Written evidence submitted by Ofgem (CGE0033)

 

About Ofgem

Ofgem[1] 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.

 

Summary of key points

  1. As an independent regulator, Ofgem does not have a role in deciding which technologies should receive support from government. We also recognise, as the Committee does, the considerable uncertainty about which technologies will make the biggest contribution to carbon reduction and the different pathways to a low carbon energy system.
  2. Ofgem’s role is to design and regulate markets and networks which incentivise the lowest cost transition to a low carbon energy system whilst remaining technology neutral. Although not the focus of this enquiry, we want to ensure that we are enabling a low carbon transition which benefits gas and electricity consumers including those in vulnerable situations.
  3. Integrating low carbon technology into distribution and transmission networks at the lowest possible cost to consumers means developing the efficient use of flexibility. We are developing changes to charges for use of and access to the network, getting the right regulatory framework for newer technologies like battery storage, and creating the right incentives on network operators to innovate and use flexibility.
  4. Ofgem are focussed on the key enablers, like half hourly settlement, which create opportunities for new business models and technologies. We are also removing barriers to market entry, addressing competitive distortions, and exploring the role of data in particular.

These reforms are set out in more detail below. We would be pleased to provide the Committee with further information if it would be useful.
 


Smart Systems and Flexibility

  1. Ofgem has a key role in the development of a flexible power system. We have set out the specific steps we think necessary to deliver this in our ‘Smart Systems and Flexibility Plan’[2] which we developed in collaboration with the Department for Business, Energy and Industrial Strategy (BEIS). The three main areas for action are:

 

  1. As our energy supply becomes cleaner it is also becoming more intermittent and more decentralised. This poses new challenges in making sure the electricity system efficiently balances supply and demand and manages network constraints. In the future all grid users will be able to adjust their production or consumption in response to price signals and prevailing network conditions. In the past the system has relied on larger, transmission-connected fossil fuel power stations to do this. In future smaller distribution-connected generators, storage operators, and end users will increasingly also do so. There will be financial benefits for doing so.

 

  1. These newer sources of flexibility can contribute to balancing the system in the short term but also reduce the need for costly network reinforcement. This might include:

 

  1. Ofgem’s approach is firmly rooted in markets and competition. We want markets to reveal prices that lead to efficient system-level outcomes and investment, whilst ensuring flexibility providers receive the value of the services they can provide. We are committed to a regulatory framework that is technology-neutral, and provides a level-playing field for all flexibility solutions.

Forward looking charges and price signals

  1. Network charges have two distinct parts to them:

 

  1. Accurate price signals about the cost of connecting to and using the network play an important role in minimising the overall cost to consumers. Effective forward looking charges incentivise more efficient use of the grid. Ofgem have proposed a comprehensive review of forward looking charges for use of the distribution network including:

We are seeking views on whether the review should also include the basis of transmission use-of-service forward-looking charging of demand.

  1. We also launched the Targeted Charging Review: Significant Code Review[3]  (TCR:SCR) in August 2017, to address distortions that can arise from residual charging arrangements. Under the current framework, the cost-reflective charges are distorted by the residual charges, sending inefficient price signals. The TCR:SCR aims to reduce these distortions and develop a fairer approach to levying these charges.  A new charging framework will drive whole system benefits; promote efficient investment decisions and new forms of flexibility whilst reducing network and system costs.  

Network Access Reform

  1. To get the most out of the electricity network, Ofgem is also consulting on proposals to reform rights of access. This will ensure networks are used efficiently and flexibly, whilst ensuring vulnerable consumers are appropriately protected.

 

  1. For many users, the current arrangements are not explicit about their rights to access the system, and there is little or no choice of different access options. Demand and generation users of the distribution network above a certain size typically have an agreed entry or exit capacity level for the distribution network. However, most small users do not currently have similarly well-defined rights of access to the network. In practice, most users are only limited by their fuse size, and may never have considered or ‘chosen’ the level of access they have.
     
  2. In the future, both demand and generation users of the network could potentially choose from different options for access at different prices. Users who are willing and able to be more flexible with their uses of the electricity system, could be rewarded by paying less. In return they could choose to accept having a lower priority for right of access to the network.

Imbalance prices

  1. Our reforms to imbalance prices are also improving price signals in the wholesale market. Imbalance prices are paid by electricity generators or demand users, on a half-hourly basis, for any mismatch between the volume of electricity they have contracted for and what they have actually either produced or used.
     
