Unrevised

Members present

Earl of Selborne (Chairman)

Lord Broers (co-opted)

Lord Dixon-Smith

Lord Hennessy of Nympsfield

Baroness Hilton of Eggardon

Baroness Manningham-Buller

Lord O’Neill of Clackmannan

Lord Patel

Lord Peston

Lord Rees of Ludlow

Viscount Ridley

Baroness Sharp of Guildford

Lord Wade of Chorlton

Lord Willis of Knaresborough

Lord Winston

_________________________

Examination of Witnesses

Rachel Fletcher, Senior Partner for Markets, Ofgem, and Maxine Frerk, Senior Partner for Smarter Grids & Governance: Distribution, Ofgem

Q176 The Chairman: I welcome our two witnesses from Ofgem. Thank you for joining us this morning. We are being broadcast, so I am going to ask now for the record if you would introduce yourselves. If either of you wants to make an opening short statement, please feel free to do so.

Rachel Fletcher: I am Rachel Fletcher. I am the senior partner for markets at Ofgem. Among my responsibilities is the analysis of security of supply and the regulation of National Grid as a system operator.

Maxine Frerk: I am Maxine Frerk. I am the senior partner responsible for all aspects of regulation of the distribution network companies.

The Chairman: And you are happy that we go straight into the questions now?

Maxine Fletcher: Yes.

Q177 Lord Patel: My question relates to who is ultimately responsible for maintaining the resilience of the UK’s electricity supply. Within that, what is the role of Ofgem, and how does that relate to the Government, National Grid and the electricity generation companies?

Rachel Fletcher: Your question actually partly answers the first part of your question. Really, responsibility relies on the interactions of several parties—namely, government, industry and us as regulator. Put very simply, the Government’s role is to set overall policy objectives, including, in the case of security of supply, what we call the reliability standard. Industry’s role is to deliver that security of supply, but it works within a framework that we as a regulator set to ensure value for money for consumers and quality of service in the delivery of the networks and the overall operation of the system.

Lord Patel: Maxine, would you like to answer before I come back on that?

Maxine Frerk: My answer is basically the same.

Lord Patel: So if the lights go out, who do the citizens blame?

Rachel Fletcher: It is really important to say that we have enjoyed a huge degree of system resilience and reliability in Great Britain, and I have no reason to suspect that that resilience is any less going into this winter than it has been in recent years. However, if the lights were to go out and we were to have uncontrolled consumer disconnections, I am certain that there would be a very careful review of what led up to that point, and questions would be asked about whether the level of risk in the Government’s reliability standard was still appropriate for the country as a whole. Questions would be asked about our role and whether we had stood in the way of any actions by the companies in the market, and about the way the market and the system operator performed. The short answer is that it would depend on what had led us to that situation.

Lord Patel: I am tempted to ask what your answers would be to all those questions.

Rachel Fletcher: Well, I am pleased to say that the lights have not gone out. It would depend on the specifics. For example, if something completely predictable had happened on the system and no appropriate measures had been put in place to address that, really serious questions would be asked of National Grid as system operator and of Ofgem. The situation at the moment is that several years ago we saw a tightening in electricity margins on the system; we foresaw the situation this year and next year in particular, and we took measures and put in place supplementary balancing reserves, particularly to protect the levels of resilience and to keep them within the reliability standard that the Government have set.

Q178 Lord Hennessy of Nympsfield: Can I follow up on your roles? We have had plenty of evidence about the 4% margin over the next two years that you have just referred to. It seems to an outsider to your world like me that there is a very thin blue line of electricity between us and potential outage and social and industrial dislocation on a considerable scale. That is very visible once it starts happening, and it would make the political weather. Do you as regulators have a duty to protect not just the citizen as consumer but in the wider sense of speaking truth unto power? Have you had occasion so far—and would you do this in future if you had such occasion—to warn publicly that that thin blue line of electricity, the 4%, was simply inadequate? Is the regulator in a position—in fact, I cannot think of anyone else who could do this on behalf of the consumer—to say that and make it public? And would you?

