Scotland's electricity and gas networks: vision to 2030

Chapter 3: Coordinating the Transition

By 2030… network regulation and governance will be more flexible and agile, based on deeper relationships with consumers. Scottish policies and priorities, as well as those of local authorities, will be taken fully into account ensuring that networks help deliver regional and local aspirations for energy. A coordinated, 'whole system' approach to infrastructure planning will exist, with strong and effective discussion between the electricity and gas network companies and everyone in the wider energy system. The way networks are funded ensures that the essential service they provide - access to affordable, reliable, and low carbon energy - is available to all citizens and businesses in an efficient and cost effective way.

Overview

The electricity and gas networks are natural monopolies that play a vital role in providing access to energy for people and businesses. Ensuring that they deliver the service that we want, to everyone, in a cost effective way, means that strong regulation and agile governance are important.

Although the technical characteristics of gas and electricity networks are very different, their shared economics, capital intensive and long term natures mean that key aspects of our vision apply equally to both - these include:

• The ways in which they are regulated and governed.
• The ways in which they are planned, especially the need for a whole system perspective.
• The ways in which they are funded.

Gas and electricity network policy and regulation are reserved to the UK Government. However, there are some important overlaps between UK and Scottish Government responsibilities on broader energy issues, and where decisions about gas and electricity networks can have an important influence. A good example is the provision of heat; the development of district heating during the coming decade will create new questions concerning the traditional split between the regulated and non-regulated parts of the energy system - with the Scottish Government having proposed and consulted upon regulation of district heating in Scotland.

We expect these overlaps to grow throughout the coming decade. The growth of electric vehicles is already forging new connections between transport policy and the electricity system - meaning that the network companies and regulator need to bear these aspects closely in mind when making decisions about the future of Scotland's networks. We will continue to work constructively with the UK Government on these matters - sharing information and making sure that Scotland's voice and interests are properly represented.

While Scotland has its own distinct targets, needs and priorities in this and other areas, the same issues and questions exist across the UK. We think that a collaborative and practical relationship between the Scottish and UK Governments will help ensure that the governance and regulatory structures can be made sufficiently flexible to accommodate differing priorities across Britain.

Scottish energy policy teams will meet with UK Government colleagues during 2019 to discuss the issues set out in this document, and how our joint ambitions can contribute towards UK wide decarbonisation and industrial strategy. This will be in addition to continuing meetings between Scottish and UK Government ministers, which cover a range of energy policy matters.

The Scottish Government similarly values its close and constructive relationship with Ofgem. We remain keen to find ways in which to improve this - to find better means of discussing and sharing views on our energy policy, and the regulator's ability to take these views into account in a manner consistent with its independent status.

We will discuss and agree with Ofgem a programme of regular meetings between senior officials focused on the energy networks in Scotland, as well as arranging an annual discussion between the Scottish Government energy minister and Ofgem's board.

We believe that electricity and gas networks enable the provision of an essential service - namely, access to affordable, reliable and low carbon energy for everyone in society. We expect this principle to inform decisions by government at all levels, and to be reflected throughout the regulatory and governance system.

Regulation and governance

The extent and pace of innovation and change is asking much more of our systems for regulation and governance. The structural changes which we need to drive through our gas and electricity systems demand practices which can adapt, adjust and respond accordingly - with the regulator playing its part in enabling networks that meet the needs and priorities of society.

Ofgem acts as the independent energy regulator, answerable to the UK Parliament and UK Government. Part of its remit is to act as a strong financial regulator to the monopoly network sector and to ensure that network companies deliver a safe and reliable service. In doing so, it oversees the broader governance structures - the licences and codes that define the rules under which the sector operates.

An important part of regulation is the way in which Ofgem agrees the level of spending that network companies are allowed to recover from network customers. These price control settlements are made for periods of several years and aim to ensure that network spending is efficient and focused, whilst giving the network companies the level of financial stability they need to invest in long term assets.

The current process is called RIIO: Revenue = Incentives + Innovation + Outputs. RIIO has a focus on regulating total expenditure across capital and operational activities - Totex - and allowing network companies to choose how they deliver the levels of service defined in their licences and the degree to which they go beyond these baseline standards. RIIO provides a range of incentives which reward networks for delivering high quality service, and penalises them where it is poor. RIIO also contains separate funding streams for innovation.

The first round of RIIO price controls began in 2013, when Ofgem agreed eight year settlements with gas transmission, gas distribution and electricity transmission; these run until 2021. The first electricity distribution price controls were agreed two years later, running from 2015 to 2023.

Gas network and electricity transmission companies are now preparing business plans for the RIIO-2 period to begin in 2021. The length of the RIIO-2 settlements has been reduced to five years, reflecting the high degree of uncertainty in the energy system and the challenges of forecasting further into the future. The second RIIO period for electricity distribution will be 2023 - 2028.

Price controls are complex negotiations. Final settlements must ensure a good deal for customers, whilst providing the stability needed for capital intensive investments where payback periods are measured in decades. They also need to account for uncertainty over the future development of the energy system. This uncertainty needs to be dealt with openly, identifying low regret options and considering the pros and cons of particular investments in different future scenarios.

