Clean Growth: Technologies for meeting the UK’s emissions reduction targets: Government and Ofgem Responses to the Committee’s Twentieth Report of Session 2017–19

Appendix 2: Ofgem Response

Cover letter from Dermot Nolan, Chief Executive, Ofgem.

Ofgem is a non-ministerial government department and an independent National Regulatory Authority, recognised by EU Directives. Our principal objective when carrying out our functions is to protect the interests of existing and future electricity and gas consumers. We do this in a variety of ways including:

We work effectively with, but are independent of, government, the energy industry and other stakeholders within a legal framework determined by the UK government and the European Union.

In Ofgem’s written evidence18 to the committee (October 2018), we set out our position on key issues such as smart systems and flexibility, forward-looking charges and price signals, half-hourly settlement, as well as the role of RIIO and network price controls. Ofgem’s responses to the recommendations in the report19Clean Growth: Technologies for meeting the UK’s emissions reduction targets’ are set out below.

Annex to letter

Recommendation 10

We commend National Grid Electricity System Operator for its ambition to be able to manage a ‘zero carbon’ electricity grid by 2025. This goes significantly beyond the Government’s projections for possible renewable power deployment by 2032, and indicates that any ‘over-delivery’ on the deployment of low-carbon power generation in the 2020s will not be incompatible with the electricity transmission system.

We urge distribution network operators to adopt a similar ambition to National Grid System Operator, of operating a zero carbon grid by 2025. Ofgem should work with distribution network operators to ensure that the regulatory framework required to allow this is in place. If sufficient progress is not made, we urge the Government to consider strengthening Ofgem’s mandate to require the distribution network operators to speed up the investment and upgrading of the distribution networks required.

Ofgem Response

A key objective of Ofgem’s regulation is to ensure that network companies support the transition to a smarter, more flexible, sustainable and decarbonised energy system, taking the appropriate steps to mitigate their own environmental impact. With the UK and Scottish Governments recently agreeing new net-zero emissions targets, and the Welsh Government declaring a climate emergency, there will be an increasing focus on decarbonisation, particularly in the transport and heat sectors. This is reflected in Ofgem’s new corporate strategy, which sets out the key objective of decarbonising to deliver a net zero economy. Ofgem sees its role as an active enabler of decarbonisation, by ensuring that consumer interests are protected in this transition.

RIIO-2, the next round of network price controls20 - which will operate from April 2021 (gas transmission, gas distribution and electricity transmission) and April 2023 (electricity distribution) - will have a critical enabling role in driving better value for consumers by learning lessons from both the current and previous price controls, at the same time as preparing the networks for the energy system of the future. Ofgem is currently setting the next round of price controls. Our aims for RIIO-2 are to prepare our networks for a net zero future, whilst ensuring costs are kept as low as possible for consumers and maintaining high levels of service and reliability. The new price controls should promote the delivery of high quality services at lower cost to consumers, paving the way for a cheaper, smarter, and more sustainable energy system.

As the growth in electric vehicles accelerates and more homes and businesses source their heat and power from cleaner energy sources, a core responsibility of networks will be to facilitate these changes. This means responding to the demands for low carbon connections in a timely way, finding efficient ways to respond to new sources of demand like electric vehicles, heat pumps, and flexibility on the networks, and supporting innovation that could expand the range of possibilities for the decarbonisation of heat, power, and transport. Ofgem’s network regulation also needs to be flexible and prepare for different conditions – but without adding unjustifiable costs to consumers.

Because of the uncertainty about the speed of change, and the infrastructure needed to meet it, Ofgem is considering adding an adjustment and flexible mechanisms into the next network price control. This would allow network companies to scale up their investment within the price control period if changes toward net zero are more rapid than expected- for example, through much higher rollout of electric vehicles or increased certainty on approaches to decarbonise heat.

More generally, Ofgem is also encouraging gas and electricity distribution network companies to start working together and with other stakeholders at a local level, to help facilitate understanding of local solutions for decarbonised heating in the future.

Recommendation 17

Ofgem must consider the interests of future consumers as well as current consumers in its decisions, including the need for decarbonisation. The projected increases in network costs for consumers and businesses that have installed on-site generation and flexibility technologies, arising from Ofgem’s proposed network charging reforms, will act as a disincentive for further consumers or enterprises to install similar technologies. This is not conducive to the overall goal of decarbonisation. However, Ofgem is right to seek to avoid the costs of network usage falling increasingly on vulnerable consumers.