Rachel Fletcher: Absolutely. Every year we publish what is known as a capacity assessment, where we provide a forward look of expected margins on the system over a four-year or five-year period. We work very closely with National Grid in doing that, but effectively our role is to provide a robust challenge to the assessment that National Grid is making, and to take a view ourselves on what margins are likely to look like and what risks and sensitivities there are around those projected margins. It was precisely because we were doing that work that towards the end of 2012-13 we started talking about the need for the supplementary balancing services that have been put in place for the middle of this decade. So yes, we see it as our role to look ahead, spot issues and then try to do everything in our power, working closely with the system operator, to ensure that that resilience is maintained. Once we get further into the end of this decade, the Government, through their capacity market and as part of the electricity market reforms, have already taken legislative powers to introduce a new mechanism to deliver the margins and the security of supply that we need as a country. That slightly dilutes the role that Ofgem has once you look towards 2018 and further ahead, but certainly in the intervening period, yes, we see that as our role.

Lord Hennessy of Nympsfield: But 4% is not enough. You are the security of supply person at Ofgem. Is it your personal view that we are on too thin a margin?

Rachel Fletcher: The Government’s reliability standard is our touchstone here; overall it is a political decision about the trade-off between resilience and cost, and the Government have made that decision themselves—rightly, in my opinion—and set that in legislation. Four per cent is about the right margin, with today’s mix of generation, that you would need to meet that standard of three hours’ loss of load expectation. When you look even six to eight months ahead and you are trying to project what the margins might be, there is always a degree of uncertainty about what is going to happen to demand and to generation plant. When we did that look ahead towards the end of last summer, there was even more uncertainty, given that we had had a number of fires and of course the Hartlepool and Heysham plant had come offline because the crack in the boiler spine had been detected. In that context, then, and given the uncertainty around the margins we were likely to have this winter, we felt that it was appropriate that National Grid went ahead and procured a supplementary balancing reserve, which has effectively dealt with that level of uncertainty and brought margins on the system to within a more comfortable range.

Lord O'Neill of Clackmannan: Is it therefore the case that the buck does not stop with you or with Ofgem but with the Government, because they have set the target of a three-hour shut-off minimum? Is that correct?

Rachel Fletcher: As I said before, it would have to depend on the specifics.

Lord O'Neill of Clackmannan: But how do the Government come to the judgment that this is what is required? How do we get from the Government’s decision to 4%? How do they come to their decision? I am not very clear. You are saying that National Grid thinks we can do it and we think we can do it, but is it at the right level in the first place? Or do we have to ask the Minister?

Rachel Fletcher: That would be a question for the Minister. The methodology that they have used is a widely accepted one—

Lord O'Neill of Clackmannan: Accepted in the UK or, let us say, in Europe?

Rachel Fletcher: Internationally. The methodology that they have used has involved estimating the value that consumers put on security of supply, and I think people in this room will appreciate that that is not a straightforward thing to do. They have applied a methodology to put a value on what we call “value of lost load” and then, using that value, to work backwards to a reliability standard, which is then translated into a margin of around 4% with today’s generation mix.

Q179 Lord Peston: Following Lord Hennessy’s point, you seemed to be answering his question in terms largely of the variance of demand causing the problem, given the available supply. What about turning this on its head? Is there a serious problem with the variance of supply? To take an extreme example, the 20,000 householders who still do not have any electricity in Scotland could say, “Well, someone ought to have put all those pylons underground”, to which the answer is, “That’s so expensive that it’s not worth while delivering electricity to you”. Would that be the right answer?

Rachel Fletcher: The reliability standard that the Government have set relates specifically to generation capacity and the adequacy of it to meet consumer demand. There are then separate questions to be asked about the standards to be used when investment is being made in networks, which perhaps it would be better for Maxine to answer.

The Chairman: So we are talking about different standards for distribution and generation, are we?

Rachel Fletcher: Yes.