This means considering carefully how risk is managed. Where spending might be approved to enable the development of the broader energy system - for example, the roll out of EVs - it runs the risk of the system developing along a different pathway, or taking place more slowly than forecast. This doesn't mean that investment should not be made, but it highlights the importance of quantifying the risk, identifying who carries it, and how it is managed.

The current price control agreements must clearly identify areas where any anticipatory spending may be required, and look carefully at options to mitigate the risk. Mechanisms should be introduced to support and enable investment where that is critical for the decarbonisation of the energy system and the wider economy.

We are following the RIIO discussions and development closely, and aim to ensure that the process and outcomes properly reflect the Scottish Government's energy priorities. That means striking the right balance between investing in the network at the right time and in the right places while supporting Ofgem in its efforts to curb excessive returns and deliver a fairer and better deal for consumers.

Governance mechanisms will also need to respond more quickly and more flexibly, with clear pathways for new and innovative businesses to inform how network codes and regulations develop. Increasing stability, transparency and open governance across the energy sector, sufficient to meet the demands of a fast changing world, will be challenging.

Ofgem is trialling open governance across some codes under which the network industry operates, while in other areas it is moving towards 'principles based regulation'. We believe these are positive developments; they signify that Ofgem understands the careful thought that must be given to the most appropriate mix of regulatory styles for the future of networks, based on the changes that are both underway and expected.

The growing interdependencies between different parts of the energy system are creating new areas in which the Scottish Government, UK Government and Ofgem need to interact. We believe that this will need new, strong and well-defined relationships between reserved and devolved government, and the regulator. Our desire to see smarter local energy provision, and our vision for local authorities to take a greater role in energy policy making, means that this collaboration needs to extend to local government.

Consumers

Big data and smart technologies give consumers new opportunities to provide services to the networks. It can also fundamentally change the relationship between consumers and networks, with new rights and obligations on both sides; consumers will become active participants in how network companies deliver their obligations for security and reliability of supply.

The growing focus on using flexibility from customers to support networks is important, particularly in the electricity sector. The 'DSO transition' (See box 5) shows that the industry is moving quickly towards a new model based on new relationships with their customers. But we need to avoid easy assumptions, and carefully consider what is feasible, desirable and affordable. We also need to remember that some consumers may not be able to adjust their consumption patterns, whilst others may find it difficult to engage in an increasingly complex market. It is imperative that these groups are not left behind.

Consumers and their representatives need to have access to the tools, expertise and knowledge that can help ensure that these rights and relationships are fully considered, and appropriate protections put in place where necessary. They will need to engage in technically complex areas, and come to informed views across a range of knowledge areas. We will also look at ways to support consumers and their representatives, communities, businesses and local authorities to engage in conversations about the future of our energy networks in the most effective way.

There have been positive developments in this area. Ofgem has initiated an 'Enhanced Stakeholder Engagement' process to ensure that network companies engage meaningfully with all users of their networks, including representatives of the end users. We will support the efforts of Ofgem and the network companies to capture meaningful input from consumers as well as other users of the electricity and gas networks, and apply that learning to develop fair and effective business plans.

Ofgem's primary duty is to protect the interests of existing and future energy consumers. It is able to choose how it interprets and fulfils this duty, a level of flexibility which can be valuable during periods of such great change and uncertainty; what matters is that the relevant principles are clearly set out, and their impact on decisions and approaches well understood.

Ofgem's decisions must balance the interests of different groups of energy consumers - for example, domestic and industrial consumers, plus those who range from relative affluence through to the fuel poor. But Ofgem also needs to consider, and to trade-off between, the short term interests of today's consumers and the interests of consumers in decades to come.

For instance, Ofgem's approach to weighing the interests of consumers in 2020, 2030 and 2050 will affect decisions about investment in network assets with lifetimes reaching into the second half of this century. Clarifying how Ofgem balances these considerations will help deliver the decarbonised networks and energy system to which we aspire.

Whole System Planning

Our Energy Strategy argues that whole system planning is a concept whose time has come. Parts of the energy system which have traditionally operated in isolation are beginning to intersect; for instance, energy for transport looks ever more likely to be delivered through our electricity or gas networks. That means new approaches and more dynamic, inclusive planning will be needed over the coming years.

The successful introduction of hydrogen into the gas network is an example of technology that could lead to new links between the gas and electricity networks through electrolysis. Another is the potential for hybrid heat pumps, which combine a heat pump with a gas boiler. A trial in Wales is looking at ways to optimise these in ways that make best use of both networks^[13].

We want to see, and to support, more formal coordination between electricity and gas network companies as they develop their business plans. But whole system planning goes well beyond just the gas and electricity network themselves, and even beyond the traditional concept of the energy system - it should take account of our broader social and economic objectives. We want a prosperous, inclusive and successful Scotland; our energy networks can play a part in realising this ambition.

The principles for planning infrastructure across the country are laid out in our Scottish Planning Policy and National Planning Framework. The NPF 3 highlights the long term developments that we anticipate across Scotland, and the values which should be captured in their design.

