Technical losses are increasing as more low-carbon technologies connect to the UK’s electricity networks. These technologies are connecting at lower voltages and using up headroom at these voltages. As more network capacity is used, losses increase. A 2018 study by WSP for the Energy Networks Association found that at maximum levels of penetration, low-carbon technologies could increase losses by up to 350%. With losses pushing up prices for customers, regulator Ofgem has become increasingly concerned about their impact.
What can be done? The answer might seem straightforward: network operators can use lower-loss equipment, such as cables with larger cross-sectional areas or transformers with lower-loss specifications. However, installing this equipment requires increased capex spend which operators have to justify in the context of the regulated market. Network costs are a key component of the consumer bill, so over-investment in the network can lead to an increase in electricity prices. A balance needs to be struck between capital investment and reduction in losses. Therefore, it is essential that losses are taken into account in investment decisions.
Within one of the previous price controls (DPCR4), there was a financial incentive mechanism in place for networks to reduce losses. However, it was complex and difficult to measure – there were issues around the stability of the incentive and unintended consequences, such as producing significant rewards for network licensees without adequately demonstrating that the rewards were warranted, or unfairly penalising other network licensees. The mechanism failed to directly link the actions of the distribution network operators (DNOs) to a reduction in losses with any confidence, which is an effect of losses being difficult to measure accurately.
This led to the mechanism being abandoned and less onerous alternatives introduced. Instead, networks were required to have a losses strategy in place and a Losses Discretionary Reward was implemented, to which network operators could apply for funding to better understand and manage electricity losses on their networks. But this approach too was unsuccessful and is not going to be continued into ED2.
Concerns regarding increasing network losses have continued. So, last year, WSP’s Power Systems team completed a study for the Energy Networks Association assessing the options for a new losses incentive mechanism.
Finding the right mechanism is tricky because losses are complex, difficult to measure, and vary based on regional topology and customers’ electricity usage. What’s more, it’s important that any mechanism doesn’t discourage low-carbon technology, the benefits of which ultimately outweigh the issue of losses.
After examining different mechanisms used around the world, we recommended a reputational incentive with a cost-benefit analysis approach for justifying lower-loss investments that require increased capex. Network operators would be assessed against a written submission describing the actions taken to improve network losses and given a score. Cost-benefit analysis tools would be used to include the financial and environmental cost of losses when assessing network investment options. This would enable networks to make investments based on lifetime cost.
This approach is being adopted for RIIO-ED2 and our report has been referenced in Ofgem’s price control documentation. Ofgem’s sector-specific methodology for RIIO-ED2 states that a reputational incentive is sufficient for ensuring the DNOs remain focussed on effectively managing losses. A financial incentive is not appropriate, it says, due to difficulties in measurement, wholly attributing outcomes to DNO actions and the risk of perverse incentives.