Maxine Frerk: On the distribution networks, and indeed networks in general, again, the Government set standards that say, for example, that gas networks are designed to anticipate a one in 20 worst level of weather in winter. In terms of the technical standards for designing the networks, the Government set the level of resilience that they require. Through our regulation, we give the companies incentives. The issues in Scotland are how many operational staff you have and how quickly you can respond. In fact, everyone is now back on supply in Scotland.

Lord Peston: Are they? Oh, that is good news.

Maxine Frerk: They were connected last night. In some sense, in what was quite a difficult situation given the severity of the weather, that was a good response. Within the price control regulations the companies have incentives, and they can either earn money or lose it depending on how many interruptions they have during a year. They also have to pay compensation to customers, which again gives them an incentive to reconnect. Those are all set through a process of consultation with stakeholders when companies develop their business plans that they put to us.

Lord Peston: To go back to the question of where the buck stops, which is what got us started here, do I understand it that if, say, you are consumer in Scotland and you have pylons delivering your electricity so you know that you might be in trouble in bad weather, the people to whom you have to address remarks are the Government, not you. Is that right?

Maxine Frerk: No.

Lord Peston: If I want my electricity to come underground—

Maxine Frerk: That is more about the business plans that the companies are putting together. You would be putting your case to the companies as they develop their business plans, but they would be saying, “Are you willing to pay the costs of having that undergrounded?”. Companies have typically done work around their worst served customers. For example, people on the remote islands in Scotland have not had any transport for the last 48 hours either. There is a balance that they have to make regarding how much they are willing to pay to ensure that they could always be guaranteed levels of service. That trade-off is made through the process of consulting local stakeholders.

Lord Peston: So the answer that you would give is that if you want to go and live on an island off Scotland, you have to pay for it?

The Chairman: It is called the island mentality, I think.

Maxine Frerk: Various costs are recovered across all customers in that company’s distribution areas, not specifically from remote areas.

The Chairman: Can I move on to Viscount Ridley?

Viscount Ridley: I was not trying to catch your eye.

The Chairman: No, but I have you down as asking a question.

Q180 Viscount Ridley: And I will quickly find it. While I am doing that, my sheep-farming friend on the Isle of Coll says that he is running out of card games to play by candlelight. The question is about Ofgem’s capacity assessment showing that the capacity margin will be squeezed over the next two winters. How is that expected to affect the resilience of the electricity system? This covers some of the ground that we have gone over already.

Maxine Frerk: My answer is that it is not expected to affect the resilience of the system because we have already put in place arrangements for National Grid to purchase a supplementary balancing reserve, which brings us to the kind of level of resilience that we have been used to having on the system over the past few years.

Viscount Ridley: Have you been getting accurate enough information about the status of plants, with regard to the unplanned outages that we have seen, to be able to deal with and unmothball mothballed plants and things like that?

Maxine Frerk: We get very good near-term or short-term information through a number of different sources. Some of it is just through our own surveillance about what is happening, but the companies themselves, through new European legislation that tries to ensure that we have transparent and well functioning markets, have to publish notifications of unplanned outages and mothballing decisions, for example. That provides us with an even better source of intelligence than we have been used to getting. We share the intelligence that we have with National Grid and DECC, so between the three organisations we are pooling the information that we have. That meant, for example, that when it came to deciding how much supplementary balancing reserve the National Grid should be purchasing for the 2014-15 winter, those decisions could be made on the basis of good, accurate and up-to-date information. When things become a bit less accurate, of course, is when you start looking several years ahead. That is why our own capacity assessment has sensitivities within it to account for that degree of uncertainty, particularly about what is going to happen to supply over a two or three-year time horizon. I have to say that one of the things that will help us in doing that now with a bit more certainty is that the capacity market, the first auction of which has just been run, helps to reveal information about which plant you might expect to be on the system come 2018 or 2019, so that already begins to make our job and the job of National Grid that bit easier.

Viscount Ridley: Is the unmothballing of plants proving easier or harder than expected? Maybe that is too general a question, but do we have experience of bringing back a gas plant that has been mothballed for a few years?

