Electricity used to be generated mostly by large power stations. Nowadays around a quarter of electricity comes from renewables. Our gas supplies mostly came from the North Sea until the mid-2000s when we became a net importer of gas. In future we could also see more gas demand being met by hydrogen, or biogas. Heating in the future might also be powered by electricity.
This means that the role that network companies play in the energy system is also changing. The networks now have to manage electricity flows coming from a larger number of smaller renewable sources, as well as large power plants. Power no longer flows simply in a linear way from big power stations, onto the high voltage grids, and then into the distribution networks which supply homes and businesses. Increasing numbers of homes and businesses are becoming 'prosumers', producing electricity on site from solar panels for example, sending power to and from the grid depending on their needs. As the system becomes increasingly smarter and joined up, consumers will have the opportunity to save money on their energy bills by letting a third party manage their consumption on their behalf. In RIIO-1 we made significant progress in developing uncertainty mechanisms to manage change—we believe these have worked well to remove unnecessary risk for network companies and reduce costs to consumers.
It is against this backdrop that we are planning the next price controls to regulate the network companies from 2021. We have made clear that the next price controls will be tougher, with lower expected returns for the companies. We will continue to manage risk in ways that bring benefits to consumers.
Length of the price control
One of the crucial factors we must determine is the length of the price control, which is currently eight years. A longer period may help the companies to plan. We know that billions will need to be invested in the energy system in the next decade. However, predicting exactly where this investment is needed during such a fast moving energy transition gets harder the further ahead you look. For example, just a few years ago official forecasts reckoned that Great Britain would have around 2GW of solar capacity in 2017. Last year we reached around 13 GW. That’s why we are proposing five-year price controls by default instead of the current eight-year period. This will better protect customers if forecast allowances or expenditure turn out to be different, since they will not be locked into paying for this over longer periods.
The price controls for the local distribution, or lower voltage, electricity network operators are due to finish in 2023. Those for the transmission, or high voltage network owners, finish in 2021. Some stakeholders argue that we need to align the timing of these controls to help manage the uncertainty. However we think a better solution is to ensure the price controls encourage all network companies to co-ordinate their activity, investment decisions and innovation programmes in ways which can benefit the whole energy system. We don’t need to start the price controls on the same date to achieve that.
Working with the system operators
As well as working more closely with each other, electricity and gas distribution companies need to work more closely with both the electricity system operator and the gas system operator. Collectively they must have an eye on what the best investment solutions are for the whole energy system, and avoid situations where the solution picked by a local network company for resolving an issue drives up the overall cost of running the system for consumers.
An example of good practice is where Western Power Distribution worked with National Grid to allow more solar generation to be connected in the South West. In return generators agreed not to operate at times of highest demand for grid capacity. This avoided the need for an expensive grid reinforcement project. We will set out our thinking on how network companies can work more closely together to benefit the whole energy system at a later date.
Over the past 13 years network infrastructure has grown while demand for gas and electricity has fallen. The uncertainty over how the energy system will develop increases the risk that the companies will invest in new 'stranded' infrastructure that is not fully used, raising costs for consumers unnecessarily.
Some options for addressing this include requiring a higher burden of proof from the companies before they invest. This could include asking companies to demonstrate how they have considered alternatives to building more capacity. These could also include “active network management” where the customer can save money by controlling how and when they are using network assets. In return the network operator can reduce the need for expensive reinforcement.
The networks are the cornerstone of the energy system which is going through an unprecedented pace and scale of change. Ofgem wants to work closely with network companies, consumer groups and other stakeholders to ensure that the next price controls continue to drive down costs for customers and deliver grids which are fit for the future.
Find out more about the energy network and performance under the current price controls in our fast facts: Network price controls and you.
You can stay up to date with key updates on the price control proposals as they develop and other Ofgem news by signing up to our Alerts & Briefings.