  2. Our Electricity Balancing Significant Code Review (EBSCR)[4] sharpened these prices and made them more reflective of the marginal costs borne by the electricity System Operator (see below). This incentivises suppliers to contract for, and invest in flexible sources of electricity to avoid imbalance costs, and could potentially drive demand for new technologies which support flexibility.

Network companies and System Operator reform

  1. Ofgem's work in regulating the Electricity System Operator (ESO) also supports grid flexibility. To balance the system at transmission level the ESO contracts for balancing services from providers to support frequency response and reserve.

 

  1. As the ESO is one of the key buyers of flexibility, the design of its markets is key to securing the right investment. By establishing a new incentive framework which places more emphasis on outcomes, Ofgem is incentivising the SO to both address the system’s long term needs, and reform its own balancing markets to increase transparency and accessibility.

 

  1. As has already been noted, increasing amounts of generation and flexible demand will be connected at the more local, distribution network level. This means we will require a more active and coordinated approach to the operation and development of the distribution network, and indeed across the system. This requires the continued evolution of distribution network operators (DNOs).

 

  1. Ofgem usually describe this more active approach as ‘distribution system operation’ (DSO), and we have been clear that we expect distribution network operators to become more active and coordinated as they embed DSO roles. This includes enabling new solutions such as storage and demand-side response to compete directly with more traditional network reinforcement (like attaching new wires), for example through bidding into local distribution flexibility auctions. A number of distribution network operators have already launched these flexibility auctions and are exploring how their roles need to evolve further. As this evolves, Ofgem is examining the extent to which new and existing third parties can undertake some of these activities, for example trading platforms.

Enabling markets and ensuring a level playing field

  1. As noted earlier, we are committed to being technology-neutral, and ensuring a level playing field for all flexibility providers. This means where potentially competitive activities are carried out by existing monopoly network operators there is a risk of foreclosing new markets, causing barriers to innovation, and distorting competition. This is why, in the Smart System and Flexibility Plan, we committed to making sure that network operators cannot directly operate storage. Allowing this would potentially give them an unfair competitive advantage over other providers of flexibility services.

 

  1. Storage operators are demand users at times when they are charging, and generators at other times. So to enable electricity storage to efficiently contribute in the new energy system we are clarifying the regulatory classification for storage as a subset of generation, and therefore subject to the same licensing framework. We are also working with industry to ensure storage providers don’t pay unfairly for the residual part of network charges twice. This removes another potential barrier to this important technology.

 

  1. We have approved changes to the GB market that facilitate participation in GB and cross-border balancing markets, such as the Trans European Replacement Reserve Exchange (TERRE). TERRE is a cross-border balancing market which will increase the opportunities for demand-side-response aggregators and other innovators to provide system balancing services to the Electricity System Operator. Opening up the balancing market to firms with flexible processes and assets allows them to share in a growing revenue stream worth hundreds of millions of pounds every year.

Supporting innovative business models

  1. Ofgem actively supports innovation which promotes benefits to energy consumers. With the Innovation Link programme, we support businesses looking to launch new products, services or business models by providing fast, frank feedback. Innovation Link also helps innovators to navigate the regulatory framework, and understand how the rules might impact their idea.
     
  2. In addition, the ‘regulatory sandbox’ programme allows innovators to trial new products, services and business models in a real-world environment without some of the usual rules applying. We have awarded seven sandboxes to date, primarily focused on maximising the benefits of locally-produced and stored electricity for consumers. The sandboxes have enabled us to support trials and identify rules or licence conditions which might pose barriers to innovation.

Enabling flexibility using data

  1. Data is intrinsic to the transition to a smart energy system, including the efficient operation of electricity networks. Better use of data can help key players, such as network companies, operate and manage the energy system in the most effective way. Improved data flows between parties will support competitive markets, innovation and new business models, and enable technologies to know where they can deliver value on the system and provide benefits to consumers. It can also help customers more actively engage with new opportunities.
     
  2. However, there is currently a lack of transparency of, and access to, certain data sets. This risks limiting competition for energy services, and presenting a barrier for innovators entering the market. To address this, Ofgem and BEIS are launching an Energy Data Taskforce that will look across the energy sector to identify gaps where data can be used more efficiently, and make recommendations for Government, Ofgem and industry. In addition, Ofgem is drawing on evidence gathered and policy development undertaken so far as part of Government’s midata initiative, to accelerate new arrangements that make it easier for consumers to share their data easily and securely with energy service providers. We have published an open letter[5] that sets out our intent in this area and delivers a call to action for the energy sector.

