Recommending Improvements in Regulation to Better Incentivise Strategic Investment in GB Electricity Networks

The Situation

As the UK economy transitions to net zero, more investment will be needed to provide capacity on the electricity network. The UK government’s targets will require electrification of sectors including heat and transport. There is rising need for network capacity to support this demand growth, as well as increasing deployment of renewables and storage technologies such as batteries.

The RIIO regulatory regime set by Ofgem determines how the electricity distribution network operators (DNOs) are funded to invest in their network. The framework, established in the regulatory price controls to which DNOs are bound, has historically encouraged incremental investment upgrades in response to connection applications or an identified trend of increased demand for capacity from existing connections.

The rapid growth in demand makes it costly and difficult for incremental upgrades to keep up with requirements in many instances. If capacity is not available when customers need it, networks will not be able to connect new loads. A lack of capacity imposes costs and delays on customers and risks delaying the UK’s achievement of net zero targets. 

The growth in network capacity requirements due to net zero changes the balance of costs and benefits between incremental reinforcement and long-term strategic investment. Strategic investment is investment to either reinforce existing infrastructure or provide new infrastructure in advance of a clearly demonstrated, immediate need for network capacity. Efficient strategic investment can reduce costs to customers and can ensure network capacity is not a blocker to rapid connections. It is in the interests of customers, the energy sector, and society to adapt regulatory frameworks so DNOs make strategic investments where it is efficient to do so.

NERA's Role

Against this background, Scottish and Southern Electricity Networks (SSEN) commissioned NERA to review how effectively the regulatory framework promotes efficient strategic investment by DNOs. Our report assesses the suitability of each of the mechanisms within the RIIO-ED2 cost assessment framework that set allowances for load-related expenditure (LRE), including the role of demand forecasting and uncertainty mechanisms. We also assess and recommend improvements to the technical assessment framework for larger investment proposals through Engineering Justification Papers and cost benefit analysis.

The Result

Our analysis finds that while there are no technical barriers to strategic investment in the RIIO-ED2 framework, there are limitations in the tools used to assess the required level of efficient investment. Its core methodologies are geared toward determining the cost to operate today’s networks in the short-term and manage incremental growth, rather than in the long-term. Specifically, there are risks and disincentives for DNOs to do so when the cost assessment framework does not reliably identify and fund efficient schemes.

Our report recommends ways the RIIO framework could evolve to better identify and fund strategic investment where efficient. We also suggest improvements to the framework for cost benefit analysis of individual investment proposals.

First, the cost benefit analysis should include the benefits of avoiding the risk of delays to new connections due to a lack of network capacity when assessing the efficiency of strategic investments. Our report provides preliminary quantification of the cost of connection delays that demonstrate delay costs could be material. Second, we propose a probabilistic framework that would better assess optimal trade-offs across several possible decarbonisation scenarios, including the benefits of strategic investment in upside demand scenarios where the network capacity of incremental reinforcement would otherwise be insufficient. 

If implemented, our recommendations could form part of a cost benefit analysis framework adapted to strategic investment. A common, rigorous approach would give DNOs clarity on how Ofgem will assess their proposals and provide Ofgem with a consistent body of evidence to assess proposals coherently across DNOs. These changes would help reduce the risks to DNOs from proposing strategic investments and better incentivise such investments in the interest of customers.