Maxine Frerk: You are getting into a level of technical questioning that is a bit beyond my own knowledge, but certainly when National Grid went to procure new balancing services, some of the most competitive plant was plant that was currently on the system rather than plant that had to de-mothball. It is certainly the case that the longer a plant has been in mothballs, the more expensive it is to bring it out and the more technical uncertainties there will be about that plant’s reliability.

Q181 Baroness Sharp of Guildford: My question follows on from the discussion we have just been having. Do you feel that we now have the right policy framework in place to ensure that the electricity system resilience is sufficient in the short and long-term? In the short term, is the right balance being struck between supply and demand measures in the national balancing services being implemented by National Grid? In the medium term, is there a risk that the capacity market will support too much capacity and cost consumers more than it should? For example, why do suppliers all receive the price at the marginal bid, whereas they may well have bid at a much lower price? Do the capacity market arrangements fail to encourage sufficient demand-side response and the use of interconnectors rather than the supply-side response here?

Rachel Fletcher: I will take that question in chunks because there are a number of dimensions to it. I think we have the right policy framework in place in the short and medium term, with the combination of the new balancing services and the capacity market. However, and I think your question alludes to this, there are a number of dimensions to the capacity market policy design that are still work in progress, particularly the participation of demand-side response and interconnectors in the capacity market. As a regulator, we are certainly very keen to see those elements of the capacity market design become firmed up sooner rather than later. As an organisation, we believe fervently in the potential of demand-side response to provide a cost-effective way of helping us to meet resilience on the system. While the Government have taken many good steps already—for example, there is a transitional option for new forms of demand-side response that the Government will be running towards the end of this calendar year, and that is a good way of trying to provide a testing ground for demand-side response; there are still some questions, particularly around the duration of contracts that are up for grabs for demand-side response in the main capacity market, which are limited to one year. There is some thinking to be done by the Government about whether the same principles that have been used to decide on the duration of capacity market contracts for generation should also be applied to demand-side response.

The Chairman: Why is the timescale so much shorter for demand-side response than it is for these other management contracts?

Rachel Fletcher: When you talk about timescales, I am not quite sure what you mean.

The Chairman: You are talking about one year for demand-side management contracts, whereas that would not feature on the new balancing services, where you would expect a longer term.

Rachel Fletcher: This is really the question I am raising about the capacity market and some future design issues that need to be considered by the Government about the way that market works. As I said, there is—in our mind, at least—a need for the Government to go back to first principles and say, “We should be applying the same principle to all participants in the capacity market, whether they be generators, demand-side response providers or indeed interconnectors, when it comes to deciding the duration of the contract that is on offer”. Another area for the Government to consider is, as your question alluded to, the role of interconnectors. The Government will be including interconnectors in the 2015 capacity option, but all the work that they have done in bringing them in for the 2015 option has raised a number of questions, particularly around the fact that interconnectors are technically different from generators—for example, they export as well as provide imports and contributions to security of supply.

Baroness Sharp of Guildford: The evidence that we received before Christmas certainly indicated that there was potentially a considerable development in the use of interconnectors that we could look to over the longer term.

Rachel Fletcher: Absolutely. We agree very much with the thrust of what the Government are trying to do. When it comes to procuring for resilience, the contribution that interconnectors make needs to be taken into account, whether that is deciding how much generation you procure through the capacity market or allowing interconnectors somehow to participate in the market itself. Some of the fine design details of how you do that still need to be worked out, and we are keen to work with the Department for Energy in working up those design details.

Viscount Ridley: I have a quick point regarding interconnectors. I was looking at some data the other day showing how the interconnector with France has been operating. It is nearly always flowing into this country pretty much full-bore, but there was a period when it suddenly flowed out of this country for a few weeks about two years ago. When you drill down into what was going then, you find that it was very cold in Germany. The huge German demand for power was drawing a lot of electricity out of France, France suddenly had a need and it started drawing electricity from us. Is it possible that there are conditions under which interconnectors could increase our problems by making demand greater elsewhere even when our own demand is greater, and could reduce reliability?

