Delivering Power: The Future of Electricity Regulation in London s Central Business District

Transcription

1 RESEARCH REPORT Report prepared for the City of London Corporation, City Property Association and London First by South East Economics and Stephen Jones Associates Published March 2012 Delivering Power: The Future of Electricity Regulation in London s Central Business District MARCH 2012

2 RESEARCH REPORT Report prepared for the City of London Corporation, City Property Association and London First by South East Economics and Stephen Jones Associates Published March 2012 Delivering Power: The Future of Electricity Regulation in London s Central Business District Z/Yen Group Limited 90 Basinghall Street London EC2V 5AY United Kingdom Tel: +44 (0) City of London Economic Development PO Box 270, Guildhall, London, EC2P 2EJ

3 Delivering Power: The Future of Electricity Regulation in London s Central Business District is published by the City of London. The authors of this report are South East Economics and Stephen Jones Associates. This report is intended as a basis for discussion only. Whilst every effort has been made to ensure the accuracy and completeness of the material in this report, the City of London and the authors, South East Economics and Stephen Jones Associates, give no warranty in that regard and accept no liability for any loss or damage incurred through the use of, or reliance upon, this report or the information contained herein. March 2012 City of London PO Box 270, Guildhall London EC2P 2EJ

4 Contents Foreword... 1 Executive Summary Introduction Background Context Approach to the study Key features of the regulatory regime Introduction The overarching legislative framework The licence regime Price control framework Regulating investment Outputs Streetworks Charging arrangements The connections regime RIIO Summary Review of Evidence Introduction Key issues Connections & adequacy of network investment Performance with an agreed connection delivery date Lead times for connection & network adequacy Streetworks Commercial impact Stakeholder interactions with the DNO Communication & service quality Long term planning Commercial negotiations Regulation GSOPs Competition/contestability Costs and charging Summary... 22

5 4 Policy Implications Overview DNO Performance Competition Regulation Customer consultation Demand assessment and modelling Consultation and communication Granularity in demand estimation DNO incentives, investment and charging Baseline outputs Locational outputs Incremental investment Charging arrangements Chapter summary Conclusions A Annex A - The Cost of Streetworks A.1 Introduction A.2 Streetworks A.3 London Permit Scheme A.4 City of London Corporation measures to improve the management of streetworks A.5 Lane rental A.6 Utilities streetworks and the cost of traffic congestion A.7 Colin Buchanan report: Road Works Count A.8 Transport for London - Lane Rental Scheme Cost Benefit Analysis A.9 Summary B Annex B - Ofgem s Powers and Duties B.1 Licence conditions C Annex C London Central Business District D Annex D - Glossary E Annex E - List of participants... 53

6 Foreword A key factor in maintaining London s competitiveness is the ability to ensure that our infrastructure is fit for the future, and able to support changing business needs and new developments. This is a long term issue that will have an important impact on future growth. The Greater London Authority (GLA) estimates that by 2032, Central London will benefit from around 20% growth in employment, and will require up to 3 million square metres of new office floor space - the equivalent of 27 buildings the size of The Shard. Having the right power infrastructure is a pre-requisite for such growth, and the way in which this infrastructure is supplied, managed and regulated has a crucial bearing on the ease with which new development can take place. The City of London Corporation, London First and the City Property Association jointly commissioned this research to examine the issues around electricity distribution in central London, given its importance not just to individual developers, but to the City overall. This independent expert review also investigates specific issues affecting power supply to new developments, such as lead times for securing new electricity connections and potential capacity constraints in the medium term. Although the current economic climate has resulted in a pause for some developments, the demand for office space and energy supplies will revive quickly. So we need to plan now for the future to ensure London can support economic growth. A just in time approach to new electricity supply will not be effective in meeting business needs in central London, especially given its distinct characteristics - densely packed and narrow congested streets and extremely high and growing density of electricity demand. Responding to needs as they arise rather than anticipating future demand can also be counter-productive, for example through the costly and disruptive nature of ad hoc streetworks. A key outcome from this research is a set of recommendations on how best to facilitate supply to meet the demand for power over the next 20 years. The report makes the case for increased investment in electricity networks in central London to meet future growth and for reforms to make the system more flexible by encouraging the network operator to invest more in infrastructure ahead of need. It also calls for developers, businesses, the network operator and Ofgem, to work more closely together to plan for the capital s future needs. Our three organisations now look forward to working together and in partnership with others to find practicable solutions to the issues raised and to share and promote good practice. Stuart Fraser Jo Valentine Anthony Furlong Chairman Policy & Resources Chief Executive President City of London London First CPA 1

