Price Preview 5 (PR5) 2021-2025 - Distribution System Operator (DSO) Revenue for 2021-2025 - CRU Ireland
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An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
An Coimisiún um Rialáil Fóntais
Commission for Regulation of Utilities
Price Preview 5 (PR5) -
2021-2025
Distribution System Operator (DSO)
Revenue for 2021-2025
Draft Determination Paper
Reference: CRU/20/077 Date Published: 22/07/2020 Closing Date: 18/09/2020
www.cru.ie
0An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
CRU Mission Statement
The Commission for Regulation of Utilities (‘CRU’) mission is to protect the public interest in
Water, Energy and Energy Safety.
The CRU is guided by four strategic priorities that sit alongside the core activities we undertake
to deliver on the public interest. These are:
• Deliver sustainable low-carbon solutions with well-regulated markets and networks;
• Ensure compliance and accountability through best regulatory practice;
• Develop effective communications to support customers and the regulatory process;
and
• Foster and maintain a high-performance culture and organisation to achieve our vision.
iAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities Executive Summary The Climate Action Plan 20191 and the recently approved programme for government 2020 set the energy sector in Ireland a collective challenge to decarbonise electricity while facilitating consumer and community engagement, significant electrification of heat and transport and rapidly increasing demand. ESB Networks, the Distribution System Operator (‘DSO’), has a crucial role to play in the successful delivery of this vision for Ireland’s future. The Climate Action Plan 2019 (‘CAP’) sets targets that include 70% of electricity coming from renewable generation sources by 2030; increased uptake of micro-generation (including ‘prosumers’ selling power to the grid); and all new cars and vans sold in 2030 being electric (resulting in 950,000 electric vehicles on the road by 2030). Greater flexibility on the distribution network will be needed to securely accommodate more renewable generation, new technologies and new demands on the system for Price Review Five (‘PR5’). This will require transformational change within the DSO, entailing the embedding of innovation, agility and developing new ways of working and delivering network services. The DSO must have access to the resources to deliver this change. To enable and sustain this transformation, the CRU expects the DSO to ensure that there is an ambitious and systematic focus on increasing efficiency in terms of cost and quality of delivery while continuing to meet the needs of the network and protecting long and short-term customer interest. The proposed efficiencies in this paper will ensure that end-users are protected as much as is possible, while still allowing for the required level of investment to take place, and continues to build upon implemented efficiencies the CRU developed in previous price reviews. In December last year, the CRU published a Discussion Paper2 on the approach to PR5. This paper highlighted that, in the context of a rapidly changing energy system, there is a need for a more agile framework to accommodate future possibilities, while encouraging efficiency, innovation and the scope to make the necessary investments to support the energy system transformation that is taking place. The PR5 Discussion Paper also set out the PR5 strategic objectives which build on the CRU’s Strategic Plan.3 The CRU’s objectives for PR5 (see Section 2.3 for more detail) aim to deliver a secure and sustainable system in a cost-effective manner that supports the delivery of our 2030 targets. These are summarised in Figure 1 below. 1 Climate Action Plan 2019 2 Discussion Paper on the Approach for Transmission & Distribution Price Review Five (CRU/19/152) 3 Strategic Plan 2019-2021 ii
An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Delivering
Continual
Efficiency
Improvements
Facilitating
a Secure
Low Carbon
Ensuring Local
Security of
Future Transforming
the Role of the
Supply DSO
Figure 1 - PR5 Strategic Objectives
When considering these objectives and the need for a more agile framework to accommodate
future possibilities, the CRU examined and proposed changes to the regulatory framework
currently in place (see summary in Section 3. Some of the key aspects of these proposals
include:
• An increased focus on consumer outcomes;
• Enhanced Performance Incentive Framework; and
• An Agile Investment Framework to provide for more flexibility for the licensees within
PR5.
The goal of enhancing the current regulatory framework is to ensure that PR5 enables the
DSO to deliver on the CAP and Clean Energy Package (‘CEP’) whilst also ensuring that
consumers are protected. The pace of change will depend on how fast system needs evolve.
The CRU is conscious that establishing a more agile investment framework for PR5 involves
some level of risk. This risk must be managed by the DSO and must not be improperly
transferred to consumers. It is incumbent on DSO to manage its costs.