Rachel Fletcher: It is absolutely possible, which is why there is still unfinished business in the design of the capacity market. The way interconnectors flow is set out by European rules. Those rules say, effectively, that interconnector flows are determined by price differences on either side of the interconnector. So in the situation that you have just explained, where the prices on the continent might be higher than ours, it is to be expected that the interconnectors will export to the continent, not import. Generally, that would be of no concern—I think it is how we would all expect interconnectors to behave—but it creates technical difficulties when it comes to assessing the extent to which you can rely on interconnectors to provide you with a contribution to resilience when you most need it at times of system stress. Indeed, that is an exercise that the Government are going through with regard to their current investigation into what they are calling the appropriate de-rating factor to apply to interconnectors that might participate in next year’s capacity option.

Lord Wade of Chorlton: How is that decision made? Is it an automatic decision by computer, or does someone make it?

Rachel Fletcher: It is an algorithm.

Lord Wade of Chorlton: So once the interconnector goes one way or the other, someone looks at the price list and it is decided automatically. There is nothing that anyone can do about it.

Rachel Fletcher: With one exception, which is—and you may already have heard this from National Grid—that the system operator has contracted for what they call emergency services on the interconnector. So if we are in a particularly tight situation, National Grid can call on emergency interconnector support into Great Britain, but that would not be a normal functioning of the market; it would be National Grid intervening and taking emergency measures.

Q182 Lord Winston: How is resilience taken into account by Ofgem’s regulation of the transmission and distribution networks? How does the RIIO model work? Indeed, does it work?

Maxine Frerk: If you look back over time, we have had a good record with our regulation of the networks delivering improved resilience. Over the past 20 years, customer interruptions as a result of network problems have fallen by 30% as a result of the incentives that we are putting on the companies. RIIO was an attempt a few years ago to look at how we would update network regulation, recognising the increased challenges that we have as the networks have to evolve a lot to cope with more distributed generation and the challenges that you as a Committee have been talking about. RIIO stands for “revenue”, which is the revenue that the companies get from running the networks, which is determined by a set of “incentives, innovation and outputs”. We are trying to ensure that there was a real emphasis not just on how much revenue the companies are allowed but on what they have to deliver on that revenue. In terms of resilience, in the short term they have a mixture of sticks and carrots regarding getting the number of interruptions and minutes lost down; if they outperform the targets we have set they can earn additional revenues, but if they fall short they lose revenue. As I said before, they also have to pay out to customers under the guaranteed standards. That puts incentives on to the companies to make their networks as resilient as possible and to respond when issues arise.

Maxine Frerk: So we try to ensure that companies put forward to us business plans that they have consulted their stakeholders on, that are well justified and that include what they can do in terms of network performance and in terms of cost. We look across the different companies and benchmark them, looking at what stakeholders are feeding through in response. As part of the framework, to ensure that they are not just taking short-term efficiency measures, effectively cutting the maintenance of the network, we have medium-term network output measures that they have to achieve, which is us effectively looking at their asset health at the end of the price control periods to ensure that it is in a better condition at the end of the period than it was at the beginning in terms of the resilience of those underlying components, and incentives around innovation to get them to look really longer term and think about proposals and put them forward to us, for which they can get innovation funding, to explore the impact of increased distribution generation and how they might run their networks in a smarter way to ensure that they are really thinking about how to get that resilience right into the future.

Lord Winston: We heard some evidence that the recent price control settlement for National Grid was “highly challenging”. I wonder whether you would comment on whether there is a risk that the price control may prioritise efficiency over resilience.