7 Executive Summary The City of London and London First with support from the City Property Association commissioned this research to examine the regulatory issues underpinning power supply to new office developments in the Central Business District (CBD) of London. The CBD has an extremely high and growing density of electricity demand and the research was commissioned in the context of reports from developers and businesses in the CBD regarding problems with lead times for securing new electricity connections and potential capacity constraints in the CBD in the medium term. This issue is of relevance to the project sponsors as the capability for development of new, high quality, office space is a key factor in maintaining London s on-going competitiveness. An adequate power infrastructure is a pre-requisite for such development and the way it is supplied, managed and regulated has a significant impact on London s development. The consultants undertook a comprehensive set of interviews with developers and other interested parties to identify views in relation to electricity network regulation within the CBD and the service offered by UK Power Networks (UKPN), the incumbent Distribution Network Operator (DNO) for the London area. These interviews identified a perception and concern amongst developers that the current approach to investment in the network is in need of improvement and a desire for changes that could deliver the future electricity network infrastructure required, within the CBD, more quickly and at lower risk. Key Interview Findings: Concern that the current regulatory system provides limited incentives for investment ahead of direct need to anticipate future electricity demand. In the context of continuing growth in demand for CBD office space, concern that investment in electricity infrastructure in the CBD is insufficient to meet future demand for electricity. Service to developers could be improved. Concerns were raised with aspects of the DNO s service, in particular in relation to communication with developers, transparency of processes and delivery of electricity connections. Concern from developers that they cannot get the certainty of service they want, or feel is necessary for their projects. This is despite a generally claimed willingness to pay more for a higher quality regulated service and quick guaranteed electricity connections. While we do not assess the merits of the views of developers in relation to these issues, the general level of dissatisfaction of this key customer group is of itself a concern. 2

8 Recommendations: The report has identified a number of potential areas of concern where further examination of issues and dialogue between the DNO, the energy regulator, developers, businesses and other stakeholders is likely to be of considerable benefit. In addition given the depth of concerns expressed by developers in relation to some aspects of DNO performance, we see merit in the DNO explicitly engaging with this group of customers to address these issues. This is likely to provide valuable guidance to the DNO in relation to the services it should be offering. UKPN is currently in the process of engaging with its customers in relation to its business plan for the period After consultation this plan will be submitted for regulatory scrutiny by the Office of Gas and Electricity Markets (Ofgem). In light of the issues raised through the study we consider that the following recommendations should be incorporated into this on-going consultation process: There should be improved transparency and consultation in relation to DNO demand estimates both on an aggregate and location specific basis. Without an accurate, common understanding of future expected demand, it is not possible to have an informed discussion of future network requirements. There should be greater clarity on the basis of the DNO s investment programme, how it incorporates uncertainty over future customer requirements and its relationship to future levels of expected demand for electricity. There should be consideration of the extent to which flexibility can be built into the DNO network, for example through investment in capacity in selected substations or in ducting ahead of need. Consideration should also be given to the wider benefits of such investment in reducing the incidence of streetworks in London. There should be an examination of the incentives on the DNO to invest on an incremental basis, ahead of need and consideration of the appropriate allocation of the risk of such investment between DNO, consumers and developers. Consideration should be given to a greater degree of targeting of GSOPs and measures of customer satisfaction, to ensure that the DNO is incentivised to meet the requirements of all customer groups. To facilitate these enhancements to the current arrangements there may be merit in the formation of joint working groups between the DNO, developers and other stakeholders to improve coordination of the future development of CBD electricity infrastructure. 3