This paper puts forward the CRU’s proposals weighted average cost of capital (‘WACC’) for
PR5. This paper also puts forward the CRU’s proposals on the DSO’s revenue for the 2021 to
iiiAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities 2025 period. The DSO’s costs and performance over the previous five years are also examined. The following sub sections set out a brief summary of the CRU’s historic (2016 – 2020) and future (2021 – 2025) review of DSO costs. It should be noted from the outset that the CRU has challenged the DSO on a relatively large proportion of its forecast operational and capital expenditure. This is a cost challenge and will not necessarily result in a disallowance. If the DSO can provide further information that provides a sufficient justification for a particular cost request, the CRU will include those revenues in the Final Determination. Therefore, the allowances approved in the Final Determination may be higher than the allowances set out in the baseline recommendation in this paper. Similarly, if the DSO does not provide sufficient justification in response to the cost challenge, the costs will not be included in the Final Determination. The total requested revenue subject to a cost challenge is €143.5m operational expenditure and €595m capital expenditure. Separately to the cost challenge the CRU has proposed that some costs be provided through the Agile Investment Framework as opposed to being included in the baseline allowance. While the cost challenge relates to costs requiring further justification before being included in the approved allowances, costs proposed to be included in the Agile Investment Framework are uncertain in terms of the timing or scope of the need. The CRU’s proposed Agile Investment Framework is intended to allow the DSO manage uncertainty around scope, needs, timing, technical solution and cost of investments, in particular, low- carbon technology take-up. This approach aims to reduce the risk to the consumer while ensuring the necessary funding is available for the delivery on the Climate Acton Plan even where the scope or system need cannot be fully defined at the start of PR5. This allows the CRU to protect consumer interests by only allowing DSO to invest when there is a greater level of certainty around scope, needs, timing, technical solution and cost. The CRU is seeking stakeholders’ views on the CRU’s proposed approach. PR4 Historic Review (2016-2020) Overall, the DSO’s expected operational expenditure (‘Opex’) outturn for PR4 is €1.38bn, which is €23m (2%) above the PR4 allowance of €1.36bn. The overspend was driven by ‘uncertain costs’ such as Storm Ophelia. There was a €38.4m (4%) overspend on controllable operational expenditure which was offset by a €40.2m (14%) underspend on non-controllable operational expenditure. Therefore, if ‘uncertain costs’ are excluded from the assessment of operational expenditure, the DSO’s total operational spend was broadly in line with the PR4 allowance of €1.36bn. Table 1 provides a breakdown of the draft determination for the DSO’s historic operational expenditure. A more detailed explanation of the CRU’s proposals is set out in Section 5. iv
An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Table 1 DSO Historic Opex Executive Summary (2016 – 2020)
DSO PR4 Opex (€m 2014 prices)
Category DSO Outturn/Forecast (€m) DSO Ex-post Allowance
Total Controllable Opex 1,114.4 1,114.4
Total Non-controllable Opex 246 246
Total Opex (excl. uncertain costs) 1,360.40 1,360.40
Total Uncertain Costs 24.9 24.9
Total Opex (incl. uncertain items) 1,385.40 1,385.40
In relation to historic capital expenditure (‘Capex’), the DSO’s total net outturn capital spend
is expected to be €1.54bn, an underspend of €196m or 11.3% against the CRU PR4
allowance, noting that the 2020 outturn is forecasted. Within this overall spend there are
significant overspends and underspends against the allowances for several expenditure
categories. Over the PR4 period the DSO reprioritised its capital expenditure towards load-
related capital expenditure to accommodate a significantly higher number of connections than
had been forecast at the beginning of the PR4 period.
Load related capital expenditure, where the DSO reprioritised its capital expenditure to
accommodate higher than expected demand connections, is forecast to be €951m, an
overspend of €132m (16%) against the PR4 allowance. Non-load related expenditure is
expected to be €477.7m, an underspend of €103m (18%) against the PR4 allowance. Non-
network capital expenditure is expected to be €198m, an overspend of €44m (29%). The non-
network capital expenditure overspend is primarily driven by unforeseen IT upgrades;
upgrading of the DSO’s aging vehicle fleet; and increases relating to tools and equipment due
to a change in accounting treatment, changes in work practices and equipment needs not
included in the DSO’s PR4 forecast. Smart meter capital expenditure is expected to be
€265m, an underspend of €147m against the PR4 allowance.
The CRU has applied a reduction of €3.5m to the DSO’s net outturn capital spend, which
includes a €1.8m reduction to the DSO’s continuity capital expenditure and €1.7m in relation
to separation of the retail system from Northern Ireland.
Table 2 provides a breakdown of the draft determination for the DSO’s historic capital
expenditure. A more detailed explanation of the CRU’s proposals is set out in Section 7.
vAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Table 2 DSO Historic Capex Executive Summary (2016 – 2020)
DSO PR4 Capex (€m 2014 prices)
DSO Outturn/Forecast DSO Ex-post
Category
(€m) Allowance (€m)
Load Related Capex 950.9 950.9
Non-Load Related Capex 477.7 475.9
Non-Network Capex 198.5 196.7
Smart Metering 265.6 265.6
Total Gross Capex 1892.7 1889.1
Contributions -351.5 -351.5
Total Net Capex 1541.2 1537.6
PR5 Forecast Review (2021-2025)
For PR5 operational expenditure, the CRU has recommended a considerable increase
€196.2m or 14% (does not include adjustments for ongoing productivity) when compared to
the DSO’s PR4 outturn. This increase is driven by a number of activities, however it is primarily
driven (€120m or over 60%) by increased planned maintenance activities, an increase in
customer relations activities, an increase in environmental management activities, and a new
smart meter operational expenditure allowance.
