Ofgem launches review of local energy system operation

On 26 April Ofgem launched a call for input on the future of local energy institutions and governance, in the context of the wider emergence of the Distribution System Operator (“DSO”) role. The call for input focuses on how the broader energy system can be planned and operated at a local level to ensure the readiness of British system for the transition to net zero.

Broadly, Ofgem is seeking input from stakeholders on three key areas:

• The energy system functions needed at a sub-national level to facilitate the transition to net zero at the least cost, and the criteria that need to be met for effective delivery of these functions;
• The suitability of current and planned institutional and governance arrangements for delivery of these functions; and
• The opportunities and risks of change, and potential options for alternative arrangements.

The deadline for responses is 7 June 2022.

Background to the call for input

Ofgem explains that the energy sector is undergoing rapid change as part of the transition to net zero, and that significant changes will be required to energy (principally electricity) production and consumption, as well as in relation to the decarbonisation of transport, buildings and industry. For these changes to take place in an efficient and cost-effective way, Ofgem considers that fundamental changes are needed to the energy system to accommodate new generation and facilitate new sources of demand.

The call for input identifies the following three energy system functions (as well as the overarching challenge of digitalisation) which will be needed for the transition to net zero to be successful, and the challenges for each.

Energy system planning

Ofgem describes the energy system planning function as “the process of taking a forward look at the needs of the energy system and deciding what needs to be put in place to meet those needs”. Given that around £100bn of investment at a local level is needed to meet net zero, Ofgem sees the electricity distribution system as a key starting point due to existing and expected changes in both demand and generation.

At present, there are several institutions carrying out some form of energy system planning (DNOs, GDNs local government, ESO, etc.), and in Ofgem’s view the roles they perform are not distributed in a way that facilitates the most cost-effective decarbonisation outcomes. Ofgem sees the need for planning to be coordinated across the system both locally and nationally, with network planning both informing and being informed by wider planning (in areas like transport, gas, heat, hydrogen and CCUS).

The proposed roles of the DSOs in the call for input aligns with the proposed responsibilities for a Future System Operator (“FSO”), a body which is expected to take over the roles of the current Electricity System Operator as well as taking on additional responsibilities in respect of, amongst other things, planning, market design and decarbonisation. You can read our Law-Now on the proposals for a new FSO here.

Market facilitation of flexible resources

Electricity markets are used in distribution network management to procure flexibility services which alleviate constraints and support restoration of electricity.

Ofgem considers that the current arrangement, in which Distribution Network Operators (“DNOs”) manage flexible resources at the local, distribution level and the ESO manages flexibility markets at the transmission level, is overly complex and not best placed to facilitate efficient and co-ordinated action. Overall, Ofgem considers that open and transparent flexibility markets, that are coordinated and interact smoothly at all levels (e.g. local, national and European) will drive the most efficient solution for the energy system.

Real time operation of local energy networks

The call for input reflects Ofgem’s view that the management of electricity flows on distribution networks in real time is key to ensuring network reliability and system security, especially in the context of increasing volumes of decentralised assets like small-scale renewables generation and battery storage.

Ofgem considers that coordination between the ESO, DNOs, and the operators of other local networks like gas distribution and heat networks, is likely to become more significant, and that the current structure creates conflicts of interests which could add unnecessary costs to customers.

The four sample framework models

Ofgem has developed four sample framework models in order to address the issues it has identified in relation to the existing arrangements. Each of the models relates to a particular institution or function, and its relationship with other relevant functions and institutions.

A summary of these (reproduced from the call for input) is included below. If you cannot read this table clearly, click here.

In relation to each of the proposed models, Ofgem is seeking views on:

• the validity of the key assumptions;
• which model offers the most advantages compared to the status quo;
• the biggest implementation challenges which Ofgem should focus on mitigating;
• additional changes needed to consider in the short term (in relation to model 1 in particular); and
• which other key changes in the energy sector Ofgem has not identified and should take account of.

Next steps for interested parties

The call for input will be open for six weeks, closing on 7 June 2022, and sits alongside a series of stakeholder workshops which are planned for June 2022. No firm date is given for the publication of a response, but Ofgem states it aims to provide conclusions by early 2023. At this point, the work will enter its implementation phase.

Comment

Ofgem’s proposed models for the separation of the DSO/DNO roles mirrors, in many ways, the debate around ESO/FSO separation mentioned above. The role of a DNO/TSO as merely a passive owner of discrete physical infrastructure is increasingly incompatible with the needs of the modern electricity system, especially in light of the transition to net zero, the greater role of flexibility and the need for whole system outcomes.

However, any proposed changes from Ofgem should be carefully scrutinised to ensure that the financial and operational benefits justify the potential costs, for example in considering whether to internally ringfence the DSO/DNO or carve out the DSO role for a separate, independent, entity.

Stakeholders in the industry should follow these proposals closely, as the potential for change is significant and the range of different outcomes is marked.