9 1 Introduction The City of London and London First, with support from the City Property Association commissioned Stephen Jones Associates and South East Economics in September 2011 to conduct an independent expert review of electricity distribution network regulation in the London Central Business District (CBD). In this report the CBD is defined as the area of core business activity in London, comprising the London Central Activities Zone (which includes the City of London, and West End) and Canary Wharf. 1 The capability for development of new, high quality, office space in the CBD has been identified as a key factor in maintaining London s on-going competitiveness. Utility infrastructure (water, gas, energy, telecoms) with the capacity to meet the demands of new office developments in a timely manner is a pre-requisite for maintaining such competitiveness. The research was commissioned to look at the regulatory issues underpinning power supply to new developments and the ways in which regulation can support the assessment of and planning for current and future demand taking into account the competitive position of the CBD overall and the City specifically. A further area of interest for the study relates to the impact and cost of transport delays arising from streetworks. Primary research in this area was outside the scope of this review, however, the views of developers and business customers were sought on the impact of streetworks and have been coupled with an assessment of the existing literature in this area. This report sets out the results of our findings. In this document we summarise the current system of regulation and set out the views of a number of interested stakeholders on the adequacy of the current arrangements and likely future requirements for electricity connections within the CBD. We then identify some key policy issues worthy of further consideration and potential implications for future developments in the framework for regulation of electricity distribution. 1.1 Background Electricity distribution networks carry electricity from the transmission systems (and some generators that are connected to the distribution networks) to industrial, commercial and domestic end users. Prior to 1990, state owned area electricity boards were responsible for the distribution and supply of electricity to consumers in their areas. In 1990, the England and Wales electricity industry was privatised with the businesses of the area electricity boards reconstituted as Regional Electricity Companies (RECs) responsible for distribution and supply in essentially the same geographic areas. However, from 1990, the RECs local supply monopolies were progressively opened to competition, with competition extended to all domestic customers in A map of the CBD can be found in Annex C of this report. 4

10 The Utilities Act 2000, required the separation of distribution and supply businesses and introduced distribution licences. There are 14 licensed distribution network operators (DNOs) each responsible for operating and maintaining the electricity distribution network in their area. The DNOs themselves are prohibited from supplying customers with electricity and must offer access to their networks on a non-discriminatory basis. Electricity supply companies, with contracts with end users, pay the relevant DNO charges for the use of the DNO network to deliver electricity to their customers. The services offered by DNOs are regulated by the energy regulator Ofgem. As a network monopoly DNOs do not, in relation to their monopoly functions, face competition and customers have no alternative to the DNO service. In this context regulation can broadly be seen as an attempt to protect consumers from monopoly power and mimic, however imperfectly, the outcomes of a competitive market. DNOs are therefore regulated in a variety of ways, including in relation to their charging, their behaviour, their development plans and the outputs they are required to provide. Of particular relevance to this project are the incentive and regulatory requirements that relate to investment and in turn the outputs that DNOs are expected to provide i.e. the physical network to deliver electricity to customers and the terms and standards of service in relation to new connections. The London DNO, London Power Networks, is ultimately the successor to the distribution business of the London Area Board and its successor REC, London Electricity. It is currently part of UKPN, which is owned by a consortium of Cheung Kong Group Companies, which acquired it from its former owner, EDF in October Context This review is particularly timely for three reasons. Firstly, it is taking place during the preparatory stages of the forthcoming electricity distribution price control review (RIIO-ED1). The price control sets out the overall revenues the DNO is allowed to recover from customers in charges and sets out the outputs the DNO is expected to provide in return for its revenues. This is the first electricity distribution price control since Ofgem concluded its RPIx@20 review of regulation and published its October 2010 Decision document to implement its new RIIO (Revenue = Incentives + Innovation + Outputs) regulatory framework. This is of particular importance as one of the key features of the RIIO model is a greater emphasis on the network monopolies engaging with their customers and demonstrating that their plans are supported by and meet the needs of their customers. Secondly, there has been a noted increase in reports of concerns amongst developers and businesses in the CBD regarding lead times for securing new electricity connections as well as potential capacity constraints in the CBD in the medium term. While there have been longstanding concerns from some parties regarding electricity connections in the CBD, these have become wider spread in 5

11 recent years as development activity has increased. In this context it is notable that the CBD has an extremely high density of electricity demand. 2 Further, given significant future predicted increases in office activity and employment 3 within the CBD, even with improvements in energy efficiency, there is an expectation of significant electricity demand growth. Thirdly, there have been suggestions from a number of stakeholders active within the CBD that existing regulatory arrangements, while potentially appropriate in areas with lower levels of economic activity and lower density of electricity demand may not be providing adequate incentives for investment within the CBD. 1.3 Approach to the study At the start of this study we held a series of interviews with a range of stakeholders in order to: gather perspectives in a structured manner from interested parties, including developers, businesses and other users of connections services; identify the key issues; and test the anecdotal reports of concerns regarding the network in the CBD. It is worth nothing that during stakeholder interviews a number of explicit and implicit positions on particular regulatory issues emerged. While this report is not intended to be a theoretical analysis of the purpose of regulation, a number of policy issues emerged from the interviews. Broadly, these regulatory positions and issues can be characterised in the following ways: i) An implicit view on the combination and trade-offs between price, outputs and quality of service that the DNO should deliver. These views then lead to further questions regarding how the requirements may be incorporated into regulatory outputs. Of particular relevance is the extent to which preferences of a sub-group of customers should be treated in the regulatory process. ii) An implicit view on the trade-offs between static short run cost minimisation (and avoidance of under-utilized assets) and a broader concept of a longer term network planning. These views typically relate to the size of the network and the extent to which the DNO should invest on the basis of future expected demand levels. iii) The extent to which regulatory outputs and charges can and should be tailored to specific customer groups. 2 See Annex C, figure 2 3 Research published by the Greater London Authority in November 2009 sets out projected growth in office employment and consequential net additional demand for office floorspace. For the period for the CAZ and Canary Wharf they estimate a growth of 19.2% in employment and 2.1m sq m net additional floorspace, with over two thirds of this growth occurring in the period

