DNO Losses
Incentive- Summary
© British Gas Trading Limited 2011
Minded-to position, with restated losses, makes outcome
far more extreme, with nearly £500m in rewards
DPCR4 Units
ENW
Northern Powergrid
WPD
UKPN
SP
SSE
Total LRRM
DPCR3 Units
Total DPCR4 Losses Performance
Incentive Scheme Value
© British Gas Trading Limited 2011
Slide 2
Unrestated
£39m Penalty
£51m Penalty
£57m Penalty
£95m Reward
£225m Penalty
£91m Reward
£186m Penalty
£113m Reward
Restated
£43m Reward
£55m Reward
£19m Reward
£234m Reward
£67m Penalty
£91m Reward
£376m Reward
£113m Reward
Minded-to Impact
£82m Increase
£106m Increase
£76m Increase
£139m Increase
£158m Increase
£562m Increase
-
£73m Penalty
£489m Reward
£562m Increase
Ofgem’s IA focuses on the ‘close-out’ term, PPL,
but this number has no meaning in itself
• The PPL is simply a ‘true-up’: it is not a reward or penalty
– It is the difference between the Total Incentive (LRRM) and Incentive
Revenue received to date1
– It is not the same as LRRM as stated in the Ofgem consultation2
– close out (PPL)= total incentive (LRRM) - Σ incentive over DPCR4
• Even when compared to published DNO expectations3, the PPL terms
proposed by Ofgem are significantly more (£224m) generous:
Close out (09/10)
ENW
Northern Powergrid
WPD
UKPN
SP
SSE
Total
© British Gas Trading Limited 2011
Slide 3
DNO 'best estimate'
£19m to return to customers
£0m
£96m to return to customers
£57m to return to customers
£2m to return to customers
£9m additional revenue
£165m to return to customers
Ofgem proposal
£1m additional revenue
£6m to return to customers
£43m to return to customers
£23 additional revenue
£17m additional revenue
£68m additional revenue
£59m additional revenue
Minded-to Impact
£20m Increase
£6m decrease
£53m Increase
£80m Increase
£19m Increase
£59m increase
£224m Increase
DNOs have publicly stated that they believe they can
have little or no impact on the Losses Incentive
One further option would be to close out DPR4 by merely
reversing gains/losses to DNOs, in effect leaving DPR4 losses
at a neutral position. This would seem to be the right thing to
do for customers; in the absence of hard evidence that DNOs
investment plans have been altered by the losses incentive, it
would seem perverse that DNOs have gained or lost
financially as a result of the incentive.
Western Power4
The mechanism depends on data that is
dominated by the behaviour of suppliers
and has almost nothing to do with the
steps taken by Distributors.
Northern Powergrid5
Ofgem proposal for Losses Incentive value
Ofgem proposal for Losses Incentive value
(LRRM) for Western Power: £19m Reward
(LRRM) for Northern Powergrid: £55m Reward
However, we do not believe that the DPCR5
Distribution Losses Incentive Mechanism
will meet its objectives of encouraging
DNOs to achieve an efficient level of losses
on their distribution networks since the
outcome is largely outside of their influence.
ENW6
Ofgem proposal for Losses Incentive value
(LRRM) for ENW: £43m Reward
© British Gas Trading Limited 2011
Slide 4
We do not believe that the existing losses mechanism is
effectively incentivising DNOs to reduce losses. It is clear that
even in the normal course of settlement, reported losses vary
much more as a result of settlement effects than would be
possible through the influence of DNOs’ loss reduction
measures. SP Energy Networks7
Ofgem proposal for Losses Incentive
value (LRRM) for SP: £65m Penalty
We are now seeking to establish what has gone
wrong in the process to arrive at this outcome
• We understand that Ofgem may not have applied a credibility test to
consider whether performance against targets is realistic
– Ofgem committed to ‘reported losses performance during the normal period
must be credible’8 further noting that this was to ensure that DNOs were not
unduly rewarded or penalised.