Maxine Frerk: I think companies will always say that their price controls are challenging. In the session that you had with them, they accepted that they could meet those efficiency standards and still meet their licence obligations through that price control. In fact, for the first year of price control on the electricity transmission side, we had allowed National Grid £1.8 billion of revenue, and they have spent only £1.4 billion. They may have said that it was challenging but they have looked at how they can engineer and restructure their procurements in order to deliver very big efficiency savings. Clearly, we then need to ensure that that is not being done—because they benefit from having come in below our allowed revenues—at the expense of letting the networks deteriorate. We will be holding them to account for the outputs that we have set, and that is how we ensure that. The regime gives them an incentive to drive for efficiency, and then we hold them to account for delivering the outputs to ensure that they are not simply cutting costs.

Lord Winston: To come back to the 4% margin, we had some evidence from John Roberts of the Royal Academy of Engineering, who had looked at two episodes, one in December 2010 when there was 10 days of very cold weather and the other in May 2008 when two major power stations had operational problems. He asks, “What would happen now if there was an extraordinarily cold spell? How do we cope with that?”. The question really is the 4% margin again, of course.

Rachel Fletcher: The loss of load expectation, the Government’s reliability standard, effectively has to be met in a range of different scenarios. It is not a standard that the Government look to be met in a normal winter, because actually there tends to be no such thing as a normal winter. That in particular is why, when we ran the numbers for the current winter and factored in cold weather or further mothballing, for example, we felt that it was prudent to allow National Grid to purchase the new balancing services so that it had that extra tool, particularly to manage those more extreme scenarios. The other variability on today’s system, of course, is how much wind varies, which is another factor that was taken into account. A low-wind scenario is another scenario that has effectively been covered through the procurement of those new balancing services.

Lord Rees of Ludlow: Following up on those stress tests done by Dr Roberts, one new issue is going to be cyber threats. Here the past is no guide to the future at all, and I wonder if there is any concern that this might be an aggravating threat—more to the distribution network than to generation, I guess—and whether, in the light of that new possible threat, you feel that the safety margin is adequate and indeed if the Government’s requirement of three hours is indeed the right parameter.

Maxine Frerk: I think you are right: obviously, you can have a cyber threat either to the networks or to individual power supplies. As Rachel set out in the beginning, in terms of the roles of the different parties, companies are responsible for ensuring that they put the necessary protections in place, but this in particular is an area where the Government, because they have much more of an understanding of potential threats and inside knowledge, will set out certain steps that need to be taken by the companies to deal with cyber threats or indeed any kind of threats. Our role is to ensure that companies are allowed the expenditure through their price controls. Because this is an area where things can change very rapidly, on the network side one of the specific reopeners is where the companies can come to us and ask for additional money in the middle of a price control if they need to in order to deal with any of those kinds of issues.

Lord Rees of Ludlow: But who does stress tests on this part of the system?

Maxine Frerk: It is for the companies to work out that they have appropriate protections in place to deal with threats and knowledge. The Government will give them the best information that they have about the types of threats that they may see emerging.

Rachel Fletcher: The Government have also specified what they call critical national infrastructure and put particular measures in place that they would like on that infrastructure. Again, the delivery of those measures and the fine design of them would be for the companies themselves but, as Maxine says, it is our role to ensure that the cost that consumers pay for any of that work is efficient.

Q183 Lord Hennessy of Nympsfield: From your stress testing work and the results that you have seen, what are your single greatest worries about all this, on an individual basis, given the duties that you have?

Rachel Fletcher: From my point of view as the senior partner for markets, the biggest challenge that I see is less to do with short-term resilience and more, now that we have the electricity market reforms in place, to ensure that those reforms and the overall electricity market work harmoniously together to keep costs down for consumers, as well as to provide goods investment signals and operational signals. We have come over a hill, if you like, in concerns about resilience. That is not to say that there are no risks at all because no system can ever be 100% reliable, but I feel confident that we have the right policy arrangements in place in the short and medium term for resilience. The real question is more than one of not losing sight of the important role that the wholesale market itself plays in providing investment and operational signals and ensuring that we do not lose the important role that that market can play, with all the inevitable attention that there has been on implementing the capacity market and EMR more generally.