12 These issues relate to the extent to which anticipatory investment should be incorporated into the Regulatory Asset Value (RAV), incentives to invest on the DNO and the appropriate allocation of risk between the DNO, developers and the larger group of customers. Against that background, the remainder of this report is structured as follows: A summary of the existing regulatory arrangements is set out in Chapter 2. The key findings of the interviews with stakeholders are set out in Chapter 3. Potential policy implications for electricity distribution regulation are identified in Chapter 4. Chapter 5 sets out some broad conclusions and a possible way forward in relation to regulation of the DNO. Annex A focuses on the impact of streetworks and summarises our assessment of a number of studies which have sought to quantify the impact of transport delays arising from streetworks. Annex B provides a summary of Ofgem s powers and duties as they relate to electricity distribution. Annex C contains diagrams of the London, Central Business District. Annex D sets out a glossary of terms. Annex E provides a list of participants. 7

13 2 Key features of the regulatory regime 2.1 Introduction This chapter identifies the key principles and features of the existing regulatory regime and provides a broad framework to consider the issues arising from the study. It is worth noting upfront that the arrangements for regulation of electricity distribution are relatively complicated and in this report we have attempted to set out a high level summary of the salient issues; further details of the regulatory regime can be found on Ofgem s website 4. Natural monopolies such as electricity distribution networks have traditionally been regulated because these companies are not subject to the normal pressures that bear on a company in a competitive sector. At a fundamental level, the lack of competition means there is a risk that the monopoly will accrue excess profits and incur unnecessary costs at the expense of the customers who depend upon its services. Additionally monopolies lack dynamic incentives to improve efficiency, to innovate or to improve the quality of the service that they provide. Economic regulation is often thought of as an attempt to protect consumers from monopoly power by mimicking the outcomes that would be observed in a competitive market. The aim of regulation can be thought of as to provide monopolies with incentives to improve their performance and to ensure that customers benefit from improved levels of service and greater efficiency. The chapter begins by providing a summary of the specific regulatory context that applies to UKPN (and other DNOs) before going on to examine in more detail aspects of the regime that are particularly relevant to this study i.e. new connections, investment, the charging arrangements and Ofgem s new RIIO model of regulation. 2.2 The overarching legislative framework Ofgem is the administrative body which supports the Gas and Electricity Markets Authority (the Authority), the regulator of the gas and electricity industries in Great Britain 5. Ofgem s powers and duties are largely provided for in statute, mainly the Gas Act 1986, the Electricity Act 1989, the Utilities Act 2000, the Competition Act 1998, the Enterprise Act 2002 and the Energy Act 2004, as well as arising from directly effective European Community legislation. Ofgem s principal objective is to protect the interests of existing and future consumers, wherever appropriate by promoting effective competition between persons engaged in, or in commercial activities connected with, the shipping, transportation or supply of gas conveyed through pipes, and the generation, transmission, distribution or supply of electricity or the provision or use of electricity interconnectors. A more detailed description of Ofgem s powers and duties is set out in Annex B For simplicity we refer to the Authority as Ofgem in this report. 8