– For ED1, Ofgem has stated that they believe an incentive value of £32m (for an
8-year control) is appropriate to incentivise behaviour9
• Critical elements of DPCR5 Final Proposals seem to have been
interpreted in 2 different, and contradictory, ways (Adjustments arising
from settlement corrections and provision accounts10)
– Different DNOs selecting different interpretations of how to apply
• DNOs seem to have driven the process of testing for normality, allowing
them to select their own periods of normality
• The process of applying reconciliations from other years to correct an
‘abnormal’ year may simply be incapable of producing a sensible answer
© British Gas Trading Limited 2011
Slide 5
Appendix: References
1.
From DPCR5 Final Proposals: ‘7.5. In DPCR4 the incentive mechanism was created so that the LRRM retains each year’s incentive amount earned on the incremental change
in outturn losses for five years. In discussions with the DNOs we have explored the algebra behind the LRRM and have explained that the LRRM equates to five times the final
year losses performance against the target. We consider this property to be appropriate as the purpose of the incentive is to reward sustainable changes in losses, and
therefore the final year should reflect the cumulative efforts over the entire price control period.’
Also from DPCR5 Final Proposals: ‘4.26. In calculating the remaining amount owed to/by the DNOs (the 'close out' amount) we will then subtract the loss incentive amounts
already included in the DPCR4 allowed revenues:
close out = corrected net LRRM incentive – Σ incentive over DPCR4’
2.
From Document G: Consultation on restatement of 2009-10 data and closing out the DPCR4 losses incentive mechanism: ‘1.31. The PPL term is simply the result of the LRRM
calculation. Its total value is the same as the LRRM, but recovery of the PPL term may be split over more than one year, as PPLt.’
3.
From DCUSA Schedule 15 forecasts for November 2012 (all amounts relating to close out of DPCR4 converted to 2009/10 prices):
http://www.dcusa.co.uk/Public/Documents.aspx?t=10
4.
From WPD response to Ofgem Consultation on “Whether to activate the Distribution Losses Incentive Mechanism in the Fifth Distribution Price Control Ref 87/12”
http://www.ofgem.gov.uk/Networks/ElecDist/Policy/losses-incentive-mechanism/Documents1/WPD%20Response%20to%20DPCR5%20Losses%20Consultation.pdf
5.
From Northern PowerGrid response to Ofgem Consultation on “Whether to activate the Distribution Losses Incentive Mechanism in the Fifth Distribution Price Control”
http://www.ofgem.gov.uk/Networks/ElecDist/Policy/losses-incentive-mechanism/Documents1/NPG%20Cover%20Letter%20to%20DPCR5%20Losses%20Consultation.pdf
6.
From ENW response to Ofgem Consultation on “Whether to activate the Distribution Losses Incentive Mechanism in the Fifth Distribution Price Control Ref 87/12”
http://www.ofgem.gov.uk/Networks/ElecDist/Policy/losses-incentive-mechanism/Documents1/ENWL%20Response%20to%20DPCR5%20Losses%20Consultation.pdf
7.
From SP Energy Networks response to Ofgem Consultation on “Whether to activate the Distribution Losses Incentive Mechanism in the Fifth Distribution Price Controll”
http://www.ofgem.gov.uk/Networks/ElecDist/Policy/losses-incentive-mechanism/Documents1/SPEN%20Response%20to%20DPCR5%20Losses%20Consultation.pdf
8.
From Document G: Consultation on restatement of 2009-10 data and closing out the DPCR4 losses incentive mechanism: ‘2.7 In addition to relatively stable reconciliation
levels, reported losses performance during the normal period must be credible, eg the normal period should not include historically low, one-off, losses levels17
17
This is to ensure that a DNO is not unduly rewarded or penalised by a year where there is a known reason for abnormal losses.’
9.
From RIIO ED1 Strategy Consultation, Outputs, Incentives and Innovation: ‘5.25. We have concluded that a sufficiently strong incentive is required to ensure that DNOs place
an appropriate level of focus on losses reduction activities, and to highlight the importance that we place on the contribution of losses reduction to carbon emissions as well as
the implicit impact of losses on customer bills. At the same time we have to balance this by considering our inability to accurately measure the outputs and benefits of any
losses reduction measures at this time. We consider that a DR of £32m will achieve the desired result.’
10.
DPCR5 Final Proposals – Financial Methodologies: p.25, paragraphs 4.19 – 4.21, Section on ‘Adjustments arising from settlement corrections and provision accounts’
© British Gas Trading Limited 2011
Slide 6