The DSO’s net capital expenditure requirement of €2.52bn is almost a €1bn (61%) increase
relative to PR4 outturn. This increase is primarily driven by a €203m increase in load-related
capital expenditure and an increase of €616m in smart meter capital expenditure. The CRU
considers that further review of the smart meter expenditure is required. The increase in load-
related capital expenditure is to account for an increased number of demand and generation
connections and network reinforcements. This includes a €36.2m (63%) increase relative to
PR4 for MV/LV system improvements, which is an important investment category that
supports low carbon technology (‘LCT’) take-up. However, it is noted that PR4 expenditure in
this area increased significantly in 2019/20 therefore maintaining, or expanding, that level of
expenditure may imply further increases.
The increase in allowances, in addition to the revenues available through the Agile Investment
Framework, reflects the CRU’s commitment to ensure that the DSO has the resources to
deliver on the PR5 strategic objectives and climate action targets. However, the CRU is
cognisant of the need to protect customers and has proposed a number of cost challenges to
the DSO for this draft determination.
A cost challenge of €143m has been applied to the DSO’s operational expenditure proposals.
While for capital expenditure a cost challenge of €595m has been applied to the DSO’s capital
viAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
expenditure proposals. This is on the basis that the information provided4 by the DSO has not
fully met some or all of the gateways of need, additionality or cost efficiency that the CRU’s
advisors applied in conducting their analysis. Further detail on gateways of need, additionality
or cost efficiency is laid out in Advisors’ Report (CRU/20/077a) published alongside this paper.
The CRU also proposes that €108m (included in the €595m cost challenge) of the DSO’s
capital expenditure request5, which primarily relates to the LCT take-up and the consequential
MV/LV system improvements, be provided for through the Agile Investment Framework rather
than included in the baseline PR5 revenues. The CRU invites views on the level of revenues
relating to LCT take-up that should be provided in the PR5 base allowances and the level that
should be provided for through uncertainty mechanisms.
The CRU’s PR5 operational and capital expenditure draft determination proposals are
summarised in Table 3 and Table 4 respectively. It should be noted that if the DSO is able to
provide sufficient justification for the requests subject to the cost challenge in this Draft
Determination these costs may be included, in full or in part, in the allowances set as part of
the PR5 Final Determination. In addition, the total expenditure over the PR5 period may
increase above the allowance set at the beginning of PR5 as the DSO accesses the additional
funds needed to deliver the CAP.
Table 3 DSO Forecast Opex Executive Summary (2021 – 2025)
DSO PR5 Opex (€m 2019 prices)
Request Recommendation Variation
Category
(€m) (€m) €m %
Controllable opex 1,384.4 1,241.0 -143.4 -10%
Non-Controllable opex 340.6 340.6 0 0%
On-going Productivity -47.8 -34.6 13.2 28%
Total Opex (excl. ongoing
1,725.0 1,581.6 -143.4 -8%
productivity)
Total Opex (incl. ongoing
1,677.2 1,547.0 -130.2 -8%
productivity)
4 As noted above the DSO provided additional information in submissions after the cut-off date for
inclusion in the advisors’ analysis. This information will be considered, along with responses to this
consultation, in the final determination.
5 It is noted that of the DSO’s forecast for investment at MV and LV primarily to support low carbon
technologies is €741m, of which the DSO requested €332m be included in the baseline allowance with
the remainder being made available through uncertainty mechanisms.
viiAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Table 4 DSO Forecast Capex Executive Summary (2021 - 2025)
DSO PR5 Capex (€m 2019 prices)
Request Recommendation Variation
Category
(€m) (€m)
€m %
Load Related Capex 1511.9 1154.4 -357.5 -23.6%
Non-Load Related Capex 763.9 585.1 -178.7 -23.4%
Non-Network Capex 378.3 297.5 -80.7 -21.3%
Smart Metering 882.1 882.1 0.0 0%
Total Gross Capex 3536.2 2919.2 -617.0 -17.4%
Contributions -414.3 -392.5 21.9 -5.3%
Total Net Capex 3121.8 2526.7 -595.1 -19.1%
Regulatory Framework
The CRU has published a Consultation Paper (CRU/20/078) reviewing changes to the current
regulatory framework and how best to address uncertainty and the transformational change
that can be expected over PR4. The proposal includes the establishment of an Agile
Investment Framework to allow the DSO flexibility to respond to changing circumstances over
the PR5 period in addition to cost and performance incentives. The CRU considers that an
enhanced regulatory framework is integral to meeting the CRU’s PR5 strategic objectives.