14 2.3 The licence regime In accordance with the Electricity Act 1989 (the Act), all DNOs must hold either a distribution licence or an exemption to distribute electricity. The distribution licence contains obligations and provisions in relation to issues such as consumer protection, the provision of monopoly services on a non-discriminatory basis, the establishment and operation of competitive market infrastructure, the integrity and development of the distribution network, the financial ring-fencing of the distribution business and the provision of regulatory information to Ofgem Price control framework In addition to these formal licence conditions, Ofgem also regulates the charges that customers pay and the quality of service that they receive. The price control, which historically has been re-set every five years 7 sets the total revenues that each DNO can collect from customers at a level that Ofgem considers would allow an efficient business to finance its activities. The current price control, which applies from April 2010 until March 2015, and is known as distribution price control review 5 (DPCR5) is based on the standard RPI- X approach used by economic regulators in the UK and overseas. Under this model of regulation, Ofgem sets a base level of revenue for each DNO sufficient to cover efficient investment and operating costs while delivering a set level of outputs. If the company manages to invest and operate at a lower cost than Ofgem assumed, then it will be able to retain the benefit of these savings and in effect increase the rate of return that it earns. The converse also applies so if the company spends more than Ofgem assumed then it will lose money and earn a lower rate of return 8. This form of price control (often referred to as incentive regulation) provides very strong incentives on DNOs to improve the efficiency with which they operate their networks. This type of regulation is generally considered to be good at incentivising productive efficiency, i.e. determining a certain set of outputs at lowest cost. However this approach also has its limitations, including that it potentially incentivises short-term savings at the expense of longer-term network viability. Ofgem has, therefore, also put in place a number of mechanisms designed to ensure that DNOs do not focus on cost cutting at the expense of customer service, or other things valued by customers, in particular: DNOs are rewarded or penalised in relation to the number of customer interruptions (CIs) and customer minutes lost (CMLs) each year. DNOs may earn or lose additional revenue according to how well they perform against a broad measure of customer satisfaction 9. 6 The conditions which are of most relevance to this study are summarised in Annex B 7 Under Ofgem s new RIIO model future price controls will last for 8 years. 8 The sharing of lower costs between companies and customers is determined by the IQI incentive rate (discussed further below). 9 The broad measure of customer satisfaction was developed over the first two years of DPCR5 and will come into force on 1 April The measure will provide financial rewards and penalties to DNOs based on their service to customers, including the level and usefulness of stakeholder engagement, the number of complaints received and addressed, and their handling of other contact with their customers. Ofgem states that the measure is intended to be broadly similar to the way that companies in competitive sectors measure their customer service and improve their performance. 9

15 DNOs have to compensate customers if they fail to meet standards of service for the speed of delivering certain connection activities, including providing quotes and completing work to connect existing or new customers to their networks. Further mechanisms reward or penalise the DNOs according to the percentage of units that are lost in distributing electricity to customers and the efficiency of connection of distributed generation (DG). 2.5 Regulating investment At DPCR5, Ofgem made provision for a significant increase in the level of investment on the networks across GB as a whole. The majority of this was intended to replace ageing, unreliable or failing assets. However, some of it was required to provide additional capacity where there were hotspots on the network due to demand growth. At the time of the price control review, Ofgem asked the DNOs to prepare business plans setting out their views on the level of investment that would be required in the network over the period covered by the price review (and beyond). Ofgem then undertook a thorough review of the company s plans before making its own assumption about the level of investment that should be included in the price that the DNOs are allowed to charge their customers. In order to incentivise the DNOs to invest efficiently Ofgem regulates them to keep (or bear) a proportion of any savings made (or additional costs) from spending less (or more) than the cost assumptions. Ofgem uses a rolling incentive mechanism to allow the companies to retain the benefit of any savings over a five year period, regardless of when in the 5 year control period these occur. Ofgem considers that this mechanism is necessary to ensure DNOs have an incentive to invest efficiently throughout the 5 year control period. Additionally, Ofgem uses an Information Quality Incentive which in essence rewards or penalises companies depending on how closely their business plan projection of capex matches Ofgem s own view of the company s requirement. Ofgem has been clear in the past that the price cap should not necessarily determine the level of investment that DNOs undertake. Rather investment should be driven by business needs taking into account statutory obligations, environmental and social impacts. Evidence from previous price control periods suggests that DNOs have tended to consistently under-spend against the price control assumptions. 2.6 Outputs In return for the revenues they receive for investing in the networks, DNOs are required to deliver a package of output measures. At DPCR5, Ofgem noted that by observing performance against these measures it would be better able to distinguish between those companies that have innovated and found ways to deliver what customers expect more efficiently, and those that have deferred investment at the expense of network health and/or performance. The output measures are intended to complement other targets on interruptions, network losses and customer satisfaction. Ofgem worked together with the DNOs to develop these output measures as follows: 10