Ofgem must revise its proposed network charging reforms to ensure that they do not disincentivise the deployment of technologies that will contribute to the decarbonisation of the UK’s energy system. The Government must ensure that vulnerable consumers do not pay an increasing proportion of network costs, and that all households have the ability to deploy technologies that will reduce their cost of energy and help to decarbonise the economy.

Ofgem Response

Our energy system is undergoing a radical transformation. We are generating and using electricity in different ways, in different locations, and at different times. To facilitate the energy transition, Ofgem is working to create a smarter, more flexible energy system. We published a plan (with government) for delivering this in 2017,21 and continue to report on the actions set out in the Plan.

There are two types of network charges: ‘forward-looking’ charges which send signals to users regarding their behaviour on the networks by the charges they incur, and ‘residual charges’ which recover the remainder of the total revenues that network companies are allowed to recover.

The current system of residual network charges incentivise users to install generation on their sites, often without an associate reduction in system costs, and in many cases, in places that actually increase the costs of running the network. This is often not smart, renewable technology, but small gas and diesel-fired generators. We want to see a set of electricity network charges which mean that where the use of smart, flexible or renewable technologies leads to savings in the costs of the network, that they share in these savings. However, we also want to ensure that the costs of running the network, that do not change with use, are distributed fairly across all users.

Ofgem have set up a programme of work to reform electricity network charging to ensure they are fit for purpose. Our reforms to access and forward-looking charges, plus our wider work to promote a flexible energy system, will ensure that where market participants can take action to reduce system costs they share in those benefits. The Targeted Charging Review (TCR) is about ensuring users pay a fair share towards the costs of the network existing. Left unchecked, the current system will leave those who are unable to afford or unwilling to invest in smart, flexible energy solutions bearing a greater share of network charges over time. We estimate that our TCR reforms will reduce consumer bills by £4bn-£6bn over the next 20 years, and aim to unlock further savings of £4bn-£15bn through our reforms to access and forward looking charges.

A new framework for charging will help remove distortions which may unnecessarily add costs to energy bills, including to vulnerable consumers, and build a more efficient decarbonised energy system, as the UK pursues its net zero emissions target for 2050.

Recommendation 48

The roll-out of smart meters is one important enabling component of a flexible energy system that can match demand to supply, allowing increased deployment of intermittent renewable power generation. However, the Government’s roll-out is severely behind schedule, in part because the original scheme had fundamental design faults, as highlighted by our predecessor Committee and the then Energy and Climate Change Committee.

The Government must ensure that it takes all reasonable steps to achieve a national roll-out of smart meters as soon as possible. In order to reduce consumer resistance to smart meters, the Government should run public engagement initiatives to raise public awareness that by having a smart meter installed, consumers can contribute to long-term reductions in the UK’s greenhouse gas emissions. Ofgem should require energy suppliers to collect and publish data on consumer acceptance rates for smart meter installation, and the reasons given by consumers for rejecting a smart meter. The Government should then be ready to act on this information to drive greater installation rates of smart meters, for example by introducing a consumer incentive mechanism. It should also require installation of a smart meter in properties without one whenever the owner or enter changes.

Ofgem Response

The industry working group considering the transition to market-wide half-hourly settlement (MHHS) has concluded that a pre-requisite for its success is for a sufficient number of smart meters to be installed before the transition begins.22 We do not believe that the expected profile for smart meter rollout23 will significantly impact the introduction of MHHS.

We expect that the rollout of smart meters and the introduction of MHHS will incentivise suppliers to provide new products and services to their customers, which in turn will help them move their electricity consumption to times of day when it is cheaper to generate and transport. It is this combination of factors, rather than levels of smart meter deployment alone, which will lead to the system savings that we expect to realise from settlement reform.

We are currently developing an Impact Assessment (IA) to consider the costs and benefits of the Target Operating Model24 (TOM), including the impact of different options for the commencement and phasing of implementation. This will include the costs relating to transition to the new systems. In terms of timescales, we are considering three different Implementation Periods (2, 3, or 4 years) starting after mid-2020, followed by the Migration Period (1 year), which includes moving all the meters (both smart and traditional) to the new system.

The IA will feed into the Economic Case of the Full Business Case, which will support our final decision on market-wide half-hourly settlement, and set out the timetable for implementation in the light of the expected costs and benefits (and including any considerations that relate to thresholds for smart meter penetration).