Maxine Frerk: On the network side, clearly the networks are vulnerable to weather. In my new role, I pay a lot more attention to the weather forecast than I used to. Sometimes you get stress testing, and indeed we have had stress testing in Scotland this weekend. The bits that worry me therefore are the things that we do not have the chance to test very often, or indeed have never had the chance to, such as an emergency that spans a much wider area and goes beyond the energy networks. A major terrorist incident in London, for example, would have ramifications for the energy networks but would have much wider ramifications too. In some sense that is beyond my remit, and obviously thinking about those kinds of issues is the kind of thing that the Government do through their E3C committee and others. Those are the kinds of scenarios that we do not have the opportunity to stress test in reality, but we have emergency planning, role-play situations and other things to try to understand what to do in those situations. Clearly, though, we have never had to work through one, so we have not seen what would actually happen in that kind of situation.

The Chairman: But the weather-related issues on distribution that you refer to are not always wind and storms; they could be flooding. Were you in post last year when flooding in the south-west was a major issue? Did that stress the system and cause problems?

Maxine Frerk: I was not, but I was involved in the investigation that we did to follow up on that. It was an example where, although there were exceptional circumstances last Christmas and the people working on the ground were working in difficult conditions, the companies did not do all that they could have to communicate with customers to anticipate the weather. We have made sure that the lessons were learnt from that experience last winter, and what we saw this weekend—we have not yet had a full review, but this is my sense of it—showed that a lot of those lessons were learnt regarding, for example, communication with customers. We have had a much better experience this time around than we did with the storms last Christmas.

Baroness Manningham-Buller: You have partly answered the question about what lessons were learnt from last Christmas, but I would like to pick up on a particular one under that heading. You referred earlier to all the distributors having business plans. Why did you reject all but one of them?

Maxine Frerk: That is a glass-half-empty or glass-half-full type of question.

Baroness Manningham-Buller: I did not realise it was.

Maxine Frerk: In the way that we used to do price controls, we always went through a number of rounds with the companies when they put forward their initial proposals, such as consulting on draft determinations. One of the aims of the RIIO framework was to try to get companies to put in better plans up front. Now we have the ability to fast-track companies; if the first plan is really good, they can be saved all the effort of going through the iterations they used to have to go through and can get on with running their businesses. I would look at it and say that we were very pleased to find that one company, WPD, put to us a sufficiently good business plan that we were able to fast-track it and it did not have to go through that process. We continued to scrutinise the business plans of the other companies and do the benchmarking and all the other analysis that we have traditionally done. That was justified as, in that part of that process, the difference between what they initially put to us and what we put out in our final proposals was £2.1 billion in efficiency savings that we were able to identify. We rejected their business plans but that is not necessarily a criticism; that is much more the normal process. The unusual ones were the ones that were able to fast-track because they were good enough.

Q184 Baroness Manningham-Buller: Thank you for that explanation. I want to ask about the Low Carbon Networks Fund. Is it sufficiently incentivising companies to invest in smarter, more responsive grids?

Maxine Frerk: I absolutely believe that it is. To recap, the Low Carbon Networks Fund is money that we made available through the last distribution price control; £500 million was available for the companies to bid for if they had proposals for new innovative solutions that they wanted to test out. When I went up to Aberdeen last year for the annual conference, I had a really positive reception and positive comments from small companies that are part of that infrastructure, as well as from the distribution network companies themselves, about the fact that we were enabling all this innovation, and there were huge numbers of stands demonstrating all sorts of different products that are coming forward. This has put GB in a really strong position in Europe. Having been relatively behind the curve, we are now one of the leading countries in Europe on that smarter agenda, whether it is storage, how to cope with more renewables or managing frequency. We do not have the Low Carbon Networks Fund but we now have an equivalent, the network innovation competitions, which cover transmission and gas as well, so that we can begin to look a little more across the piece, not just at the distribution networks.

Baroness Manningham-Buller: And how do you decide which of these splendid innovations are the ones you, or the companies, are going to run with?