16 A Load Index (LI) relating to general reinforcement expenditure is used as a framework for collating information on the level of capacity utilisation at specific sites across the distribution network, and for tracking changes in capacity utilisation over time. A Health Index (HI) relating to asset replacement expenditure is used as a framework for collating information on the health (or condition) of distribution network assets and tracking changes in network health over time. Fault rates - fault rates are used as a secondary network output measure for asset replacement expenditure. At the end of DPCR5, DNOs will be required to demonstrate that their actual level of network investment in asset replacement and general reinforcement has delivered the agreed level of outputs. If a DNO can demonstrate it has satisfactorily delivered its outputs over the price control period then Ofgem has stated that it would take no further action. On the other hand, Ofgem has stated that there will be financial consequences for DNOs that fail to deliver the agreed outputs (or an equivalent) and cannot demonstrate this was in customers' interests. It should be noted that this does not tie the companies into delivering exactly the same mix of outputs by the end of the price control. They have flexibility to reprioritise based on the latest information but must be able to demonstrate that they have delivered the same or better value for consumers. For high value projects i.e. those where the costs are in excess of 15m, Ofgem noted that there was some uncertainty over whether these projects would go ahead during DPCR5 or whether issues such as planning consents or resourcing constraints would delay them. Ofgem, therefore, introduced specific measures for these high value projects as follows: an ex ante allowance was included in the baseline (subject to an efficiency adjustment where appropriate) the DNOs were required to commit to project specific outputs, and if outputs are not delivered an adjustment will be made based on the 'outputs gap'. In addition, if the total spend on high value projects is +/- 20 per cent of the total ex ante allowance and all outputs are delivered then the HVPs will be eligible for a reopener. 2.7 Streetworks The price control contains provision for the costs that are likely to arise in response to the Traffic Management Act. At the time that Ofgem set the control in December 2009 there was significant uncertainty about the level of these costs over DPCR5. In effect, the DNO s price control includes an allowance of 4m for these costs over the five year period. This was a reduction from the company s own forecast of 5m. This allowance excludes costs arising from permitting schemes under an assumption that no permitting schemes would be introduced. Instead, Ofgem stated that it would consider additional costs arising from the introduction of permitting schemes as part of a price control reopener during 11

17 DPCR5 or in RIIO-ED1. The implications of streetworks are considered further in Chapters 3 and 4 and Annex A. 2.8 Charging arrangements After the base level of price control revenue has been determined by Ofgem, in a separate exercise, DNOs set out how the allowed revenue is to be recovered from different customer groups. Ofgem reviews these charging methodologies and can veto them if it does not think they reflect DNOs costs, are not sufficiently transparent, or discriminate unduly against particular groups of customers. Ofgem and the DNOs have been working for a number of years to introduce a common distribution charging methodology to ensure that use of system charges are more cost reflective across the 14 DNOs. Customers are expected to benefit from the project through lower expenditure on the networks, lower costs to suppliers in managing a variety of methodologies and improved choice by facilitating competition from independent distribution network operators (IDNOs). Of particular relevance to this study are the implications of the common charging arrangements for investment signals. The new arrangements have been designed to direct customers away from congested parts of the network thus reflecting the lower cost of using those parts of the network where there is surplus capacity. Ofgem approved a common use of system charging methodology for lower voltages in November 2009, and charges based on the new models were introduced from 1 April Ofgem approved the extra high voltage distribution charging methodology (EDCM) for import charges (i.e. as they apply to demand customers), in September 2011 to apply from 1 April 2012 subject to certain conditions. 2.9 The connections regime Ofgem has been promoting competition in the gas and electricity connections markets for a number of years. Competition has grown rapidly in the gas connections area, to the extent that more than half of all connections are now installed by Utility Infrastructure Providers (UIPs) or Independent Gas Transporters (IGTs) rather than the former monopoly incumbent network provider. However, competition in the electricity connections market has developed at a much slower pace. A review by Ofgem published in March 2011 suggested that in the metered electricity connections market, market penetration for new entrants stood at around 13 per cent 10. At DPCR5, Ofgem introduced a number of new measures designed to encourage better performance by DNOs for all stages of the connections process. These measures included: New guaranteed standards of performance (GSOPS). This covers all of the key milestones in the connections process. Where a standard is not met the DNO is required to make a compensation payment to the individual customer. 10 Ofgem s Gas and Electricity Connections Industry Review

