Flexibility and change

Transitioning from DNO to DSO – regulating more active distribution networks. By Mark Bartholomew

Transitioning from DNO to DSO – regulating more active distribution networks. By Mark Bartholomew

The need for more active network management by distribution network operators (DNOs) has been discussed for some years. It is now being actively promoted by the Department for Business, Energy & Industrial Strategy (BEIS) and Ofgem in the context of the transition to smart grids. Their July 2017 Smart Systems and Flexibility Plan identified that a transition from the traditional DNO model to a Distribution System Operator (DSO) role will be key to the evolution of markets in local flexibility services for network management purposes. The transition represents a major change in the electricity sector and, inevitably, regulation in this area will need to adapt.

Why the need for flexibility?
Flexibility is not an issue confined to the GB system; the need for it is being driven across the Continent by the EU’s decarbonisation targets. As explained by the European Distribution System Operators’ Association (EDSO) in its ‘Toolbox for Electricity DSOs’, distribution networks have been designed as passive systems that simply provide a means of linking generation with demand. That approach increasingly no longer holds good, as the level of installed intermittent renewable capacity (e.g. wind and solar) connected at distribution voltages increases. Locallyconnected generation, storage facilities and flexible demand, referred to collectively as ‘distributed energy resources’, do however also present an opportunity for distributors to manage their networks because they have the potential to provide flexibility services.

Ofgem has defined flexibility – in its 2015 Position Paper – as ‘modifying generation and/or consumption patterns in reaction to an external signal (such as a change in price) to provide a service within the energy system’. Traditionally, conventional generation has been the main source of flexibility and Ofgem recognises a need to encourage other sources, including industrial and commercial customers, domestic customers, storage providers and aggregators.

Flexibility services can be used not only for the purposes of managing intermittency but also to manage congestion at the distribution level, which traditionally has been addressed only through reinforcement works. It has the potential to provide an alternative solution to major capital works, deferring or avoiding the need for network reinforcement and to support cheaper and timelier connections.

A need for regulatory change?
Ofgem and BEIS made clear in the Smart Systems and Flexibility Plan that market-based solutions should be adopted by distributors to procure flexibility services. Whilst additional regulation will not therefore be required for flexibility services, DSO activities will remain largely monopoly activities and will require continuing regulation. As such, Ofgem has recognised that some regulatory changes are likely to be needed. The Energy Networks Association (ENA) is running the Open Networks Project, which is designed to transform the way energy networks work, underpinning the delivery of the smart grid. The project is a major industry initiative in which network operators from the UK and Ireland, academics, NGOs, Government departments and Ofgem are all participating. Projects such as this can be expected to highlight where regulatory developments are required.

The Open Networks Project has identified several key DSO functions that are likely to need some development. These include co-ordination between network operators, to enable whole system planning, operation and optimisation; network operation, to maintain a safe and secure system and investment planning, to identify requirements for additional capacity and find the most efficient ways of meeting those requirements. Also highlighted was the need for DSOs to facilitate markets in which distributed energy resources would compete to provide network services.

The development of these functions is likely to mean changes to the relevant licences, codes and regulatory policies covering the operation and use of distribution networks. Some key interfaces will need clarification, such as how DSOs would engage with consumers to procure flexibility and the relationship between National Grid as GB System Operator and a future DSO. In general terms, there will be a greater need for co-ordination between various parties as the roles of transmission and distribution operation become more interdependent. More clarity is also likely to be needed before investments in infrastructure are made; for example, to ensure that the costs of such investments are shared fairly.

Innovation and Regulation
Since 2015 the RIIO framework (Revenues = Incentives + Innovation + Outputs) has been used in Great Britain for distribution price control purposes in place of the former RPI-x approach. The RIIO framework was designed by Ofgem to deliver outputs of value to consumers, such as improved reliability or better customer service, and to encourage DNOs to be innovative and to deliver their outputs in the most efficient way, giving the same attention to technological or operational solutions, as they traditionally gave to capital investments.

Ofgem has expressed the view that the RIIO framework can accommodate the transition from DNO to DSO. However, the transition will require additional investment by electricity distributors who will need to embrace new technology. They have been used to a relatively low-risk environment and the transition to DSO is likely to involve higher risk investments than they have been used to making.

In general terms, the GB regulatory framework will require changes for the purposes of introducing the DSO model but these might be relatively limited in scope and mostly concerned with supporting the new functionality required. However, transitioning to a DSO model in the context of the recently-introduced RIIO framework might be challenging, particularly so when Ofgem has stated that the next price control period, RIIO-2, will be tougher for investors and returns will be lower.

Shakespeare Martineau
Mark Bartholomew is partner in the energy team at law firm, Shakespeare Martineau, a law firm that doesn’t think and act like the rest. It has the peripheral vision needed to ensure that clients don’t just exist in their marketplace, but own it. As a fast-moving, ambitious and entrepreneurial firm, its advisers think beyond just legal solutions by providing creative, dynamic and pragmatic advice that works for businesses and individuals.

For further information please visit: www.shma.co.uk