Author: Ayan Kanhai Aman, Policy and Markets Lead, Electron
The European Union’s Network Code on Demand Response is in the works. It aims to incentivise more demand response – a form of energy flexibility – to enable system operators to make the most of their grid systems. System operators across the EU will soon need to prepare to transpose the network code, due to be finalised by 2026 and implemented by 2028.
In Britain, the procurement of flexibility services will help shift 30% of electricity demand loads out of peak times by 2030 and reduce system costs by around £5Bn each year by 2035.
One of the most effective tools that has boosted the use of that flexibility in Britain is Ofgem’s total expenditure (TotEx) price control.
The role of price controls
Governments or regulators put price controls in place to set limits on the amount of revenue that energy network companies can earn from their customers.
The revenue cap considers the costs of maintaining and upgrading the network, a fair return on investment for the companies, and other factors such as inflation.
The price control framework includes incentives to encourage network companies to operate efficiently and innovate.
Companies can earn additional revenue by exceeding certain performance targets, such as reducing outages or integrating more renewable energy into the grid.
The traditional approach to grid investment
Traditionally, price controls separate capital expenditures (CapEx) and operational expenditures (OpEx).
CapEx essentially focuses on investments for reinforcing the grid’s physical infrastructure. OpEx is the cost of operating and maintaining networks, such as repairs, inspections, engineering, staff – and system operation or flexibility costs.
In the EU, price controls tend to reflect a “building block” approach, keeping CapEx and OpEx separate – with some exceptions such as the Netherlands.
TotEX: Becoming more economically efficient
Today, all nations have Net Zero and decarbonisation targets to hit. This means they need to transition to a decarbonised power system over a very short timeframe.
TotEx (TotEx = CapEx + OpEx) models encourage a holistic way of thinking. They allow both CapEx and OpEx solutions to be considered in a complementary manner.
CapEx investment in the grid will always be vital as demands for electricity grow. However, solutions like flexibility can help system operators make more targeted decisions about where to build.
It can ensure they invest in the right places and maximise their returns. System operators can therefore optimise their existing networks by deploying solutions like flexibility alongside necessary grid reinforcements, to accelerate the path to Net Zero.
Giving equal consideration to OpEx expenditure therefore encourages system operators to choose the most economically efficient option to resolve constraints.
This was the approach deployed in Britain through RIIO (Revenue = Incentives + Innovation + Outputs).
Before mandated flex in Britain
Before the current price control framework, flexibility was not formally procured in Britain as it is today. The emphasis was instead on ensuring reliable and continuous supply through traditional, centralised means, primarily by maintaining adequate generation capacity.
There was a reliance on traditional grid reinforcement and flexibility was hampered by the lack of infrastructure, such as installed smart meters.
This meant that the full value of distributed energy resources was not captured. Those assets had difficulties connecting to the grid and had limited market access.
Aggregators – and therefore small-scale distributed energy resources (DERs) – faced barriers to entry into those markets. There was also a lack of incentives for distribution system operators (DSOs) and DERs alike to participate in flexibility.
These challenges intensified as renewables increased and new decarbonisation targets placed pressure on energy markets and their regulator, Ofgem.
DSOs needed to find new ways to:
- Optimise the use of the existing network
- Become more targeted with grid reinforcement through a flexibility-first approach
- Integrate more renewables.
The TotEx approach through price control framework RIIO was the solution.
Flexibility incentivised
Initially, RIIO-ED1 (2015-2023) encouraged distribution network operators to deliver value for money while decarbonising the power system. The focus was still on traditional network investments and outputs rather than explicitly on flexibility.
RIIO-ED2 (2023-2028) was when flexibility took centre stage. Ofgem created performance incentives linked to financial rewards. These encouraged system operators to consider flexibility to optimise the existing networks ahead of grid reinforcements.
In addition to implicitly encouraging the procurement of flexibility services through the TotEx model, Ofgem also explicitly mandated a flexibility-first approach through their Sector Specific Methodology Decision:
“Where flexibility services offer a more cost-effective solution to manage network constraints, DNOs are expected to procure these services.”
Flexibility savings
The impact of this framework? We previously shared how the savings that system operators see from using flexibility is about more than the cost savings from deferring grid upgrades; it is a long-term solution.
Over the next price control period – RIIO-ED2 – the six British DSOs will save £2.2 billion in total, according to our analysis. This includes:
- An estimated £310 million off the back of better-informed CapEx decisions thanks to improved network visibility through operating flexibility markets
- £607 million through flexibility procurement instead of grid buildout
- And a potential £1.2 billion saved thanks to flexibility markets enabling accelerated, smarter new connections.
According to Ofgem, following this trajectory, the DSOs’ investments in flexibility could save consumers £10 billion a year by 2050 and help cut Net Zero costs by up to £70 billion.
The future expense of the grid
That’s what it looks like in Britain. But how can this benefit grid systems elsewhere?
Think on where we’ll be in five years’ time, with the increasing demands on our electricity networks.
Some examples: EV connections are accelerating. The IEA says: “Every other car sold globally in 2035 is set to be electric based on today’s energy, climate and industrial policy settings.”
Electricity demand from data centres is projected to grow 160% by 2030, according to Goldman Sachs’ research.
Investing in all the necessary grid upgrades to support this growth in electricity demand, without introducing flexibility, will become increasingly expensive.
Electrification will require €67 billion a year grid investment from 2025 to 2050 in the EU, according to Eurelectric – and that’s on average.
Eurelectric’s data shows that investment would need to start this year at €36 billion, then double until 2040, and continue at 1.7 times today’s levels until 2050.
The future of price controls in Europe?
Regulators are likely to consider how system operators can make these critical grid upgrades in the most effective manner. That means allocating investment in the most economical way – especially when considering the impact of these investments on consumers.
Designing the right price control framework is how they may choose to do this.
There are of course other ways to mandate flexibility outside a TotEx price control model, such as Performance-Based Regulation or a Cost-Benefit Analysis Requirement.
Yet, this is one consideration for regulators as they look to develop and incentivise flexibility in power systems.
Regulators that recognise the merits of a TotEx approach may start thinking about how to maximise the system operators’ use of system flexibility imminently – so system operators would be wise to consider how to get started with flex.
Read more
The enduring role of flexibility in an expanding network
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Your guide to the draft EU network code on demand response
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What it takes to scale flexibility markets: The Value / Volume thesis
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