meantime. We will continue to investigate the whole-systems approach in our ongoing inquiry into 2020 renewable heat and transport targets.
213 Q29 [Scott Mathieson]
214 Citizens Advice () para 23
215 Citizens Advice () para 24
218 Citizens Advice () para 23
219 ETI () para 31
221 British Gas ()
225 Ofgem, , May 2016
226 ETI () para 28
228 UKERC ()
231 UKERC ()
234 UKERC ()
241 Q258 [Maxine Frerk]
242 Q225 [Phil Sheppard]
243 UKPN () para 5.2
244 Electricity Storage Network ()
248 RWE () para 6.1
251 UKERC ()
256 EMR refers to the Capacity Market, an auction system designed to improve security of supply, and Contracts for Difference (CfDs), a subsidy and price-stabilisation mechanism for renewable generation; these were introduced in the .
258 Ofgem, , Condition C27: The Network Options Assessment process and reporting requirements, para 9
259 Q270 [Maxine Frerk]
260 The Electricity Capacity Regulations 2014 (SI 2014/2043),
263 Citizens Advice () para 30
264 EDF Energy ()
265 Energy and Climate Change Committee, , HC (2015–16) 509, Qq22, 55 [Duncan Burt]
271 Q271 [Maxine Frerk]
273 Rt Hon Amber Rudd MP, , 18 November 2015
274 “Ministers ready to pull the plug on National Grid”, The Times, 3 March 2016
275 Federal Energy Regulatory Commission, , accessed 13 June 2016
282 Q277 [Maxine Frerk]
283 ICE (), REA (), Q43 [Stephen Goldspink]
15 June 2016