Ofgem's new investment framework shows scale of challenge for GB grid owners

Details of Ofgem’s new accelerated strategic transmission investment (ASTI) framework, published late last year, illustrate the scale of the challenge faced by electricity transmission network owners in Great Britain.

National Grid Electricity Transmission, Scottish Power Energy Networks and SSEN Transmission, known collectively as ‘the TOs’, are responsible for delivering the extensive onshore transmission system enhancements that are needed to achieve the government’s 2030 power sector decarbonisation target. The TOs also have a key role to play in fulfilling the government’s ambition to connect up to 50GW of offshore wind capacity to the GB grid by the same date.

Moreover, the ASTI decision (85 pages / 1.67 MB PDF) comes amid an unprecedented focus on security of supply due to the invasion of Ukraine and the need to reduce our reliance on gas and other energy imports.

ASTI decision’s impact on scale of investment

The ASTI decision identifies 26 strategic transmission projects with an estimated cost of £20 billion which will be taken forward under a streamlined regulatory approval and funding process. This process represents a significant departure from the multiple regulatory assessment stage gates in the existing regulatory approval and funding process, known as the Large Onshore Transmission Investment (LOTI) regulatory framework.

The removal of the 26 projects from the LOTI framework is a clear recognition that the necessary investment would not be made at the pace required to achieve the government’s power decarbonisation and offshore wind connection ambitions if the projects had to be taken forward under the multiple assessment stage gates involved in that process.

The streamlined approach under ASTI will not only accelerate the pace of investment but will also enable the required investment to be considered and delivered in what Ofgem calls a “programmatic fashion”.In other words, ASTI represents a departure from the traditional LOTI incremental network build approach, in which network enhancements are assessed on a project-by-project basis through a succession of regulatory approval and funding stage gates. The new framework also represents a move towards what Ofgem calls a “co-ordinated top-down network planning approach”.

The traditional project-by-project assessment approach is no longer seen as being fit for the purpose of meeting our power decarbonisation and offshore wind connection targets, not to mention the need to improve our security of supply, which has assumed a new sense of urgency in recent times, due to events elsewhere and the unprecedented volatility in wholesale gas prices experienced in 2022.

The 26 ASTI projects span the length and breadth of the country and include the Western Isles HVDC Link, which will establish the first connection between the island of Lewis in the Outer Hebrides and mainland Scotland. The HVDC Link will play an important role in the development of the offshore wind capacity in the waters off the northwest coast of Scotland. These offshore wind projects are being taken forward by the developers whose bids were successful in the Crown Estate Scotland’s ScotWind offshore wind leasing round in early 2022.

Other ASTI projects also include substantial network enhancements designed to alleviate the bottlenecks which currently restrict the flow of wind generation from Scotland to the major demand centres in the south of the country, particularly during periods of high renewable generation.

Ofgem has had to weigh up a number of competing factors, some of which are seen as detrimental to the consumer interest, in making the ASTI Decision. For example, the new framework will reduce the level of regulatory scrutiny that Ofgem applies to the assessment of detailed project design options and costs, depriving consumers of the additional protection which comes from the detailed scrutiny carried out under the LOTI framework.

The 26 projects will also be taken forward outside the Competitively Appointed Transmission Owner (CATO) regime for the procurement of onshore electricity transmission, which will be introduced if the proposals in the Energy Bill currently before parliament are enacted in their present form. This will deprive consumers of the cost savings that the competitive process would potentially deliver - particularly in the long-term cost of capital. At the same time, however, consumers will see a benefit from the accelerated development of the lower cost renewable generation which will be facilitated by the ASTI projects by, for example, enabling the connection of up to 50GW of offshore wind sooner than would otherwise be possible.

The faster pace of network enhancement enabled by ASTI will also bring about a lowering of constraint costs sooner than would be possible under the LOTI framework. Constraint costs are compensation payments made to generators for reducing their output when instructed by the system operator to maintain system stability and manage flows on the transmission network. These costs are ultimately passed through in consumer bills and have been rising rapidly in recent years because onshore wind generation is typically built in remote coastal areas, far from major centres of population and demand. Generators are regularly instructed to reduce output during periods of high renewable generation due to bottlenecks at critical points in the transmission system.

Ofgem’s analysis concludes that consumers will be better off overall under ASTI than under the LOTI “business as usual” counterfactual. Its assessment of the benefits to consumers under its central scenario are estimated at £2.1bn, with an estimated benefit of £3.1bn in the best-case scenario and £0.9bn in the worst-case scenario. These estimates are likely to be conservative, given that they do not take into account the wider strategic benefits which will come from the accelerated decarbonisation of the power industry.

Procurement of onshore transmission assets

In arriving at its decision on ASTI, Ofgem will have considered how consumers are likely to be affected by the fact that the investment in the 26 ASTI projects will form part of the relevant TO’s Regulated Asset Base (RAB). The need to accelerate the ASTI projects means that their development must be progressed before the introduction of the long-awaited CATO regime, which was first consulted on by Ofgem in 2015.

The regime will require the TOs to procure new, separable and high value – those likely to cost £100 million or more – onshore transmission assets by way of a competitive tendering process. This in turn means that consumers will not benefit from the cost savings, particularly in the long-term cost of capital, which are thought to be deliverable if multiple bidders are competing with each other to build, own, maintain and finance the assets in the long term under the CATO regime.

Ofgem’s assessment is that, even if the CATO proposals in the Energy Bill are enacted without undue delay, the detailed subordinate legislation bringing the new regime into effect will not be in place before the end of 2024. This means that there is significant uncertainty around the exact timing of introduction of the CATO regime. The TOs will, of course, have to procure the construction and delivery of the ASTI projects in compliance with their obligations under the Utilities Contracts Regulations. The critical point here, however, is that, unlike a procurement under the CATO regime, competition will not be applied to the long-term ownership, financing and maintenance of the ASTI projects.

