Whose losses are they?

Last week I spoke on a panel at a webinar hosted by Enertechnos, a company which produces low loss cables for the electricity distribution sector and who have just produced a report on how losses impact our ability to meet net zero.

We have consistently argued that Ofgem is not putting enough focus on the important question of losses in its approach to RIIO2 and so I was happy to share my views on the topic and which are also reflected in Sustainability First's response to the consultation on the sector specific methodology for RIIO ED2.

Technical losses occur as electricity travels through the network, and energy is lost primarily in the form of heat and noise. Currently these technical losses on the distribution network account for around 6% of all electricity generated. That's quite a lot. Losses from the transmission network are lower (another 1-2%) but still significant. For the distribution networks losses account for around 90% of their operational carbon footprint so it's important from an environmental perspective too.

In some countries the DNOs have to buy electricity to make up the losses and hence have a direct interest in minimising them. Here in GB the suppliers pick up the tab with complex rules for allocating costs between them, which is what they worry about rather than trying to get the DNOs to reduce the overall level.

Since DPCR3, back in 2000, Ofgem has therefore sought, through the price controls, to put incentives on the DNOs to reduce the level of losses. In DPCR4 there was a volume-related financial incentive which was continued in DPCR5. However, it then became clear that the volume measure used was unreliable and was impacted heavily by adjustments made by suppliers to their settlement data. Ofgem therefore suspended the incentive mid period. In ED1 Ofgem instead introduced a licence requirement for DNOs to minimise losses and the Losses Discretionary Reward where DNOs could earn financial rewards for taking clear steps to better measure and manage losses. Last week Ofgem announced the results of the third tranche of this incentive in which – out of a potential pot of £14m – it decided not to make any awards because DNOs were not performing well enough (or more precisely – they "had not provided the evidence").

Given this background it is surprising and worrying that Ofgem is proposing in RIIO ED2 to stop having any financial incentive around losses but is instead intending to rely on "reputational regulation". It is not clear how Ofgem expect that this will get the companies to up their game when £14 million sitting on the table apparently hasn't. At a time when Ofgem seeks to place a stronger focus on de-carbonisation with their De-carbonisation Action Plan this backward step does not make sense.

Ofgem's ambivalence on tackling losses seems to be because it's complex. With more flexibility services and low carbon technologies connected, the networks will be operating closer to capacity and that means more losses. The networks suggest it's a price worth paying to get LCTs connected and Ofgem see increased utilisation of the networks as a "good thing". The networks may be right that losses will need to be higher than they have been historically but that doesn't mean they should be ignored.

And anyway, the networks argue, that electricity losses cease to matter as we de-carbonise. Try making that argument in relation to energy efficiency – it wouldn't stand up. In the short-term losses are still a source of carbon emissions and in the longer term – if they increase to say 10% then that is 10% generation and system capacity that we will need to meet the increased demand from EVs and heat pumps, which is already a challenging prospect. Losses still matter.

And there are technical solutions which even if they can't eliminate losses altogether will reduce them. Low loss equipment is more expensive but delivers savings to the system. The networks proposal is that this should be taken into account in the CBAs that they have to produce to justify expenditure in their business plans. That clearly makes sense – the trade-offs need to be done properly and if the costs are justified the additional expenditure should be allowed.

What I struggle with is what then stops the companies subsequently deciding to use standard, cheaper kit and pocketing their share of the saving as an efficiency? That is exactly the sort of behaviour that in other areas Ofgem seems to be concerned about and has introduced Price Control Deliverables (PCDs) to address. Why not on losses?

What you want is for the DNOs to care about losses and to properly factor them into their own decision making on an ongoing basis. The only way that will really happen is with a financial incentive that will encourage them in a proportionate way to deliver on the commitments they make and to continue to search out opportunities for further saving.

The other reason given for not going down this path is the challenge of measurement as Ofgem found in DPCR5. However, there is nothing so far in RIIO2 about trying to improve that measurement. There is an acknowledgment in the industry that smart metering and increased network monitoring should help with measurement but no real will to tackle the issue – perhaps for fear that Ofgem will then use the metric and penalise them for increasing losses. But measurement really should be prioritised. If you can't measure losses you don't have much chance of managing them.

Although Ofgem failed to reward industry efforts under the Losses Discretionary Reward it did seem to prompt some innovative work to understand and reduce losses. There are real concerns that this momentum will be lost.

As it stands Ofgem is relying on reputational incentives around the companies' business carbon footprint and the requirement for them to have science-based targets for reducing their own emissions as part of their Environmental Action Plans. As a minimum Ofgem needs to make sure these targets are aligned with the 1.5 degree pathway and that losses are clearly included in Scope 2 emissions. But we would still maintain that a reputational incentive is not enough.

While designing a suitable financial incentive may be hard in the absence of robust metrics, Ofgem has a new tool in its toolbox in the form of the "strategy delivery incentive" proposed for vulnerability, connections and DSO transition. The companies have to put forward a strategy – including some metrics – and performance will then be judged based on how they deliver against that strategy with the potential for a financial reward or penalty based on their performance. The metrics prevent this being purely subjective but it is not completely mechanistic so the data quality is less of a problem. This would seem to provide a ready answer for losses (and other environmental issues where Ofgem is currently planning to rely on reputational regulation).

Sustainability First are advocating this in their response to the Draft Determinations. We hope that others will join that call.