David McNaught discusses innovation in the electricity distribution industry
Promoting and fostering innovation is a complex problem in any industry; the forward impetus of innovators, driven by a desire for competitive advantage, can be stymied by corporate inertia, entrenched interests, myopia or any other of a whole host of factors. These barriers are a significant concern even in situations where organisations are fully able to exploit the benefits of their own innovation; they become stifling in the context of tightly regulated industries. Where an organisation has its role shaped primarily by licence and legislation, and its income calculated by a fixed return mechanism, innovative approaches are very unlikely to result.
The UK’s electricity distribution networks, and the Distribution Network Operators (DNOs) licenced to run them, existed in just such an innovation limbo following privatisation in the 1990s. By the time the industry regulator, Ofgem, started consultation for the fifth Distribution Price Control Review (DPCR5) period, which was due to commence on the 1 April 2010, there was wide recognition within the industry that DNOs were not incentivised to take innovative approaches to service delivery. The DNOs argued that they were doubly bound: their licensing terms made them responsible for the full costs of any failed innovation projects, and the financial gains from successful innovation were likely to be subject to claw back at the next price control review period.
In short, the previous network price control regimes, despite the laudable aim of providing lowest price to electricity customers, had incentivised DNOs to reduce their cost bases, simply by driving down the cost of operations and maintenance and extending the life of their existing assets.
In response to this situation, Ofgem used the DPCR5 to establish the Low Carbon Networks Fund (LCNF); a £500 million competitive project fund whose intended purpose was to replicate the incentives supporting and promoting innovation present for companies in other industries. In addition, the fund was designed to help the DNOs ‘to prepare for their role in the low carbon economy’. My organisation, Frazer-Nash Consultancy, was involved as technical consultants scrutinising and recommending potential projects on their effectiveness at facilitating carbon reduction, assuring security of supply and providing value for money for distribution customers.
The DPRC5 period came to an end on the 31 March 2015 and the LCNF closed to new projects. The fund’s conclusion, and the completion of the first tranche of projects commissioned under it, presents a natural opportunity for retrospection and to present an initial ‘hot take’ on the fund’s successes and imperfections.
In plain, numerical terms the LCNF has allocated over £240 million of funding on 23 major and 42 minor projects with each of the UK’s six DNOs having at least one major project funded. The fund has realised Ofgem’s objective to allow the DNOs to ‘try out new technology, operating and commercial arrangements’. All aspects of the ‘trilemma’ of challenges – reducing carbon emissions, increasing security of supply, and ensuring affordable costs to energy consumers – have been investigated. The projects have sought a variety of solutions for the unprecedented challenges to the UK’s energy infrastructure: new technology, novel management techniques and sympathetic policy approaches have all been investigated as providers of the necessary changes to the sector.
Beyond the delivery of individual projects, the biggest successes of the LCNF have probably been its sector-wide effects. By giving industry participants a ‘walled garden’ for new approaches, in which innovative ideas could be trialled on their own merits, the fund has fostered a sectorwide culture change. The best evidence for that success has been the introduction of the RIIO (Revenue = Incentives + Innovation + Outputs) funding mechanism as the follow up to DPCR5. Many of the assumptions that RIIO makes about the sector’s abilities to innovate and drive down costs would have been inconceivable without the LCNF. The LCNF itself has now been replaced for funding new projects by the Network Innovation Competition and the Network Innovation Allowance, both of which build on the LCNF’s structure, approach and achievements.
Some critics would suggest that, in purely project terms, the LCNF has failed to deliver a ‘killer app’: no single project has broken through to make a significant impact outside of the industry. Despite some impressive aspirations, the projects have, on the whole, not been as effective as had been envisaged in engaging domestic consumers. Public engagement is vital for many of the issues facing the electricity network: distributed generation, electric vehicles, the electrification of heat and the provision of smart meters are all key issues for the coming decade, and many of the projects engaging on these topics have reported difficulties getting wider traction.
These shortcomings notwithstanding, the sector-wide impacts that the LCNF has been able to achieve make it an interesting template for how innovation might be promoted in other heavily regulated markets. Firstly, a proactive regulator willing to recognise a shortfall in the industry structure and propose amendments to incentivise the innovative behaviour that is required. Secondly, a willingness to assign funding, not just to promote individual projects for immediate results, but to deliver structural change. Thirdly the readiness of regulated organisations to engage and collaborate with new parties, seeking to draw in new expertise and fresh views of their industry.
The Low Carbon Network Fund was made available to the DNOs in recognition of the fact that the regulatory environment had, perversely, failed to incentivise network operators’ trialling of innovative methods, approaches and technology. On those terms, the LCNF has been a successful catalyst for changing the perspectives of the distribution industry. It has encouraged key players within the industry to value and seek novelty; to engage with new tools, techniques and partners and to initiate the development of an operational culture which is positive about participating in the transition to a lower carbon future.
David McNaught is a chartered mechanical engineer at Frazer-Nash Consultancy Ltd, a leading systems and engineering technology company. With around 700 employees, Frazer-Nash operates from a network of ten UK and Australian offices. The organisation excels in solving complex engineering challenges for clients in the aerospace, transport, nuclear, marine, defence, and power and energy sectors.
For further information please visit: fnc.co.uk