Ofgem seeks to clarify the role of DNOs in relation to electricity storage and small-scale generation

Background

To date, there has been a lack of clarity on the role that Distribution Network Operators (“DNOs”) can play in the development, ownership and operation of electricity storage. As part of the commitment to remove regulatory barriers in relation to the storage market contained in the Smart Systems and Flexibility Plan, Ofgem is consulting on changes to the electricity distribution licence (“the Consultation”). The Consultation was published on 29 September 2017 alongside a separate consultation in relation to the licensing of electricity storage.

New licence condition

Ofgem has previously stated that it is concerned that DNOs owning and operating storage have the potential to create conflicts of interest, and distort or even foreclose the wider flexibility market for third party providers.

The primary change proposed by the Consultation is to introduce a new licence condition which ensures that, regardless of their size, DNOs cannot operate storage facilities or small-scale generation. The licence condition applies to all storage and generation whether or not such assets are required to have a generation licence. Previously, only the holding of a generation licence by a DNO was specifically prohibited under the Electricity Act 1989.

However, Ofgem is proposing to publish a guidance document that allows DNOs to operate storage in the limited specified circumstances. Where the DNO meets the obligations under UK and EU legislation to legally separate the operation of storage or generation assets, this will be permitted. Ofgem expresses a preference for such operation to be undertaken by an entirely independent third party. The DNO’s compliance statement will need to report on any such arrangements to ensure effective management and operational separation.

The Consultation only seeks to change the existing parameters around the operation of storage or small-scale generation by DNOs; it does not affect the existing regime for ownership of storage or small-scale generation by DNOs. However, Ofgem notes that this new licence condition is “a minimum first step”, particularly in light of the move to Distribution System Operators, which may exacerbate any conflict of interest concerns.

Exceptions to the new licence condition

The Consultation proposes the following exceptions:

1. Islanded network generation: Existing DNO-operated generation on isolated networks is proposed to be exempt from the new licence condition. However, any new or replacement developments will require Ofgem’s consent;
2. Low Carbon Network Fund: Where a DNO operates existing storage facilities, for example, under the Low Carbon Network Fund innovation funding, Ofgem will work with these storage operators to manage the assets, but the Consultation is clear that this should not be seen as a precedent for future DNO storage involvement;
3. Network safety: The DNO operates storage or generation for specified activities limited to the normal business activities of the DNO, and primarily for safety purposes. For example, Uninterruptible power supplies (UPS) – devices used at substations and other DNO sites to ensure that critical equipment remains energised in the event of a system outage – would be permissible, as they are necessary for the safe and reliable operation of the DNO’s networks;
4. Exemption: The DNO applies to Ofgem for an exemption. However, there is a very high threshold for acceptance of the application, which would require that the DNO demonstrate the following:

• Market failure: that “it had taken every possible effort had been made to seek a market based-solution at an efficient cost”. The Consultation suggest that as a minimum this would require an open and competitive tender;
• Economic and efficient solution: the operation of such storage by the DNO is the most economic and efficient solution to a specific network issue; and
• Minimised conflict of interests: that measures by the DNO are in place to minimise conflicts of interest, and to mitigate potential distortions to, or discriminations in, the market.

These tests are consistent with the proposed European rule changes in the Clean Energy Package.

Any consent would be granted via an Ofgem Direction, which may contain conditions in relation to time limits on consent, additional monitoring or reporting, and additional measures to manage potential conflicts of interest.

What next?

The Consultation closes on 27 November 2017. Pending consideration of responses to the Consultation, Ofgem will proceed to issue a Statutory Consultation by early 2018. A decision on whether to incorporate the licence modification should be made in Spring 2018, and if it is approved, the modification should come into effect by Summer 2018. Separately, Ofgem will publish its guidance document, which will clarify how DNOs can participate in storage projects in a way that manages potential conflicts of interest.