Ofgem has published its decision on accelerating onshore electricity transmission investment (the “Decision”), which follows the consultation in which Ofgem sought views on its proposals to support the Government’s Energy Security Strategy (“ESS”). The ESS (which we commented on here) sets out ambitious targets for low carbon generation, including connection of up to 50GW of offshore wind capacity by 2030.
The Decision makes clear that the existing onshore electricity transmission network cannot support the Government’s ambitious growth targets. As such, it introduces a new regulatory approval and funding framework for transmission owners (“TOs”) to deliver onshore electricity transmission projects required to achieve the 2030 renewable targets. The Decision also creates exemptions from Ofgem’s competition models for certain projects considered “deliverable” by 2030 and establishes a new incentive which rewards/penalises TOs for early/late delivery, respectively. Ofgem's decision is expected to have significant implications for the electricity sector and for the wider energy market.
The consultation, published on 8 August 2022 (the “Consultation”) recognised that the Large Onshore Transmission Investment (“LOTI”) regulatory process (explored in more detail further below) may make it more difficult for TOs to expedite delivery of projects. The Consultation identified 78 onshore electricity transmission network upgrade projects (worth £21bn) required for Security and Quality of Supply Standard (“SQSS”) compliance to connect the proposed offshore generation to the network by 2030. 26 of these projects were deemed high-value strategic projects (“Strategic Onshore Projects”) (worth £19.8bn) and were the focus of the Consultation. The Consultation also acknowledged that the RIIO-ET2 regulatory approvals framework and funding mechanism (“RIIO-ET2”) requires revision in order to make it more agile and responsive in respect of TOs delivery of projects.
Current Regulatory Framework – Large Onshore Transmission Investment (LOTI)
The current regulatory funding regime for large onshore transmission projects is covered by the LOTI process (large projects being those with a value over £100m) which itself is part of the RIIO-ET2 price control package which became effective as of 1 April 2021. LOTI’s purpose is to ensure that TOs are adequately funded in the delivery of large strategic onshore projects with provisions in place to protect consumers from, for example, inefficient costs. The features of the LOTI framework described in the Consultation as perceived to be inhibiting the accelerated delivery of transmission projects were the following:
- the prospect of onshore transmission competition – the lack of clarity as to whether a project would be delivered by a TO or a competitively appointed transmission owner (“CATO”, which is a delivery vehicle that has been the subject of extensive discussion and consultation over several years) could delay procurement and contracting. For further commentary on CATO, please see our Law Nows on the Energy Bill 2022 and CATO legislation.
- lack of early certainty that the project is needed – final confirmation of the project is at the Final Needs Case (“FNC”) stage which is considered a barrier to early engagement with contractors.
- TOs can apply for approval of full project allowances only after planning permission is secured – some costs which have been incurred by the TOs prior to regulatory approval may be unrecoverable if planning approval is not granted.
- multiple regulatory “gateways” before final funding approval – regulatory gateways are seen as a resource burden, a source of uncertainty and add to project timelines.
- uncertainty about the financial consequences of failure to deliver projects on time – the LOTI process contains a Large Project Delivery (“LPD”) mechanism which includes a Late Delivery Charge (“LDC”). The LDC applies to delayed projects and is decided at the project assessment stage. This is another source of uncertainty in respect of potential financial exposure for TOs and makes it difficult for TOs to efficiently manage the risk through their supplier strategies.
Role of Competition and Exempting Projects
The Consultation considered the role of competition in onshore electricity transmission (“ET”) infrastructure which Ofgem considers to be a key component of RIIO-ET2. Ofgem explains in the Consultation that although the TOs have argued onshore competition could increase timelines for new onshore ET projects, Ofgem’s position is that it does not consider there to be any evidence third-party delivery would take any longer than TO delivery. However, Ofgem simultaneously recognises that there may be projects for which TOs will need to engage with the supply chains prior to finalised regulatory arrangements; the delay of which, pending finalised legislation, could lead to further delays and unacceptable wider consequences for the GB electricity market. As a result of this, the Consultation proposed exempting all or some Strategic Onshore Projects where this is in the interest of consumers.