BEIS are currently consulting on a policy framework to continue to drive the rollout post 2020, under which Ofgem would provide regulatory oversight of energy suppliers’ progress against installation targets, taking action in line with our enforcement guidelines. BEIS are also calling for ideas for additional policy measures that the Government could consider to further complement and support the smart meter rollout post-2020. Households who do not switch are currently protected by the default tariff cap. Whenever the price cap is lifted, some backstop protection may need to remain in place for vulnerable or other groups of customers, who may struggle to find a fair price in an increasingly complex digital market, where smart meter-enabled innovations like time of use tariffs become more common. We will carefully monitor the market, including price cap compliance, to consider the case for future price protection, particularly for various specific vulnerable groups. Many consumer groups have particularly emphasised that they want to understand how consumers in vulnerable situations will be protected post-price cap, and have explicitly expressed desire for longer-lasting protections for consumers in financially vulnerable situations.25

Recommendation 49

Market-wide half-hourly settlement of energy consumption costs will incentivise energy suppliers to offer tariffs that reward consumers for using energy when it is abundant, helping to enable higher levels of intermittent renewable power generation. However, Ofgem has highlighted the dependence of market-wide half-hourly settlement on widespread smart meter deployment. Given the low current uptake of smart meters, this indicates that there could be very significant delays in the introduction of market-wide half-hourly settlement and the benefits of widespread ‘smart’ tariff adoption.

Ofgem should clarify what it determines to be the critical mass of smart meters required for market-wide half-hourly settlement. Since the introduction of marketwide half-hourly settlement will help to catalyse smart meter take-up, Ofgem should not set an overly stringent critical mass, and should be prepared to recover the costs of incomplete smart meter deployment from the suppliers of those consumers who do not have smart meters (in a way that protects vulnerable consumers).

Ofgem Response

The transition to market-wide half-hourly settlement (MHHS) has defined a pre-requisite of having sufficient smart meters rolled out before transition can start. We do not believe that the expected profile for smart meter rollout, as recently set out in the BEIS ‘Consultation on a Smart Meter Policy Framework post-2020’,26 lead to delay in the introduction of MHHS.

We expect that the rollout of smart meters and the introduction of MHHS will incentivise suppliers to provide new products and services to their customers, which in turn will help them move their electricity consumption to times of day when it is cheaper to generate and transport. This – rather than an absolute threshold for smart meter installations – will lead to the system savings that we expect to realise from settlement reform.

We are currently developing an Impact Assessment (IA) to consider the costs and benefits of the Target Operating Model27 (TOM), including the impact of different options for the commencement and phasing of implementation. This will include the costs relating to transition to the new systems. In terms of timescales, we are considering three different Implementation Periods (2, 3, or 4 years) starting after mid-2020, followed by the Migration Period (1 year), which includes moving all the meters (both smart and traditional) to the new system.

The IA will feed into the Economic Case of the Full Business Case, which will support our final decision on market-wide half-hourly settlement, and set out the timetable for implementation in the light of the expected costs and benefits (and including any considerations that relate to thresholds for smart meter penetration).

BEIS are currently consulting on a policy framework to continue to drive the rollout post 2020, under which Ofgem would provide regulatory oversight of energy suppliers’ progress against installation targets, taking action in line with our enforcement guidelines. BEIS are also calling for ideas for additional policy measures that the Government could consider to further complement and support the smart meter rollout post-2020. We expect them to hear ideas for financial incentives and penalties as part of this process.

Households who do not switch are currently protected by the default tariff cap. Whenever the price cap is lifted, some backstop protection may need to remain in place for vulnerable or other groups of customers, who may struggle to find a fair price in an increasingly complex digital market, where smart meter-enabled innovations like time of use tariffs become increasingly common.

Recommendation 52

Regulation of UK energy markets will play a key part in the development of a smart and flexible energy system. The RIIO price control framework has helped to support innovation in the gas and electricity networks, but it is vital that the second price control framework promotes even greater levels of innovation as the energy networks undergo a period of significant change.

Ofgem must ensure that its second price control framework does not dilute its support for innovation and that the framework should further enable and incentivise network operators to innovate as part of their core business, rather than through standalone projects. Ofgem should work with network operators, energy suppliers and flexibility services providers to ensure that flexibility systems are always considered and deployed ahead of infrastructure construction, where possible and affordable.

Ofgem Response

The RIIO-1 price control (which runs up until 2021/2023) provides strong incentives for companies to innovate and look for efficiencies within the operation of their network, such as the Totex Incentive Mechanism. The Totex Incentive Mechanism enable companies to retain a financial share of any efficiencies they realise during the course of the price control period. It means any underspend is shared between the network company and its customers. Therefore, efficient spending leads to better returns for investors and lower network charges for customers. Additionally, RIIO-1 provides companies with additional innovation funding through the Innovation Rollout Mechanism, Network Innovation Allowance, and Network Innovation Competition.

