Box 92 UK network regulation and DG

The UK gas and electricity market regulator, Ofgem, has been a pioneer in developing and implementing incentive regulation mechanisms. It was the first regulator to explicitly include DG and network innovation into its incentive regulation framework. In its 2005 Distribution Price Control Review, Ofgem introduced a 'DG hybrid incentive' to promote DG connections and two instruments to foster network innovations: 'Registered Power Zones' and an 'Innovation Funding Incentive' (Ofgem 2004a, 2004b, 2004c).

The 'DG hybrid incentive' explicitly includes DG-related costs in the regulation of DNOs, allowing them to pass through some of the additional network cost to the generators. It is a 'hybrid' instrument as it also provides a volume-related (per kilowatt) revenue driver. This rewards DNOs with revenue as additional DG capacity is connected to their grid. This combines incentives for efficiency (the lower the costs of a DG connection, the higher a distribution network operator's profit) with protection of the distributed network operator against cost uncertainty. This should mean that it is in the DNOs' interest to integrate the new generators as efficiently as possible. If they achieve this, they can earn a higher rate-of-return.

The 'Innovation Funding Incentive' and 'Registered Power Zones' are designed to be complementary, addressing different stages of the innovation process (research, development, demonstration and so on). The 'Innovation Funding Incentive' promotes 'development' projects tackling technical aspects of distribution networks, including network design, operation and maintenance. The 'Registered Power Zones' scheme supports demonstration projects employing new, more cost-effective ways of connecting and operating DG. Tailoring incentives to stages in the innovation process in this way is a vital consideration, highlighted in Chapter 8.

In this way regulation could, as a minimum, be adjusted so as to provide a level playing field, ensuring incentive regulation does not work against investment in DG. Beyond this, the incentive regulation framework can be used to support the political objective of increasing the share of DG at low cost.

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