Half hourly settlement

  1. Ofgem believes half-hourly settlement (HHS) will be crucial to facilitating a smarter and more flexible energy system. Settlement is the reconciliation of discrepancies between a supplier’s contracted purchases of electricity and their customers’ actual demand. For most consumers, this settlement process is currently based on estimates of when customers use electricity, and consumption levels based on average consumer use, rather than their actual use. This is because historically, most meters could not record consumption for each half hour period, but this will change with the introduction of smart meters.

 

  1. In the future, if customers are settled using half-hourly smart meter data, it will expose suppliers to the real cost of supplying them. This will incentivise suppliers to help their customers shift consumption to times when electricity is cheaper to generate and transport, and new technologies such as smart appliances or aggregators could potentially play a role. Ofgem are currently developing the business case for market-wide rollout of half-hourly settlement, and our final decision on market-wide settlement reform is expected in the second half of 2019.

Electric Vehicles

  1. Electric vehicles (EVs) create new opportunities for demand-side-response, and can act as storage where they are able to export electricity to the grid. Our energy system needs to be ready for the roll-out of EVs, and ensure they are integrated in a way which enables their use for grid flexibility.
     
  2. To achieve this, Ofgem has examined how EVs affect different aspects of regulation. We have published a paper on the impact of electric vehicles[6] and have consulted on reform to electricity network access (as noted above) which will unlock capacity to accommodate EVs. Ofgem is also working alongside the Government to develop legislation that will require future EVs charge points to have smart functionality to respond to external signals.

The role of RIIO and the network price controls

  1. Our price control mechanism ensures that licenced electricity networks are able to connect and accommodate the renewable energy resources that will enable GB to meet emissions reductions targets. The RIIO[7] model of price regulation encourages innovation by incentivising network operators to behave in particular ways, for example reducing the number of times electricity consumers experience power cuts.
     
  2. In addition, if a company underspends relative to its price control allowance it will share this underspend with consumers. This means companies are incentivised to seek out innovative and more efficient solutions when delivering outputs for consumers. For example, RIIO creates an incentive for network companies to find the best value solutions to meet their need, and make trade-offs between potentially costly new network investment and procuring flexibility from connected users.

 

  1. In addition to the core incentives in RIIO, specific innovation funding is provided. The Network Innovation Allowance (NIA) is a part of each licensee’s price control settlement to be spent on smaller-scale research, development and demonstration projects. The Network Innovation Competition (NIC) funds larger scale flagship development and demonstration projects. Finally, the Innovation Roll-out Mechanism (IRM) funds networks to roll-out proven innovations with carbon and/or environmental benefits into their business-as–usual processes.

Whole-system approach

  1. Actions on one network or sector have increasing impacts on others. For example, distribution-connected generation, storage and demand can provide beneficial flexibility which can reduce network constraints, and support national system balancing needs. Meanwhile, other related sectors are becoming increasingly interlinked; the decarbonisation of heat and transport, for example, means demand from these sectors may become increasingly intertwined.

 

  1. It is therefore important to ensure the system as a whole is effectively coordinated to deliver value for consumers. Ofgem are investigating whether any enabling reforms need to be introduced, or regulatory barriers removed, to support the delivery of whole system outcomes. We are also undertaking work which aims to clarify the obligations of Transmission Operators (TOs) and DNOs in supporting efficient whole system outcomes.

 

  1. In developing RIIO2 we will further explore how to efficiently incentivise network companies to deliver effective whole system outcomes[8].
     

 

October 2018

 

[1] Ofgem or the Office of Gas and Electricity Markets is the name used to describe the body of civil servants responsible for performing functions on behalf of the Gas and Electricity Markets Authority (GEMA).

[2] Ofgem, Upgrading Our Energy System: Smart Systems and Flexibility Plan

[3] Ofgem, Targeted Charging Review: Significant Code Review launch statement

[4] Ofgem, Electricity Balancing Significant Code Review     

[5] Ofgem, Enabling customer data in the energy sector

[6] Ofgem Future Insights Series: Implications of the Transition to Electric Vehicles

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

[8] Ofgem, RIIO2 Framework Decision