Ofgem’s review of the 26 Strategic Onshore Projects identified 10 projects as highest priority in terms of unlocking consumer benefits by accelerating delivery.
A further 5 projects worth £4.1bn were identified as eligible for competition although it was acknowledged that they would be unlikely to be delivered through competition without delay risk.
The Decision (published on 15 December 2022) sets out Ofgem’s decision on accelerating onshore electricity investments. It confirms Ofgem’s intention to implement a new Accelerated Strategic Transmission Investment (“ASTI”) regulatory framework to fund the large onshore transmission projects necessary to deliver the Government’s 2030 net-zero goals.
The ASTI framework will apply to an initial 26 projects (which differ somewhat to those originally consulted on) however the list will remain under review. Each of the 26 projects will be exempt from consideration for delivery via Ofgem’s competition models. Ofgem will also introduce a new Output Delivery Incentive (“ODI”) which will reward or penalise TOs for delivery, while also making use of Price Control Deliverables (“PCD”) and Licence Obligations (“LO”).
One of the significant outcomes is the decision to exempt the 26 identified projects from the competition model process. While Ofgem accepts that the uncertainties around finalising enabling legislation and competition models can result in major delays, they state that exemptions from competition under ASTI will permit fast engagement with supply chains for TOs.
The Decision outlines that the key issues considered when exempting projects are, inter alia, (i) the risk of delay were the projects not to be exempted; (ii) the requirement of early engagement with contractors to ensure timely delivery; (iii) impact of achieving 2030 targets; and (iv) certain projects not meeting the criteria for competition or require earlier construction than Ofgem’s expectation of competition legislation would allow.
Changes to the LOTI Framework
Of note is Ofgem’s decision to streamline the LOTI funding approval process summarised in the table below.
In recognition of the TOs’ potential need to alter their delivery models and incur early construction costs ahead of receiving planning permission in order to achieve target delivery dates, Ofgem considers the new ASTI approval and funding model can support the TOs by accelerating the funding and approval processes whilst still ensuring consumers are protected through robust cost assessment and clear output deliverables. Pre-construction funding (“PCF”) will be made available to fund pre-construction works which qualify under the framework and TOs will be permitted to substitute PCF allowances between ASTI projects. For a number of ASTI projects that are already in receipt of PCF under LOTI in RIIO-ET2, Ofgem has made it clear that these projects will not be eligible to receive PCF under ASTI.
Further to creating a flexible approach, Ofgem will aim to reduce the time it takes for full project assessment (“PA”) from the current 6-12 months to 6-9 months. This, as they state, will entail a significant level of specialist resource within Ofgem in respect of the 26 projects currently in the ASTI scope.
The basis of the ASTI ODI is to incentivise TOs to deliver ASTI projects on time. The key features detailed in the decision include:
- daily reward and penalty rates for each project set at 30% of the forecast constraint cost for one year of delay divided by 365;
- target delivery dates of 31st December of the year in which the Electricity System Operator (“ESO”) requires the project to be delivered;
- no penalties for the first 12 months of the delay where a project is not delivered by the target date;
- rewards at the daily rate which apply for each day between the date of delivery and the last day of the 12th month of the target date where a project is delivered earlier than 12 months after the target date; and
- an aggregate project-level cap on rewards and penalties: 10% of forecast total expenditure (totex) for that project. In addition to a cap on daily rates of 5% forecast totex, with a collar of 2% forecast totex.
The ODI will also include a licence obligation to deliver on time whereby failure to do so will entitle Ofgem to take enforcement action.
Ofgem intends to implement the outcomes of the Decision into the RIIO-ET2 licences with the engagement of TOs in order to institute a Licence Drafting Work Group. It is expected that a statutory consultation on the licences will be held in Spring 2023 with a view to formally implementing the ASTI framework into the licence in Summer 2023. Ofgem also intends to consult on and publish an ASTI Governance document in 2023.
Overall, Ofgem's decision to accelerate onshore electricity transmission investment is a major step forward in the UK's efforts to transition to a low-carbon economy. By ensuring that the electricity transmission system is able to accommodate the increasing demand for renewable energy, Ofgem is making efforts to pave the way for the widespread adoption of clean, renewable energy sources.