NPF 3 highlights the need to develop the electricity transmission and distribution networks to meet our low carbon goals. It also identifies five areas of coordinated action that have particular significance for the delivery of the low carbon economy, and where the infrastructure assets needed to realise the potential of those areas should be progressed in a co-ordinated manner. These include the waters around Orkney and their potential for marine energy, and the Peterhead and St. Fergus areas in terms of opportunities for CCUS.

The NPF underlines the need to balance competing uses for natural and infrastructure assets, and to ensure that development takes place in ways that respect the environments and landscapes in which it is located. For example, the NPF prioritises the need to mitigate environmental and visual impacts in ways that help ensure that infrastructure is a positive addition to places.

More broadly, the current suite of development plans prepared by Strategic and Local Planning Authorities form the legal basis for making decisions on planning applications. Proposals that accord with the development plan should be approved unless material considerations indicate otherwise.

We will expect new network infrastructure projects to make clear how they can help meet the NPF's aspirations. We would also like network companies and the regulator to work closely with us as we continue to develop our planning policy. We intend a review of the NPF and Scottish Planning Policy following the passage of the Planning Bill, which is currently with the Scottish Parliament.

Our aspiration for a smarter local Energy Strategy will be influenced by the role that local authorities have in planning and consenting developments within their area. The development of Local Heat and Energy Efficiently Strategies (LHEES) will take place hand-in-hand with Strategic and Local Development Plans.

We want local authorities to work with electricity and gas network companies on these matters - ensuring that their strategies take full account of local network infrastructure, and especially areas where specific developments can improve those networks. This could mean locating new demand in areas where wind energy is often constrained, and potentially preventing it from being switched off at certain times. It could also involve considering ways in which local energy resources can support resilience and reliability of supply in isolated communities.

A gap remains between the broad economic and societal planning policies led by national and local government, and detailed network planning carried out by individual companies. There are currently no institutions, either nationally or locally, responsible for looking across the whole energy system, and considering direct and indirect social and economic impacts. We think this needs to be corrected.

Scenario planning is an increasingly common component of planning and development. National Grid's Future Energy Scenarios (FES)^[14] process for GB is well established. SP Energy Networks and SSE Networks have now begun to develop similar scenarios for their own electricity network businesses and areas in Scotland, and which can be fed into the GB FES.

Scenario planning has great value in helping us understand costs and benefits that particular decisions deliver depending on uncertain areas such as economic growth, technological development and changing societal attitudes as well as helping us identify investments that keep options open across different pathways. We believe it should underpin the way in which the networks are planned and investment decisions are made.

Whilst these principles are being used today and continue to broaden the set of energy sectors they consider in order to understand the impact on their specific networks, there is an opportunity to apply any lessons learned in pursuit of a truly whole energy system approach.

We believe that there is a case for institutions to be developed and given responsibility for whole energy system scenario planning. These should be capable of developing regional and local scenarios and pathways that take the whole energy system into account, and which can inform decisions made by planners in any part of the system.

There's a strong case for building up this kind of scenario development up from work carried out at local levels. This might often be at the local authority level, for example - building on the LHEES pilots getting underway in Scotland just now.

We believe there is an opportunity for Scotland to lead the way on coordinating whole system and local focused input into network planning assumptions. We will include thinking in this area within the Scottish Energy Networks Group, which will bring together senior representatives from industry, government and consumer groups, and which we will set up in 2019.

Network Funding

Paying for electricity and gas infrastructure is complex. Getting it right will play a huge part in delivering a genuinely inclusive energy transition.

Today's charging mechanisms use the principles of cost reflectivity and cost recovery to fund the building and safe, secure operation of our networks. But these are based to a large extent on assumptions about how consumers, businesses and generators have used networks in the past.

The same technologies which we expect to create more value and flexibility for consumers could conceivably allow us to drill costs down to a level where we can measure the impact each and every customer has on the networks.

Whilst this could increase the opportunities to set network charges in a cost reflective way, it is difficult to see how this would be appropriate for getting access to affordable, reliable energy.

The Scottish Government believes that the networks' role in providing this essential service should be the guiding principle by which decisions are made on how customers are charged to access them. The principles of cost-reflectivity, cost-recovery, fairness, certainty and transparency can all suppport this; but by placing the essential service role of networks at the heart of decisions over funding will ensure that everyone in society and across the economy has affordable and reliable access and connections to our energy networks.

The social importance of affordable access to networks is already recognised in the Hydro Benefit Replacement Scheme^[15]. This is implemented by the UK Government, and protects customers in the north of Scotland from having to pay in full the higher costs of electricity distribution in their area, since these costs are judged rightly to be inappropriate for what is an essential and universal service.

Ofgem points out quite legitimately that, as things stand, any significant redistribution of costs away from a cost reflective outcome - for example, to protect particular groups of vulnerable customers - is a matter for government.

We agree, and believe that striking the right balance between cost reflectivity and cost sharing needs a more transparent process through which governments can consider, agree and implement the right principles. We believe that our principle of an inclusive transition, and our belief in affordable, reliable and low carbon energy as a fundamental right, is the right value around which to plan network charging. We intend to work with the UK Government and Ofgem to help design and influence the principles around which future network charging should be developed.