Price controls and heat decarbonisation
At the end of this week, we start the 2023 - 2028 price control period for Distribution Network Operators (DNOs). The networks are an important part of electrifying transport and heat, as they invest in infrastructure upgrades and develop regional flexibility markets. Here are a few reflections on the ED2 final determinations that Ofgem published in November 2022 and how they impact heat decarbonisation.
Low carbon technology uncertainty
One of the great difficulties for the 2023 - 2028 price control is the uncertain speed of the uptake of low carbon technologies, including smart heating. The UK government has a target of 600,000 heat pump installations per year by 2028 and is supporting innovators such as Caldera, Sunamp and tepeo to electrify heating.
Electrification of heat requires training engineers, building flexibility markets and upgrading physical networks. If uptake of electrical heating is slower than expected, Ofgem wants to minimise the risk of inefficient network upgrades. If uptake is faster than expected, Ofgem wants to minimise the risk that network capacity becomes a blocker. This balancing act is why the final determinations allow for a degree of anticipatory investment and include the potential to reopen the settlement.
The business plans of all the DNOs see just under 3 million heat pumps in operation by 2028 across Britain, each with a thermal store (whether smart thermal store or a hot water cylinder).
DNO business plan forecasts of heat pumps and thermal stores by 2028
Grid upgrades versus flexibility
Heat decarbonisation must speed up during the 2020s for the UK to remain on track for net zero. While Ofgem sees a need to invest in grid infrastructure to support products such as heat pumps, the final determinations are less confident talking about the role of heat flexibility. Some plans propose at high-level securing flexibility through pre-heating buildings with heat pumps. Others recognise that further work is required. This partly reflects that many of the DNOs are unsure about the flexibility of heat demand and are still learning about electrified heating.
This is why DNOs are undertaking heat flexibility research. UK Power Networks is partnering with Ovo and tepeo, a Thermal Storage UK member, on Neat Heat. This involves installing 30 smart thermal stores to understand the benefit to the grid and customers. SSEN is working with Sunamp, another Thermal Storage UK member, on Project Re-Heat. This involves installing 150 heat pumps with thermal stores to enable customers to be more flexible in the times they use electricity for heating.
Flexibility governance
Ofgem provides DNOs with around £130 million of funding for the procurement of flexibility during RIIO-ED2 and have included provisions for this to increase if necessary through uncertainty mechanisms. Ofgem is not prescriptive about the technologies or types of flexibility used, allowing new products to emerge.
The lack of certainty about heat flexibility partly reflects that Ofgem is continuing to work on what the governance for Distribution System Operators will look like and what their role should be. Ofgem is now consulting on proposals for both governance and flexibility.
Low voltage (LV) network monitoring
While much focus is on the transmission system plans of National Grid ESO to connect renewables, we also need to better understand the state of the distribution network. Ofgem is conscious of the lack of data about the LV network. This price control requires DNOs to increase LV network monitoring. These "Network Visibility Strategies" should be in place by 2028, with some DNOs aiming to complete the process earlier than that. This information is critical to successful heat and transport technology deployment, pinpointing pinch points.
Who pays for system upgrades
Consumers pay for DNO infrastructure upgrades through their energy bills. Ofgem's estimates on cost of capital and allowances form a big part of the price control debate. Recent increases in the cost of equity and debt are reflected in the price control. The cost of equity is 5.23% (up from 4.75% in the draft determinations), while the cost of debt is 3.01% - 3.07% (up from 2.3%). The cost of equity at 5.23% is actually lower than the 6.4% cost of equity for the previous price control.
This cost of debt and equity combined with an ongoing 1% efficiency challenge is how Ofgem plans to ensure that the average customer pays £100 per year for electricity distribution, while allowing networks to invest more over the next 5 years. The actual cost to consumers will depend on the extent to which the uncertainty mechanisms are used and the level of inflation.
The networks will need to work incredibly hard to ensure that the wires and substations remain sufficient for increasing renewable generation and demand for electricity.
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