Incentivising the distribution system operator

distribution system operator

By Matt Rennie, Partner, EY-Parthenon Power & Utilities Team

Around US$700m has been invested by private equity companies in series A, B and C investments over the past two years to arbitrage the 87-hour network peak that occurs in most developed economies annually. Their investment is based on a premise that if new technology can lop the network peak – and be paid the true cost of avoiding the current levels of peak-related capital expenditure – then supernormal returns await. This is not foolish – around 50 per cent of network capital expenditure relates to just one per cent of the year; opening this up to new entrants will make unicorns. 

Disruptive changes increase the complexity of running an electricity network

If disruption is a tsunami, then the waves hitting the energy sector are surely getting larger and more frequent. Beginning with solar in 2006, the pace has increased with each new development – batteries, electric vehicles (EVs), virtual power plants, blockchain, IoT, machine learning, microgrids, big data … We are now in the age of the quickening; the reducing cost synthesis of all of these as we move towards 2020.

The rise of renewables and new energy technologies mean that it has never been more challenging to run an electricity network company.

By 2045:

  • Renewable capacity will reach 75 per cent in Europe and 50 per cent in Australia
  • 95 per cent of the vehicles on Europe’s roads will be electric (up from 2 per cent currently)
  • EV storage capacity in Europe will rise to 900GWh
  • In Europe alone, some US$15b will be required annually to provide the network capacity required to build new networks, replace existing networks and provide the greater visibility, monitoring and control that will be required of electricity flowing across grids.

Distribution system operators will promote an innovative, flexible energy market

These changes are redefining the role of the networks. Rather than acting as managers of load, transfer and intelligence, networks are becoming Distribution System Operators (DSOs). While the network company of today maintains a safe and reliable grid, the DSO of tomorrow will promote innovation, flexibility and non-network solutions. It will improve the resilience and security of the electricity system at a local level, and it will facilitate neutral markets for more efficient whole system outcomes. 

But network companies are not presently incentivised by either regulators or shareholders to meet these needs, with both pushing hard at each end of the spectrum for price rises and falls based on ambitious views of today. Regulatory asset bases are built by capital expenditure, and capital expenditure is built by the peak. 

Related article: Western Power to roll out advanced meters

The industry’s difficulty in adapting to the transition prompted EY to collaborate with Eurelectric on a recent survey that compiles the viewpoints of network companies in Europe. Results reflect the doubt, confusion and strategic challenges facing the industry as it prepares for its emergence as DSO rather than network company: 

  • 83 per cent of survey respondents agreed that rooftop solar and batteries will become economically viable and a driving choice for customers by 2025
  • 72 per cent said that integrating digital tools and management of data was a key challenge to overcome within their companies
  • 72 per cent said they held great uncertainty about the future operating models they would adopt in a DSO environment 
  • 75 per cent of survey respondents reported however that regulators do not have a clear understanding about the role of the DSO and how regulation needs to change to accommodate it. 

DSO must be incentivised to invest now for the future

We are approaching a time of great ambiguity in the way in which network companies are incentivised to play a part in the transition of the energy system and to the creation of their role as DSO, and, in particular, to make the profound changes required to achieve it. 

From a functional perspective, these changes will touch all aspects of the organisation:

  • Network operations will require visibility of power flows, loads and connections at the distribution level
  • Network planning will need to identify and plan capacity requirements, coordinating a lower level of decisions than currently with transmission network service providers
  • Asset management will require real-time monitoring of network performance
  • Operations will require new methods for DER and EV adoption impact assessment and risk mitigation, platforms for procuring flexibility services, and the development of new commercial frameworks and digital information channels for these flexibility services as they arise.  

Making these changes will be expensive and will require an acceptance of a need to invest now for the benefit of later generations, paving the way for an urgent and collaborative need for a new regulatory compact. DSOs must be able to be incentivised to provide appropriate whole system outcomes, with price controls which include funding and appropriate outputs/performance targets, and the development of an open, level playing field between all market players including distributed generators, flexibility providers and communities.  These changes would include:

  • Implementing standards and data management models
  • Removing barriers to battery development
  • Recognising the role of the DSO
  • Rewarding innovation with greater incentives
  • Encouraging the evolution of network tariffs to ensure distributed generation pays a price consistent with its contribution.  

As the role of the network changes, the regulators, government and the system operator must throw the network industry a ball they are capable and incentivised to catch.  The future of our system depends on it. 

Related article: AEMC says policy needs to incorporate emissions