18 A price accuracy review scheme. This ensures that customers are able to challenge the accuracy of a DNO's quotation for a connection through a simple and easy to understand process. Regulated Margin. Ofgem permits DNOs to make a regulated margin of four per cent on contestable connection activities fully funded by the customer in certain market segments where Ofgem considers competition to be viable. This margin was introduced to provide headroom for the development of competition. A route for DNOs to demonstrate that there is competition in their local connections markets. In order to encourage DNOs to facilitate competition, Ofgem allows them to earn an unregulated margin on their competitive activities subject to passing a Legal Requirements test and a competition test. Ofgem has also committed to conducting a full review of any outstanding market segments that have not been judged by the end of December 2013 and may refer any matters of concern to the Competition Commission. Ofgem has also introduced a detailed reporting requirement for connections activities enabling it to have oversight of charges and cost recovery. DNOs are incentivised to recover costs accurately as Ofgem can use its enforcement powers to deal with excessive or systematic over or under recovery RIIO In October 2010, Ofgem published its formal decision document 11 to implement a new regulatory framework, known as the RIIO model (revenue = incentives + innovation + outputs). The RIIO model was the culmination of Ofgem s RPI-X@20 project under which it undertook a detailed review of energy network regulation. The review looked at how best to regulate energy network companies to enable them to meet the challenges and opportunities of delivering the networks required for a sustainable, low carbon energy sector. RIIO is designed to encourage network companies to: play a full role in delivering a low carbon economy and wider environmental objectives; invest efficiently to ensure continued safe and reliable services; and innovate to reduce network costs for current and future consumers. The RIIO model will be applied to the electricity and gas transmission owners, (TOs), the DNOs and the gas distribution networks (GDNs). Ofgem is currently in the process of carrying out the first suite of price reviews under the new framework which will apply to TOs and GDNs for an eight year period from April The first review of DNO s under the new model will apply from April UKPN has started to consult with stakeholders on the development of its investment plans under the first RIIO distribution review. UKPN s consultation process includes workshops, formal written consultations as well as an on-line

19 questionnaire to ascertain views. UKPN has recently consolidated the views put forward in its consultation on outputs in a report published on its website. Additionally, UKPN proposes to publish a document identifying the outputs it intends to take forward into the formal regulatory process and has plans to consult in 2012 on targets for these outputs and to test customer willingness-to-pay for specific improvements and levels of service Summary Regulation is integral to the way in which DNOs such as UKPN operate their networks. Ofgem s main tool for regulating the behaviour of DNOs is the price control which limits the amount of revenue that the companies can receive from customers and sets the outputs that the DNOs are expected to deliver. Ofgem will shortly be initiating the next distribution price control review which will provide stakeholders with an opportunity to review the current regulatory arrangements and to propose improvements where these are considered necessary. In the meantime, a number of measures are in place through licence conditions and Ofgem s policy framework which are designed to protect customers who wish to obtain a new connection to the network. These include a number of new measures introduced at DPCR5 to further encourage the development of competition in the connections market and to compensate customers who receive poor performance from the DNO with respect to connections activities. We consider further in the next chapter how these measures are perceived by the stakeholders that we met as part of the study. The investment plan for the five year period ahead is set at the time that the price control is established. While the DNO is free to depart from the assumptions made by Ofgem and to spend more or less as necessary to meet the needs of the network, in practice once the price cap has been set the DNO has a very strong incentive to spend less than the forecast. The new common charging arrangements introduced in recent years should facilitate more cost reflective charging which should in turn incentivise greater levels of connection to less congested parts of the network. The implications of these issues are explored further in Chapter 4. 14

20 3 Review of Evidence 3.1 Introduction In this chapter we set out a summary of the evidence that was gathered from the research phase of our study. The key stages to this process were as follows: Following a review of historical documentation relating to electricity network regulation and investment in the CBD, areas of interest were developed. In light of discussions with the City of London, London First and the City Property Association a range of stakeholders were identified and invited to participate in structured interviews during Q We principally met with developers of commercial office space, and / or their advisors, who had experience of securing large electricity connections in recent years. We also met with a small number of large end users as well as other interested stakeholders including UKPN, Ofgem and the GLA. The interviews were mainly conducted in person by the consultants although a small number were undertaken by teleconference. As the purpose of the interviews was to have a detailed discussion of the key issues for stakeholders the participants largely determined the areas of focus. We are grateful for the co-operation and positive contributions of the interviewees, and note that all interviews were conducted on the basis of non-attributable comments. The remainder of this chapter sets out the key findings of these interviews with developers; some discussion of how these views may fit into a regulatory policy conceptual framework and potential areas for further study. In this chapter we are presenting the views of stakeholders on issues of importance to them, primarily to identify areas where there are widespread concerns and where further study and dialogue may be of benefit. We have therefore sought to focus on areas in which there is a degree of uniformity and consistency in stakeholder views. We must stress that the purpose of this chapter is not to make an assessment of the accuracy of stakeholder views. We also note that while we have discussed some of these issues with the DNO we have not provided the DNO with detailed evidence in relation to specific developer claims and have not attributed any views to the DNO in relation to these issues. 3.2 Key issues While there was some variability in emphasis and dissenting views on specific issues there was a high degree of consistency amongst industry stakeholders regarding key concerns in relation to services offered by the DNO. Almost uniformly the most significant concern amongst developers related to a lack of certainty that electricity connections can be delivered by the DNO within a timescale consistent with new developments. More generally, a variety of concerns were raised relating to the quality of service offered by the DNO. In this 15

