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Inside RIIO-2: Ofgem’s innovation stimulus reform

Image: Getty.

Image: Getty.

Industry regular Ofgem has proposed a number of reforms to the innovation stimulus to be included in RIIO-2, including the introduction of a new innovation pot and the removal of the Innovation Rollout Mechanism (IRM)

Earlier today (18 December 2018) Ofgem published its RIIO-2 sector specific methodology document which included the headline news that it intended to effectively halve the cost of equity cap to 4% from 2021.

However the 217-page document also includes a raft of proposed reforms as to how network innovations will be financed and supported, proposals which could have a significant impact on how network companies trial and implement emerging technologies and business models.

The headline reforms include new measures that network companies undertake more innovation as ‘business as usual’ (BAU) cases, removing the IRM reopener, replacing the Network Innovation Competition (NIC) with a new innovation funding pot dedicated toward larger, more strategic challenges, and a potential overhaul of the Network Innovation Allowance (NIA)

Increasing more innovation as ‘BAU’, and an end to the IRM

Ofgem has said that any additional dedicated innovation funding underneath RIIO-2 should be time-limited, with the overall stimulus package designed to result in a “cultural shift” wherein network companies transition more innovations into business as usual activities.

It now expects companies to fund lower-risk operational and maintenance innovation projects as BAU, with the existing totex incentive mechanism used to ensure that networks companies share the benefits of such innovations.

Companies will be expected to demonstrate how innovations will be applied through BAU activities within their business plans, and Ofgem’s enhanced engagement framework should be used wherever necessary to check the level of ambition shown.

But in terms of the Innovation Rollout Mechanism, Ofgem said it had not seen compelling evidence that there is a need for it to continue under RIIO-2, with the regulator pointing in particular to the shorter five-year control period and the fact that, to date, just two applications had been successful.

Replacing the Network Innovation Competition

Meanwhile, a new network innovation funding pot has been proposed to replace the Network Innovation Competition, designed specifically to place a “sharper focus” on the strategic challenges facing networks in the future.

Ofgem is to establish a new governance arrangement to define what constitutes a relevant system transition challenge, for which it will consult with external stakeholders such as BEIS, UK Research and Innovation and the country’s network operators.

In terms of funding levels, Ofgem currently considers it relevant to fund projects of a similar size to the NIC, which has typically supported projects between £3 million and £15 million, with early-stage research and development challenges envisaged to receive less than £3 million.

Uncertainty remains over the Network Innovation Allowance

Ofgem said it was uncertain about whether there is a need to continue with an annual innovation allowance within RIIO-2, stating its belief that a number of projects funded via the NIA under RIIO-1 could have been funded through companies’ totex allowance instead as they have the potential to deliver savings for other network companies.

The regulator also expressed concerns that NIA projects had not always built upon lessons from previous projects, and argued that it had found it difficult to track the benefits of projects supported under the NIA.

As a result, Ofgem is considering reforming the NIA to align it with wider public innovation funding and to enable increased engagement with third parties.

Next steps

A decision on the overall structure of the RIIO-2 innovation stimulus is to be published in May next year alongside the wider RIIO-2 sector specific decision, and industry stakeholders are being encouraged to contribute to today’s consultation before the deadline of 14 March 2019.

A consultation will then follow in mid-2019 to determine the level of funding available, the operation and governance of the innovation stimulus package, and the role of wider requirements on network companies to publish joint innovation strategies.

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