Storing up problems. The sub-optimal economics of network charging.

This week Ofgem have released a working paper which contains their initial thoughts on the crucial decision about the distribution connection boundary. Winter Working Paper: Distribution connection boundary – discussion note.

Currently at distribution network level, new generators and large new demand customers have to contribute to any upgrades that they ‘trigger’, not only on their connection’s voltage level, but also the voltage level above. And when you are talking about high voltages, you are talking about a lot of money.

This is in direct contrast to projects like Hinkley Point C, which are on the transmission network and so do not pay for triggered reinforcement. As a result the Hinkley Point network costs will be pushing ￡1bn, but the costs sit on our bills rather than theirs.

Furthermore having absorbed the huge increase in distributed generation, large swathes of the distribution network are now constrained for new generation. The result of this is that large parts of the country, new distributed generators (particularly renewables and storage) are having to pay high costs to connect to the network. But the majority simply baulk at the cost and just give up and go away. 

The real scandal is that this holds back business and investment (social and economic) in areas of weak or constrained network.

The Access and Forward-Looking Charges Significant Code Review has thankfully noted that this system has downsides and, as a result, Ofgem are reviewing how the connection charge at distribution level could be revised, including making it more ‘shallow’. This means that new customers should pay less reinforcement costs. The cost of resulting upgrades to network would then be taken on by the DNO and charged back (in some form) to users over time.

However a concern they express in the latest working paper is about costs, stating that “while a more shallow connection boundary will reduce costs for the connecting customer, it could mean that overall network costs are higher, with higher costs for customers as a whole.”

But is that really the case?

Currently DNOs are responsible for absorbing the network costs of incremental changes in demand or generation at a household level including small rooftop PV and electric vehicles. But they are required to recharge costs relating to larger generation, new demand (such as housing developments) or indeed storage – despite the fact that these are all on the same system and their actions all influence each other.

Indeed some generation constraints have been exacerbated by falling demand and some areas have both generation and demand constraints at the same time. If a housing association want to roll out a programme of household energy efficiency measures, it could quite feasibly exacerbate generation constraints. In the current system it is unclear whose problem that is. 

Any economist will tell you that tying the hands of DNOs like this is bound to lead to the sub-optimal outcomes of which we see evidence today. Inefficient investment and under-capacity. The prolonged Christmas period of engineering work on the railways should be a timely reminder that under-investment in assets simply defers and ultimately increases the cost.

As a result, we think ‘shallow’ charging will significantly increase value for customers, and at the very least not increase costs nearly as much as much as Ofgem fear.

This is because a shallow charge would finally give DNOs the ability to plan system wide and potentially to come up with much better and, probably, cheaper solutions to balance out and optimise the distribution network than if they continue to treat demand changes and generation connections as separate problems.

However to make the case for value creation rather than additional cost, a cost benefit analysis will need to have a wider scope than Ofgem are currently likely to consider. This review is already committing the economic sin of considering only one part of a broader energy system. Like insulating a house ignoring the fact that the users like to leave the windows open.

The right way of assessing this change would be accounting for carbon as well as the impact of renewables on electricity price. You’d also need to add back in the opportunity and economic costs for areas where generation has been unable to connect and investment doesn’t happen, along with the currently uncosted constraints that already impact generators on ‘flexible’ contracts.

To do this Ofgem need to recognise the fundamental facilitating role of the electricity network in achieving net zero objectives. It is imperative that the networks, as the bedrock of the future decarbonised system, are optimised, invested in and managed effectively as a whole system to service as much renewable generation as possible for the least system costs.

Or the results of this sub-optimal economics will come back to haunt us.