21 area the most prevalent concern raised by respondents related to problems with communication between the DNO and developers. In the following section we have attempted to broadly group the messages received from interviews. We do however recognise that there is significant crossover and inter-dependency between these issues and that messages could be grouped differently. 3.3 Connections & adequacy of network investment As noted above, the most significant concern amongst developers related to a lack of certainty that electricity connections would be delivered by the DNO within a timescale consistent with new developments. This has been broadly grouped with concerns regarding network investment as in the majority of interviews these issues were conflated. At a high level a common example would be developers suggestions that due to inadequate investment the DNO could not guarantee connection in a timescale that was consistent with their development. In more detailed discussions we were, in most cases, able to separate out a number of specific aspects of these concerns Performance with an agreed connection delivery date The first aspect of these concerns related to cases where a delivery date had been agreed with the DNO for connection of a new electricity supply. In our discussion with developers, a number of examples of slippage in connection times were put to us. It was further suggested these slippages had a significant commercial impact on projects. We note that while developers presented examples of significant slippage to connection delivery dates we have no evidence of any delay resulting in project cancellation. However, it was evident that developers regarded the slippages they had experienced as having significant impacts on their projects, which required substantial time and effort to manage and mitigate. Moreover, there was a widespread perception amongst developers and to some extent end users that there is a real risk to delivery of projects and that the network is on the edge. Developer views on the causes of slippage and delay were again reasonably consistent. While there were some views that the cause was general poor monopoly performance, for virtually all developers this was at most a partial cause of slippage, with participants regarding network constraints (through their consequential impact on the technical complexity of the connection) as a more significant factor. The concerns that could broadly be categorised as relating to poor service were primarily around a lack of ownership and poor communication by the DNO. Indeed, most developers regarded the performance of the DNO teams directly dealing with their connection positive in delivering some form of electricity supply by hook or by crook to allow project schedules to be met. Of particular note was the view, that given the constraints, technical solutions offered by the DNO were generally good. It was put to us by several stakeholders that while the DNO had always had some delivery variability with regard to connections, these were now technically more complex and typically had longer lead times. A proportional slippage in these 16

22 lead times, was more likely to impact on project delivery than has historically been the case. In the past, it was argued, as connections were taking place at lower voltage levels, closer to developments, with limited network reinforcement required, the connections were less complex, with fewer interdependencies. Therefore, typical connection lead times were low and even a significant proportional slippage in connection lead times was manageable. For example a slippage of three months, within a one-year connection timetable was deemed to be manageable and would not critically impact on project delivery. It was suggested that due to the continued growth in electricity demand and the typical need for DNO network reinforcement and more complex, longer connections, with greater need for streetworks, connection lead times are longer, with typically greater interdependencies and risk factors Lead times for connection & network adequacy The second aspect of these concerns relates to developer perceptions regarding connection availability for future developments. We noted a general view amongst developers that there is a shortage of planned capacity in the CBD. In particular, there is a sense that despite a planned increase in capacity in certain areas within the CBD, demand for connections for known future office developments means that in a number of places this increased capacity is already fully booked, prior to its technical completion, with no spare capacity for other potential future developments. It is also a common view amongst developers, that those who do not reserve capacity in these planned areas or routes will face significant lead times for connection that could cause a material delay to projects. Some developers also noted that in their view there is a general awareness of this issue amongst sophisticated end users and tenants and that it is recognised as a significant project risk Streetworks In addition to the concerns set out above, some developers raised the implications of the current approach to network investment on the incidence of streetworks and the impact of streetworks on developers businesses. In general, the view expressed was that the current approach to investment was ad hoc and incremental and would result in a continued increase in the number of streetworks. This is due to two factors i) incremental projects and investment typically require multiple occurrences of streetworks in the same area and ii) as the network becomes more constrained, connections must be made at nonconstrained points, which may be a significant distance from developments. Developers typically identified two consequences of streetworks. The first is that streetworks are complex and can add to project delays, therefore an increase in the need for streetworks typically increases the complexity of a project and increases the scope for delays and shocks. This adds additional risk to connection lead times. In this context it is relevant that a significant number of examples of slippages in connections raised by developers were attributed to streetworks issues. 17