RIIO-2 – a Fundamentally frank perspective

Fundamentals Ltd Business Development Director, Vincent Thornley, offers his views on RIIO-2 and its impact on the energy sector in general and electricity transmission in particular.

Can we start with a basic explanation of RIIO-2

RIIO stands for Revenue = Incentives plus Innovation plus Outputs. It is a general principle of operation established and is overseen by energy regulator, Ofgem. Within RIIO sits three key elements – Electricity Distribution (ED), Gas Distribution (GD) and Electricity Transmission (ET). We are currently in the period of RIIO-1, with RIIO-2 now in consultation before implementation.

Transmission and gas controls have run two years ahead of Electricity Distribution, so ET2 and GD2 begin in 2021. ED2 starts in April 2023 and is the element with most impact on Fundamentals, but many of the principles being laid down for GD2 and ET2 will have a direct effect on ED2.

What is the most significant change RIIO-2 presents?

Potentially, it’s the end of Network Innovation Competition (bidding for flagship projects) or the Network Innovation Allowance. There’s an expectation from Ofgem that innovation by the Distribution Network Operators (DNOs) will continue, but that it will be funded by the companies themselves.

To date, Competition and the Allowance have produced a step-change in network development and have been the envy of networks worldwide by enabling the network companies to develop unique projects. In the reporting process, DNOs must state how that innovation is being used and there has to be positive benefit expected at the outset. Although some projects won’t turn out as expected, there is almost always a net positive value anyway and Ofgem believes the companies should be paying for this.

In essence, innovation is "doing new things." People in the industry have always done new things - there were always little bits of innovation happening even before the programme started (initially called the Low Carbon Networks Fund - LCNF), but the whole regulatory environment didn't allow them to do as much as perhaps they wanted to. The network companies often get castigated, but they are playing in a heavily regulated environment, so the environment has to be right in the first place.

That said, there is a positive element to the scheme ending. If you approach a network operator with something innovative, the natural response is to squeeze it into an existing innovation programme. Under the current system, if there's no human or financial resource available for the year, then it doesn't go ahead. Under the new system where it's open-ended, it could have the effect of increasing innovation, but time will tell.

Is there a particular innovation that you think will benefit particularly from RIIO-2?

Fundamentals' biggest project at the moment is delivering Electricity North West’s (ENW) CLASS (Customer Load Active Systems Services) project. This involves delivering some of the capability needed to manage the frequency through the voltage control on tapchangers.

CLASS is truly innovative. Its forerunner was an LCNF Tier 2 project in 2013 and I was also involved in that with Siemens. ENW drove the idea and its development, tried it and is now rolling it out across the network. It’s already delivering massive benefits in being able to manage load and generation balance and is a gamechanger in the whole area. 

I feel fairly confident that it's a big enough gamechanger that Ofgem will require all the operators to have this capability in their networks as part of the ED2 element of RIIO-2. 

The implications for Fundamentals are already very positive as well. Key enablers are being built into our SuperTAPP SG product as a result of CLASS. Other network operators are already installing it, knowing that the capability is there if needed. We realised it could tie into RIIO-2 and its implications when ENW moved it from innovation to business-as-usual. 

This innovation would not have happened without LCNF and one of the strong characteristics of price control DPCR5 which Ofgem then carried forward into RIIO. If ENW had been required to pay for the entire project themselves, CLASS might not have been trialled to the same extent. However, demonstrating to Ofgem the value of what they were doing and the success of the large-scale trial was the cherry on the cake. 

There has been backlash in the industry to Ofgem’s proposed cost of capital framework. Do you agree with the criticism?

I think this may be a storm in a teacup because while cost of capital effectively generates an element of the income made by the network companies, a bigger focus is probably the rewards and incentives. Setting incentives to improve the network means they get the rewards. So, by cutting cost of capital, a good chunk of the revenue will come from the incentives.

The amount the DNOs can receive on capital plant will be reduced. However, in reality each company agrees a contract to deliver plant to a specific level of health which requires x amount of money, but Ofgem bases this on the cost of capital it has decided on.

So, we’ve actually moved away from the idea of just paying for the amount of plant installed.  It's about the costs of delivering the service and DNOs are being encouraged to do this. Ofgem noted recently that they’re talking about the Open Networks project, being led by the Energy Networks Association (ENA), and encouraging DNOs further because it’s encouraging greater use of non-capital, flexibility methods.

Flexibility seems to be the ‘buzzword’ around RIIO-2 and energy distribution in general. How will this manifest itself?

There are two elements to Flexibility: hard and soft. Soft is about encouraging network users to adapt and change their use, most likely through commercial incentives. There will be a lot of new elements focused around trading platforms to allow customers to interact with the whole soft flexibility.

Hard flexibility is about physical assets and how its operating parameters can be changed to help network capacity. There’s a lot that can be done there. Across most of the UK network, the final point where voltage is controlled is at 11kV level. Where there are pieces of asset beneath that voltage, they’re generally performing in the same way and that's OK.