One of Ofgem’s key ambitions for RIIO-228 is that network companies fund more innovation as part of their regular activities, and roll out past proven innovations into their business. We have retained the Totex Incentive Mechanism, plus we have also introduced a Business Plan Incentive, and will ensure that the RIIO-2 business plans of companies will be challenged on their level of innovation ambition.

For RIIO-2, we have also decided to replace the Network Innovation Competition with a new innovation funding pot, to focus on strategic challenges related to the energy system transition.

Additionally, for RIIO-2 we have stated that any Network Innovation Allowances that companies will receive will be based on the extent to which the companies improve the public reporting of projects they have funded, including costs and benefits, as well as demonstrating that successful innovation is being diffused across the energy sector.

We are also maintaining existing expectations and requirements for companies to collaborate on network innovation projects with each other, and with third parties. For example, we are maintaining the requirement for companies to create and maintain joint industry-wide gas and electricity innovation strategies, in order to provide strategic direction to their innovation activities.

Ofgem is committed to a technology-neutral regulatory framework, that provides a level- playing field for all flexibility solutions.

Flexibility should be deployed where there is evidence that it is both possible and affordable. Ofgem is encouraging Distribution Network Operators (DNOs) to routinely tender flexibility. Based on this policy push, all DNOs have committed to seek flexibility for any reinforcement.29

We are reviewing how DNOs calculate the value offered to them by flexibility services. We are also placing clear expectations on them to ensure that the price paid for flexibility services accounts for the option value of flexibility, compared to traditional reinforcement. Full assessments of option value should account for the benefits of avoiding reinforcement costs where load growth does not meet projections. They should also account for future technologies that may be able to meet network and system needs at a lower cost than traditional reinforcement.

Ofgem is also driving increased transparency within DNOs, encouraging them to publish their decision-making processes externally, to ensure that there are no conflicts of interests in the decisions they take.

We are driving policy through licence conditions to ensure that the key enablers required to establish flexibility markets are delivered by DNOs. This is in response to recent recommendations from the Energy Data Taskforce.30

We are working with stakeholders across the industry to make sure these reflect the needs of users. Going forward, Ofgem will be hosting an industry stakeholder workshop in November on flexibility, flexibility valuation, and the coordination of flexibility services.


18 Written evidence submitted by Ofgem (October 2018): http://data.parliament.uk/writtenevidence/committeeevidence.svc/evidencedocument/science-and- technology-committee/technologies-for-meeting-clean-growth-emissions-reduction- targets/written/92053.html

19 Clean Growth: Technologies for meeting the UK’s emissions reduction targets (August 2019): https://publications.parliament.uk/pa/cm201719/cmselect/cmsctech/1454/145402.htm

20 RIIO (setting Revenue using Incentives to deliver Innovation and Outputs) is Ofgem’s price control mechanism for gas and electricity networks

21 Upgrading our energy system: smart systems and flexibility plan (2017) | https://www.gov.uk/government/publications/upgrading-our-energy-system-smart-systems-and-flexibility-plan

22 The Design Working Group, chaired by ELEXON, submitted their final report on the Target Operating Model and Transition to Ofgem in August 2019. The document can be found here: https://www.ofgem.gov.uk/system/files/docs/2019/10/dwg_final_report_stage_2v1.0.pdf

23 Smart meter policy framework post-2020 (September 2019): https://www.gov.uk/government/consultations/smart-meter-policy-framework-post-2020

24 Design Working Group preferred TOM report (February 2019): https://www.ofgem.gov.uk/publications-and-updates/design-working-group-preferred-tom-report

25 Before we would recommend to government to lift the Default Tariff Price Cap, we will assess if Conditions for Effective Competition are in place in the market, as set out in our published framework. We will consider whether customers who appear to be in vulnerable circumstances due to financial or other reasons are in need of additional price protection.

26 Smart meter policy framework post-2020 (September 2019): https://www.gov.uk/government/consultations/smart-meter-policy-framework-post-2020

27 Design Working Group preferred TOM report (February 2019): https://www.ofgem.gov.uk/publications-and-updates/design-working-group-preferred-tom-report

28 RIIO-2 Sector Specific Methodology – Core document (May 2019): https://www.ofgem.gov.uk/system/files/docs/2019/05/riio-2_sector_specific_methodology_decision_-_core_30.5.19.pdf

29 Energy Networks Association’s Flexibility Commitment (December 2018): http://www.energynetworks.org/assets/files/ENA%20Flex%20Committment.pdf

30 Delivering Energy Data Taskforce recommendations (July 2019): https://www.ofgem.gov.uk/publications-and-updates/delivering-energy-data-taskforce-recommendations




Published: 1 November 2019