RIIO-ED2 and Load Related Expenditure

Last week, Ofgem published their RIIO-ED2 Draft Determinations (DD’s) for GB Distribution Network Operators (DNOs). The DD’s outline Ofgem’s initial view on the cost envelope DNOs will need to work within from 2023-2028. Ofgem provide ￡20.9bn of initial funding and uncertainty mechanisms to address further investment needs. ?

A key component of this funding is Load Related Expenditure (LRE) – DNO investment focused on increasing network capacity. LRE has a crucial role to play in RIIO-ED2 in readying the networks for higher demand for electricity. This article summarises the approach Ofgem has proposed, and what it means for DNOs over summer as they develop their response by the 25th of August.

Why is Load Related Expenditure so important?

Higher demand is anticipated through a step change in the uptake of technologies including electric vehicles and heat pumps. This increase is directly linked to Government policy and decarbonisation commitments, including the target to roll-out of 600,000 heat pumps by 2028. For the network to be able to handle this, significant capacity increases are required.

What is the challenge Ofgem faces in setting Load Related Expenditure allowances?

Ofgem want to ensure that DNOs don’t block progress to net zero by making sure they have enough funding to expand network capacity and allow us as consumers to install new low carbon technologies (LCTs) in our homes without delay.

This must balance against the uncertainty of where and when increased demand will arise, and ensuring investment only takes place when it’s really needed. This tension is sharpened for Ofgem given the context of high energy prices and affordability challenges many already face.

What have Ofgem decided at Draft Determination?

Baseline allowances: Ofgem signalled early in the RIIO-ED2 process that a mix of baseline allowances and uncertainty mechanisms (UMs) would be needed, given the challenges forecasting the scale and pace of the LCT rollout. In the DD’s, Ofgem have provided ￡2.68bn in LRE baseline funding – some 18% less than DNOs requested (on a net basis). DNOs experienced between 10.9% to 21.2% cuts to requested load related capex.

Scenarios: Ofgem were concerned by the scenarios used by DNOs in creating their plans. Concerns covered approaches to local engagement, network utilisation and deliverability. Consequently, where required Ofgem have adjusted plans such that all DNOs baseline forecasts align with the lowest net zero complaint scenario – the ESO’s System Transformation FES. Ofgem believe this will only upfront funding where they are reasonably confident it will be needed.

Uncertainty Mechanisms (UMs): Ofgem propose to address additional demand above the System Transformation scenario through UMs. These include automatic volume drivers for lower value interventions including secondary reinforcement and LV services. These volume drivers are accompanied by protective measured including a cap on total expenditure linked to the CCC’s Balanced Pathway scenario, and mid-period parameter reviews. More material changes will be facilitated through and LRE re-opener. ??

What are the implications for DNOs?

DNOs have a busy summer ahead as they prepare responses to the DD, due to Ofgem by the 25th of August. In the context of LRE, they should seek to address the following:

Step 1- Understanding the totex adjustment. Whilst Ofgem’s publicly available documents give the high-level story on LRE adjustments, the devil will be in detailed models. DNOs need to reconcile these against their submissions to be clear what adjustments have been made.

Step 2 – Responding on scenarios. Assuming no errors are found in step 1 (and these should be clarified at the earliest opportunity with Ofgem), DNOs need to make a tactical decision on Ofgem’s decision to impose System Transformation as a baseline scenario. Either accept it and work out the overall implications for the RIIO-ED2 strategy and deliverability or influence Ofgem to accept an alternative scenario. DNOs have a strong understanding of their areas and need to determine how Ofgem’s approach will impact their ability to deliver net zero locally.

Step 3 – Responding on UM approaches. Ofgem’s proposed use of UMs will likely remain, regardless of the final baseline allowance. What’s important is ensuring the process works well for DNOs and their customers by allowing quick responses to demand increases. Volume drivers are described as automatic, but DNOs should work with Ofgem to ensure they operate as seamlessly as possible - there isn’t yet strong evidence of how effectively Ofgem can implement such a large number of UMs as proposed across sectors in RIIO-2.?

Step 4 – Responding on UM calibration. Once the totex adjustment has been fully understood, and DNOs have a response position on UMs, they should ensure that the proposed unit rates don’t leave them out of pocket. Where concerns are identified, strong evidence should be included in the DD response to propose alternative values.

The DD response will need to cover a lot of ground but given the scale of adjustments made by Ofgem on LRE, it should remain a focus area for DNOs in advance of the 25th of August deadline.?