Distribution key to ‘weaponising’ demand side

As the demand side evolves and distribution networks become more dynamic, the role, business model and ownership of network operators is set to change.

May 13, 2019

A more dynamic demand side is a key building block of the energy transition. But the ability to achieve this depends strongly on the rapid evolution of electricity distribution networks and their operators.

Investment, technology & policy incentives are converging to transform the role of distribution networks.  For example:

  1. Embedded capacity: New generation & storage assets are increasingly distribution connected (rather than transmission connected), e.g. embedded wind, solar, gas engines, batteries & smaller CHP.
  2. Smart tech: Rollout of smarter technology & software within businesses and households is set to facilitate a more dynamic bi-directional real time role for the demand side.
  3. EVs: The impact of rapid deployment of electric vehicles & associated charging infrastructure will be primarily focused on distribution networks.

This is challenging the traditional ‘plain vanilla’ function of distribution networks.  Networks were developed to allow a simple one-way flow from centralised generation on the grid to end consumers. But a much more dynamic landscape is evolving with multiple sources of supply and demand interacting across the network.

This is creating physical infrastructure constraints within the network.  It is also increasing network management & balancing complexity. These factors bring the role of distribution network operators (DNOs) firmly into focus.

Evolving role of the network operator

DNOs have traditionally had a relatively staid business model focused on security of supply and quality of service. While these two goals remain key, the capabilities required to deliver on them are increasing substantially in scale and complexity.

DNOs will need to evolve rapidly and purposefully in order to facilitate an increasingly dynamic & decentralised future.  Policy makers have coined the term ‘Distribution System Operator’ (DSO) to describe their vision for an ‘evolved DNO’. But the practicalities of reaching this DSO vision may fundamentally change the revenue, ownership and financing structures that characterise DNOs today.

Whether privatised or, as in many countries, under municipal ownership, the DNO enjoys a regulator-approved natural monopoly over the wires in its territory.  Its primary revenue streams are stable, and generally price-regulated on a cost-plus model.  This more or less guarantees a reasonable rate of return if the operator is competent.  Privately owned DNOs therefore enjoy a low cost of capital and attract owners seeking stable, regulated returns.

The DNO business model has relied primarily on performing some basic, conventional ‘medium tech’ functions reliably and efficiently.  Everyone involved in electricity from generators to consumers depend on these being done well, but it is not rocket science.  Most of the ‘higher tech’ action in the industry has traditionally been upstream of the DNO, in the hands of larger and more sophisticated transmission or ‘grid’ operators (TSO).

Many current developments and trends point to this changing fundamentally over the coming years, as summarised in Table 1.

Table 1: ‘Traditional’ vs ‘Future’ role of distribution networks and operators

Traditional Future
Generation assets Dominance of large centralized plant, exporting to transmission grid Rapid growth in decentralized distribution connected generation & storage
Consumers Passive; price-takers Many active ‘prosumers’ of all sizes
System balancing A grid function: flex assets dispatched centrally Also a DNO/DSO function: flex assets deploying on a transactional basis
Demand side response Limited role of demand side; struggling to achieve participation & potential Significant participation in system balancing & optimisation at all levels
EV charging Very limited quantities; slow charging; one-way electron flow Large quantity; some very fast; some two-way electron flow
Key infrastructure actors Grid/TSO pre-eminent: legacy of central dispatch & control DNO/DSO of increasing importance: decentralisation
DNO/DSO skillset & revenue model Efficient management of ‘med-tech’ assets & processes for regulated monopoly return
In addition, participation in ‘hi-tech’ physical & transactional dynamics for additional risk & reward

 

There are competing visions as to how the evolution from DNO to DSO will work out, but two significant aspects are common to all of them.

  1. The physical infrastructure required to connect all these components together in an effective manner will be different, and most likely more complex and sophisticated. And it will no longer be the transmission system that bears the brunt of this.  In fact TSOs could play a materially diminished role.
  2. If the potential of the new physical assets and infrastructure is to be realized effectively, the nature of business taking place throughout the system will increasingly involve many more players, acting dynamically in multilateral, real time transactions.

The network operator is no longer simply focused on ensuring adequate physical capacity for electricity to flow to customers.  Instead they are actively managing dynamic real time activity across all network participants.

Impact on capability & ownership of DNOs

DNOs are centrally and strategically positioned in the value chain.  When fully evolved into DSOs, they should be one of the most important category of actors in the power sector.

But how readily can organisations that have made their money through efficient deployment of relatively unsophisticated technologies and processes adapt to facilitate this transition?  If they do not, or only do so slowly, they may at least miss commercial opportunities. At worst, they may act as brake on progress in the industry as a whole.

By contrast, if DNOs succeed in an effective evolution to DSOs, there will be new revenue generation opportunities. The transition to DSO should also facilitate significant efficiencies from optimised deployment of new technologies and methods along the entire value chain.

One important factor may point to an optimistic scenario.   Taking the UK as an example:  the existing DNOs have relatively large resource bases (though very much smaller than, say, National Grid) and are under diverse ownership.  It seems possible that within this ecosystem, experimentation should be possible that will quickly reveal which apparent opportunities are real or a dead end; and which managements are capable or sluggish.  Darwinian commercial processes may then steer the sector towards the most fruitful opportunities and the new best practices that will realise them.

In any event, the commercial risk profile of the rapidly evolving DNO is likely to increase quite noticeably over time.  Becoming a DSO, the proportion of its revenues that are underpinned by regulated monopoly will likely diminish with merchant activity increasing.  The cost of capital will rise correspondingly.  These factors will attract a different class of owner that can embrace and indeed drive the changes that are coming.

May Mannes joins Timera as a Managing Director.  See more details in our recent Angle here or May’s CV and background on Our Team page.

 

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