However, some parts of the network that are becoming more dynamic: electric vehicles, photovoltaics, electric heating - all happening at different times of day. So, the point of control needs to move further down the network to provide greater control and, of course, flexibility. 

How will this innovation, flexibility and altered cost structure affect hardware in real terms?

In my opinion, new equipment is going to be more about control technology rather than actual plant that carries load. It will be about extending the observability/visibility that DNOs have of their whole network. There’s a good chunk that's not very visible lower down the chain.

This change in emphasis will be needed to maximise utilisation through finer grain control, along with early detection of issues to correct them. That's exactly where Fundamentals is positioning itself at the moment - we're about improving the health and performance of the grid. Being able to understand the state of the cables underground; if the cables have any issues; where the issues are going to occur to allow operators to go in and fix them. That technology is built on Artificial Intelligence and Machine Learning, and Fundamentals will absolutely be concentrating in that area to deliver the improved health required as part of ED2.

How does the move from DNOs to DSOs fit within RIIO-2?

Although the change from Distribution Network Operator (DNO) to Distribution Systems Operator (DSO) is coincidental with RIIO-2, it is naturally very closely intertwined. Currently, networks are simply networks of equipment that move electricity from one point to another, with the overall electricity system managed by the national grid system operator.

It will be a constantly moving target – you won’t achieve it in one go; it will be in stages. But the reason it has to happen is because we need a flexible network. When you have a lot more renewable generation on the network, it is variable and that’s not a negative, it’s just different and we need a network that is different to accommodate it.

So, the network loads have to be adaptable in the same way as generation is adaptable and that can be done by moving them in time – i.e. when we use things - and by energy storage. This doesn’t have to impact on people’s lifestyle, but we do have to have a system which is built to recognise those needs.

The concept of DSO is that each network becomes a distribution system and becomes part of the management of the overall system. The ENA Open Networks project proposes five Future Worlds.  In my opinion, some of them are mutually exclusive, but some could co-exist. Of the five, my least favourite is World D, where the ESO co-ordinates frequency, because it maintains everything within the National Grid System Operator's hands and that's more or less what we have today. We need a bigger change than that, but of the others, I can't yet state an absolute favourite.

The direction of travel set by Open Networks will include elements which fall within the ED2 price control, because Ofgem will want to encourage this.  Essentially Ofgem is saying: "Before you buy any capital plant, examine why you can't use a flexibility method." 

At the moment I sit on the BEIS Ofgem Smart Systems Forum, formerly the Smart Grid Forum. Our remit has expanded to look at the electrical energy systems, recognising it’s more than just electricity with links to transport and heat. A principle role is ensuring delivery of the BEIS Smart Systems and Flexibility Plan, launched a couple of years ago. This lends itself nicely to DSO as distinct from DNO and also sits within the timeline of ED1 and ED2.

It’s about distribution networks contributing to the system as a whole - essentially about frequency. The balance of generation and load across the whole system is what determines frequency (nominal frequency in the UK is 50 Hz), but it can never be exact because it depends on generation versus demand.

If generation is less than demand, machinery slows down and vice versa. It’s the role of the System Operator and, depending on the model, the DSOs will also play a role in ensuring the frequency remains as consistent as possible.

What is the biggest challenge of RIIO-2 to the industry?

The biggest challenge is any major step changes in regulation. For us as a manufacturer, living in the regulatory cycle is challenging, because network operators’ spend goes up and down and that's never easy. 

The challenge for British ElectroTechnical and Allied Manufacturers Association (BEAMA) members is to moderate this cycle. There is a programme from the industry trade body at the moment focusing on recognising the value the supply chain delivers and not taking it for granted.

Step change has always influenced the industry and the challenges are always at the end of a regulatory period. If there's too much change in a new scenario, and the overall effect is operators sitting back and stopping spending, then that's a problem for the whole supply chain. When operators do decide to start spending again, they might find not everyone is there waiting for them.

One of the steps for BEAMA is spreading the message of the benefits delivered by the supply chain. The message to the operators is: “We appreciate you have your regulatory cycles, but please plan more than the next year ahead. We need more gradual change to demand, as we have to gear up in just the same way as you do and forewarning of needs will help us prepare.”

Finally, what is your prediction for the next three to five years as RIIO-2 is rolled-out?

As always, the focus will be on the health of equipment on the networks and getting the best ‘bang for your buck’ – although not literally I hope!  It is not always the best solution for operators to go out and buy new plant. A lot can be done with refurbishment and maintenance of existing plant and this can increase the health of those network assets.

From Fundamentals’ perspective, including tapchangers, we can do a lot do with the health of assets. We also believe tapchangers and their maintenance could be a key feature in next price control reducing cost and increasing cost effectiveness.

Undoubtedly, DNOs will play to the rules set by the regulator. If the regulator wants best use of money and operators can deliver a more effective network at less cost, they will get to keep some of the money saved. So, the benefits are shared between customers and network operators.

In essence, it’s in everybody's interest to deliver the required network health at the lowest cost and I believe refurbishment will play a key role in that.

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