The lengthy negotiation over the £20-30 billion sought by the electricity distribution networks for the next five years is being finalised. Ofgem has published its Draft Determinations on the RIIO price controls for the electricity distribution companies, setting out what revenues the networks can earn and what they must deliver. While we support much of Ofgem’s proposals, we are extremely sorry to see the regulator backtrack on proposals to financially incentivise companies to reduce their environmental impact.

As part of the price control Ofgem provides financial incentives for companies to improve what they do in a range of areas such as supporting vulnerable customers, cutting the time to connect customers, developing the distribution system operator role, increasing network monitoring and reducing interruptions.

Over the past two years Sustainability First has repeatedly made a considered and detailed case on why the companies’ environmental impact needs a financial incentive tied to key outcomes. Without this, Ofgem isn’t sending a clear signal to the companies that delivery on decarbonisation and the environment matters just as much as for other key areas of performance.

At one point, Ofgem seemed to ‘get this’ - but has latterly backtracked. Instead, the companies are only to be made to report on their environmental performance to their stakeholders. In our view this is wholly inadequate for such a high-impact and specialist area where it can be hard to compare meaningfully across the companies. We still see financial incentives as the way to drive environmental performance, but we’ve also suggested additional ways for Ofgem to give “reputational regulation” some teeth. It’s therefore disappointing that Ofgem doesn’t seem to have considered even these proposals.

Two key but neglected issues – losses and SF6

As we set out in a blog earlier in the year some environmental impacts are especially critical. There are two major areas of network operations where we particularly want to see the companies being pressed to do more. These are the “invisible” sources of greenhouse gases that account for over 90% of a distribution company's carbon footprint. They aren’t sexy like electric vehicles but they matter.

• First, electrical losses. More needs to be done to tackle the 7% of power that is simply ‘lost’, through leakage, as it transfers across the distribution networks from generator to customer. Losses are complex to manage – but they add needless cost to customer bills, require more generators to be built to meet net zero and add to carbon emissions, especially at peak-times. Some power-loss is inevitable due to the basic physics of power-transfer but there are important steps the companies can take such as installing more energy efficient equipment. Without some form of financial incentive however, we don’t see why the companies would bother. Nobody ‘owns’ the losses problem. But losses are set to grow dramatically and effective losses management sits at the heart of whole-system efficiency. With energy bills at stratospheric levels, losses - which across transmission and distribution account for around £100 per customer - should be taken far more seriously by Ofgem.
• Second, the networks hold equipment that contains a highly potent and long-lived greenhouse gas, sulphur hexafluoride (SF6). The companies must work out what to do with the 200,000 items of kit across their networks that this greenhouse gas. While much of this kit is sealed, it can still leak and the companies have to deal with that. But also, vitally, the companies must develop detailed plans for how, over time, they will tackle the huge logistical feat of getting all SF6 equipment safely off their networks. 

The companies tend to see both losses and SF6 as largely outside their control short term and hence are fearful of incentives that might translate into financial penalties. And Ofgem seems preoccupied with the worry that the companies might invest too soon in new equipment. We disagree on both counts.

But if the companies and Ofgem aren’t responsible for these issues who is? It’s clear from the company plans that there are a range of innovative and relatively low-cost actions the companies could take in the next five years to reduce losses. But will network owners and managements prioritise such steps without some form of financial incentive?

The journey so far

This has been something of a roller coaster journey. In the original ED2 methodology proposals Ofgem proposed to rely simply on what they term “reputational regulation” for the environment (ie getting the companies to produce an Annual Environmental Report). On losses Ofgem took a backward step compared to ED1 where there was at least some financial incentive.

In our Sustainability First response in 2020 to the methodology consultation we argued strongly that financial incentives were needed to get the companies to focus on these issues and drew attention to the environmental scorecard approach adopted in electricity transmission. Ofgem listened and in its final ED2 methodology decision said it would introduce a scorecard with financial incentives.

However, in their detailed environmental action plans the companies only put forward a very narrow set of metrics (on for example fleet electrification) for inclusion in the environment scorecard. While we certainly could not support financial rewards for such narrow metrics, it does not make sense that Ofgem seems to have just given up on having any financial incentive in this area.

Meaningful comparisons

In its Draft Determination Ofgem argues that stakeholders will be able to compare across companies due to a more standardised approach to the Annual Environmental Report. This thinking is wholly unrealistic. We have highlighted to Ofgem the real difficulty we ourselves had as expert stakeholders in comparing across the business plans and detailed strategies. Realistically, environmental stakeholders simply don’t have the resource to carry out the in-depth work needed to test and properly compare performance across the companies in these technically complex areas.

Ofgem should not leave it to companies to “spin” their performance in glossy reports to their stakeholders. Instead, Ofgem should at the very least commit to producing or commissioning an annual report that compares across the companies (with RAG ratings or league tables). This would then pave the way for informed oral hearings where CEOs could be publicly challenged on their environmental performance, especially regarding progress on their net-zero targets plus their long term management of losses and SF6. We have already made these suggestions at working level in Ofgem. We very much hope that Ofgem will give these ideas serious consideration and not pass the buck. It simply is not credible to depend on ill-resourced environmental stakeholders to step into the vacuum to do what should be the regulator’s day-job.