HVDC cabling supply chain constraints

The market for HVDC cabling and other long lead items is a global market as countries take further steps to enhance their security of supply and renewable asset base. This means that projects in Great Britain are competing for scarce supply chain manufacturing capacity with transmission projects elsewhere in the world. The streamlining of the regulatory approval and funding process under ASTI will allow the TOs to mobilise their supply chains and procure long lead items such as HVDC cabling sooner than would otherwise be the case.

Streamlined regulatory approval and funding

Pre-construction funding (PCF)

The ASTI framework will include an upfront PCF provision, enabling TOs to use up to 2.5% of the current forecast of the total costs of the ASTI projects, excluding any project for which pre-construction funding has already been provided under the LOTI framework, to fund activities up to the time of submission of a planning application.

This means that Ofgem, unlike the case under the LOTI framework, doesn’t have to undertake an assessment of efficient pre-construction costs on a project-by-project basis, allowing the TOs to make an immediate start on the development work which needs to be carried out prior to submission of a planning application.

There is likely to be a potential reopener which Ofgem will consult on later this year. A reopener would permit an adjustment to the PCF allowance where efficient pre-construction costs are likely to be materially in excess of 2.5% of the forecast total expenditure across the relevant TO’s ASTI programme. Any unspent PCF allowance will be returned to consumers. Ofgem believes that this approach will give the TOs the funding needed to submit high-quality and robust planning applications, minimising the risk that planning does not get approved and enabling TOs to submit planning applications within an accelerated timeframe.

Early construction funding (ECF)

A TO will be able to access ECF of up to 20% of the forecast total expenditure across its ASTI programme to enable it to fund certain pre-agreed activities. This could include, for example, strategic land purchases, early enabling works and early procurement commitments, as well as other activities approved in advance by Ofgem. A TO would be able to access this ahead of receiving planning permission, if it can demonstrate to Ofgem that it is reasonable to undertake these activities early in order to meet target project delivery dates.

Under the LOTI framework, projects typically do not get any construction funding until after grant of planning permission. ECF is therefore a unique feature and, from a consumer perspective, a risk of the ASTI process, since costs may be spent on projects which do not receive planning permission. Overall, Ofgem concluded that the potential benefits of ASTI to consumers outweighed the risk of wasted costs associated with abandoned projects.

TOs should be aware that Ofgem will undertake a full assessment of all project costs, including early construction costs – but not costs funded out of the PCF allowance – after submission of the planning application in order to arrive at the total expenditure allowance for efficient costs.

The ASTI decision envisages that an Ofgem-triggered reopener in summer 2023, and another in summer 2024, to increase the ECF allowance beyond 20% in “exceptional circumstances” will be included in the ECF design. This is in recognition of the current market volatility and the uncertainty around the extent of supply chain commitments which TOs will be required to assume to achieve delivery of projects by target dates.

Full project assessment (PA)

Fundamentally, the PA will be the same as the full project assessment carried out by Ofgem under the LOTI framework. The PA will be undertaken after submission of the planning application and Ofgem will determine an efficient costs allowance – only costs which are judged to be efficient will be included in the allowance. Ofgem said that it will aim to reduce the time it takes for a full PA from the current 6-12 months under LOTI to 6-9 months under ASTI.

The ASTI process will include a cost and output adjusting event (COAE) re-opener mechanism to potentially adjust outputs, target dates and allowances. This will be used if material changes are made to the outputs that TOs must deliver, or where the efficient outturn costs deviate from the efficient costs allowance determined at the PA stage by +/-10%.

The ASTI COAE mechanism will be similar to the COAE mechanism under the LOTI framework, the principal difference being that the materiality threshold for ASTI has been reduced to 10% from the 20% applicable under LOTI. Further details of the COAE mechanism will be provided in an ASTI governance document when it is published by Ofgem later in the year.

Rewards and penalties

The ASTI decision strikes a balance between the acceleration of the regulatory approval and funding processes and ensuring that consumer interests are protected by a robust cost assessment and system of incentives, including output delivery incentives, for the accelerated delivery of transmission assets. These will reward TOs for meeting target delivery dates and penalise them for failing to meet target dates.

The aggregate reward and penalty for each project is to be capped at 10% of the forecast total expenditure for the project, with the reward and penalty rates based on a forecast of the consumer detriment arising from a delay and of the consumer benefit arising from acceleration.

Planning system reform needed

Whilst the ASTI decision brings much-needed clarity to the TOs’ investment programmes and to the wider industry, Ofgem has rightly pointed out that the new framework on its own will not be sufficient to deliver the required investment at the pace required. Action needs to be taken in a number of other areas.

In particular, the planning system will need to be reformed to support the rapid delivery and fast tracking of nationally significant infrastructure like transmission assets that meet specified eligibility criteria. The delivery of the ASTI projects at the pace required to meet the government’s power decarbonisation and offshore wind connection targets will require a collective effort between the TOs, supply chains and the Westminster and Scottish governments.

Bringing ASTI into effect

Ofgem is engaging with the TOs to progress the development of the new conditions which will have to be added to their transmission licences to bring the ASTI framework into effect. The regulator’s current intention is that the statutory consultation for the required licence modifications will be launched in the spring, with a view to implementing the framework in licences in the summer. Ofgem recognises that the TOs’ delivery plans make provision for expenditure on ASTI projects from Q4 in 2022, but also considers that the policies reflected in the ASTI decision will give the TOs sufficient reassurance to start work ahead of the required licence modifications.