How will UK DSOs create new value?
In my previous blog, I set out some of the services which DSOs could provide, such as market facilitation, EV charge ownership, consultancy, CHP ownership, etc.
It is clear that the services are only practical if they prove profitable, but the DSO will also need to demonstrate a public good in providing them in what will remain a monopoly position within a regulated market. As enablers, the central demand balancing and coordination processes managed by the TSO will need to be well designed in consultation with DSOs in order to create a system where all can profit; and clearly the regulatory framework will need to adapt to the changing roles and innovations.
The DSO will need to develop a commercial model for the responsibilities and opportunities above. For example, local balancing of micro grids is likely to be an effort-intensive role, so there will need to be a clear way to make this efficient and financially rewarding. The current distribution charging DUOS mechanism could be adapted with charges for Availability, Energy Shipped and Maximum Demand applied at a domestic level when a customer switches to being a Prosumer. A central element of the local electricity market could be capacity auctions, where the DSOs set up auctions for various suppliers, Prosumers and aggregators to provide power directly to their grid, or via microgrids. The DSO would need to do this in order to make money entities connected to the grid that were net producers and not consumers (outside of emergency needs) such that the DSO derives some financial benefit by providing Prosumers the stability of being connected to their grid.
However, whilst a capacity auction initially sounds appealing, it does come with the problem that if Prosumers end up in a bidding race to the bottom they may simply defect from the grid entirely, resulting in falling customer numbers. An additional social consideration is that those customers who can defect are likely to be from better-off demographics, which would leave the lower-income demographics with increasing grid charges to compensate. It is unlikely that government would allow that situation to occur and this will thus be a key driver in Ofgem’s decision making around the DSO model. The auction trading model is likely to be heavily automated and via a portal service, in some ways similar to the retail switching sites. The DSOs with the best platform will be the ones with first mover advantage over smaller players looking to enter the market.
Clearly there is a delicate balance to be struck here as the economic incentives for all participants need to be sufficient to make the envisioned system work. The DSO will thereby have to make money by trading ‘flexibility’ in the system at a regional and national level. This will require setting up virtual power plants by grouping Prosumers and other small generators – such as PV and wind – and working together to sell into the day-ahead market. To do this, the DSO will need to create a system with a clear incentive for participants to flex their consumption and production to meet the demand management needs of the DSO – in effect, back-to-back contracts which allow the DSO and other actors to make financial gain from balancing the needs of the regional/national system – if Prosumers will not actually have visibility, or even awareness that this is what they are part of.
DSOs may go beyond trading in flexibility to helping to create it. In areas of low DER penetration there will be opportunities to identify projects that will create DER capacity. The DSO would be well placed to appraise these projects for their ability to reduce overall generation costs, or serve the needs of distribution system flexibility. It could even invest or enter into joint venues (potentially with other DSOs). This might involve providing capital investment for the development of DER installations or CHP units. Other commercial services which the DSO could get involved with include ownership of Electric Vehicle (EV) charging points and charging a fee for use. However, this is a problematic proposition as an increasing numbers of EV charge points increases the demand for EVs, which drives demand for EV charging points and therefore investment. This type of self-driving demand for capital investment makes the business case more difficult to reconcile. Regardless of the activities the DSO chooses to enter into it will need to understand where value is created in the organisation, which will require thinking about the value chain.
The future DSO value chain showing where most value can be created
The below value chain model demonstrates that if the new DSO is to create value, the opportunities are greatest at the business strategy end of the spectrum. Under the DNO model this has traditionally been at the regulatory funding end so it is clear that new skills and business thinking will be required. It will be imperative that the DSO has clear information about the system and assets (not necessarily directly owned) at its disposal. It will need to set out its contractual and business relationships in such a way that it can extract value from them when operating the system and it must be clear about what services are in its portfolio and how precisely they will be delivered. If any of these things are not in place then effective system/asset management and efficient delivery alone will not create the necessary value. However, should all of the first three links in the chain be properly developed, it will enable the value created to be released into the DSO business.