Maxine Frerk: So we have an annual process where companies can put forward proposals. We have an external panel of experts, a mixture of academics and business people, who form a view based on those proposals. Last November we approved eight additional projects at the network innovation competition and rejected two of those that had been put forward to us because they had not given enough evidence. Having been positive about this, though, I do not want to sound complacent, so we are carrying out a review, which will be kicking off very shortly, looking back at the experience of the Low Carbon Network Fund to see if there is more that we could have been doing or different criteria that we could have been applying to take forward that learning into how we run the network innovation competitions in future.

The Chairman: You said that you were impressed by the innovation opportunities that you saw in Scotland. Taking a different utility sector—water, for example—I have often heard it said by small SMEs, or spin-outs from universities, that it is very difficult sometimes to get the large undertakers to take seriously some of the innovative ideas coming out, particularly in the field of IT regarding monitoring systems, leakages and the like. Is this to any extent true in the electricity generation sector? After all, you have the same problem of large incumbent organisations, very often not always exposed to the sharp cutting edge of what is going on in the university sector spin-out companies—or are you confident that they are open to innovative ideas?

Maxine Frerk: I think our innovation fund has had a big impact in that space. A number of small companies and academics are involved in supporting some of those bids. There is also an organisation, which we played a role in helping to get set up, called the Energy Innovation Centre, which acts as a broker between those rather big and perhaps unapproachable distribution network companies and small parties. That is one of the steps that we took a while ago to try to help, and to do a bit of matchmaking, to get those organisations talking to each other. I am not saying that we have got it all right—I know that there are issues with intellectual property and other areas that have been raised with me that can make life harder for small players, and that is the kind of thing we want to look at as part of our review—but we have a good track record here in having got a lot more small players into the innovation space in energy.

Q185 Baroness Hilton of Eggardon: To follow on from that question from the Chairman, it has been suggested that a systems architect is needed to co-ordinate better and drive strategy forward. Do you think such a thing is necessary? Could Ofgem fulfil that role? If so, would you need additional functions, powers and legislation to carry it out, or do you have sufficient already?

Maxine Frerk: We absolutely recognise the problem being described, which is that as we move from a very centrally planned and very stable system to one that is much more distributed and complex, we need to look end-to-end across the system at distribution, transmission and the things that are being attached to the distribution network. I would be very reluctant to have another organisation set up, because the big issue is always accountability. Already, as we discussed earlier, there is the question of what DECC’s role, our role and National Grid’s role is, and having another party in the space would only risk further confusing that accountability.

The systems architect that has been described is much more on the engineering side. We have engineers in Ofgem, but Ofgem is essentially an economic regulator looking at the framework, so there are elements of what we do that can help to contribute to that space. Something that we have been talking about internally is National Grid’s own role as the system operator. We have some proposals out at the moment that we are consulting on, such as an enhanced role for National Grid as SO that would require it to be more proactive and think more about planning further ahead, rather than simply being a reactive organisation. We have two codes at the moment, which the IET may have talked about: the grid code and the distribution code. You need things that look across the piece of those two codes and some of their challenges. We have already had examples of where they have been able to set up a joint work group to look at the question again. I think one of your previous witnesses talked about inertia and the impact that having more distributed generation had on the rate of change of frequency—again, those are some technical issues within the network—and the two code panels were able to work together to solve that. Within Ofgem, we can look at whether we should be doing more to formalise those sorts of arrangements. There are things that we should be doing and more discussions that we can have through the Smart Grid Forum, which brings different parties together to look at some of the future challenges. There are elements of what is needed from a systems architect that are happening in different organisations, and it is probably more about ensuring that we have all those covered and thinking about the roles of the grid in that space and the way we manage some of the code panels. That could go a long way towards addressing those issues without creating another body.

The Chairman: Thank you. We have reached the end of the session. We are most grateful to you both for your help. You will of course get a written transcript of the proceedings, so do correct any minor errors. If there is any further information you wish to impart to us in writing, please feel free to do so. Thank you very much for your help.