Weighted Average Cost of Capital
The CRU’s proposed Weighted average cost of capital for PR5 is set out in Table 5 and further
details are set out in Section 10.
Table 5 Weighted Average Cost of Capital Executive Summary
CRU Recommendation DSO Proposal
Weighted Average Cost
3.8% 4.2%
of Capital
Allowed Revenues and AUP
The CRU currently proposes to allow total expenditure of almost €4.1bn for the five-year
period. The detail behind these expenditure allowances are detailed in this paper. The
expenditure has the potential to be almost €4.8bn if the DSO can provide sufficient justification
for those requests which are subject to a cost challenge. The Average Unit Price (‘AUP’)
impact analysis in The AUP declines year-on-year over the PR5 period notwithstanding the
increased investment anticipated over the period. This effect is more pronounced in higher
demand scenarios. However, it should be noted that costs may increase over the PR5 period
as additional investments are made through the Agile Investment Framework. Therefore, the
viiiAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
AUP seen over PR5 will be significantly impacted by the speed of transition driven by the CAP
and the overall demand levels over the period. In this context the CRU considers it prudent to
profile the revenues to avoid significant price volatility. When considering the appropriate
profile in final determination the CRU will take into consideration the final allowed revenues as
well as the potential need for increased investment through Agile Investment Framework .
Please note that the impact of COVID-19 has not been considered as it is not possible at this
time to accurately predict the impact this will have. The CRU will consider this further in the
Final Determination.
below compares the AUP using the proposed allowed revenue and the potential allowed
revenue if the total cost challenge revenue is allowed in the final determination. The DSO’s
forecast annual consumption is used in this analysis.
Table 6 Allowed Revenues and AUP
Calendar Year AUP Impact - Scenario Analysis (2019 monies)
Category 20206 2021 2022 2023 2024 2025
AUP based on Proposed Revenues
Smoothed adjusted
839 856.12 858.44 86081 860.81 855.42
revenues (€m)
Annual consumption
24,952 26,181 27,064 27,978 28,827 29,549
(GWhr)
Annual consumption
- 4.93% 3.37% 3.38% 3.03% 2.50%
Growth
AUP (c/kWh) 3.36 3.27 3.17 3.07 2.98 2.89
AUP Growth -2.7% -3% -3% -3% -3%
AUP based on Allowed Revenue plus Total Cost Challenge
Smoothed adjusted
909.27 911.74 914.26 913.74 908.53
revenues (€m)
Annual consumption
24,952 26,181 27,064 27,978 28,827 29,549
(GWhr)
Annual consumption
- 4.93% 3.37% 3.38% 3.03% 2.50%
Growth
AUP (c/kWh) 3.36 3.47 3.36 3.26 3.17 3.07
AUP Growth 3.3% -3% -3% -3% -3%
The AUP declines year-on-year over the PR5 period notwithstanding the increased investment
anticipated over the period. This effect is more pronounced in higher demand scenarios.
However, it should be noted that costs may increase over the PR5 period as additional
investments are made through the Agile Investment Framework. Therefore, the AUP seen
6 These are the values that were used when setting the 2020 DSO revenues
ixAn Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities over PR5 will be significantly impacted by the speed of transition driven by the CAP and the overall demand levels over the period. In this context the CRU considers it prudent to profile the revenues to avoid significant price volatility. When considering the appropriate profile in final determination the CRU will take into consideration the final allowed revenues as well as the potential need for increased investment through Agile Investment Framework . COVID–19 Note This Price Review is being conducted in the context of changing economic circumstances as a result of COVID-19. The CRU has continued to engage with the DSO on the potential impact on COVID-19, however, uncertainty remains. There may be impacts on demand and changes to work practices for the DSO. For the weighted average cost of capital, our advisors have noted that it is not possible to draw long-term inferences about the cost of capital for PR5 from market movements since the start of the COVID-19 crisis. The CRU will further assess any long-term impacts when the final determination is made. Public/Customer Impact Statement Ireland’s electricity networks deliver secure electricity supplies to homes and businesses in the country. The CRU allows ESB Networks and EirGrid (“the network companies”) to charge money towards the cost of building, safely operating and maintaining the electricity system in Ireland. These charges are reflected in customers’ electricity bills and make up the network companies’ revenue allowances. The revenue allowances are collected from suppliers via the use of system charges and charges per unit of electricity that they buy, which is then passed on to customers in their electricity bills. Depending on other factors (for example the cost of wholesale electricity and fuel) the use of system charge typically accounts for about one third of an average residential customer’s electricity bill. The CRU’s role is to protect electricity customers by ensuring that the network companies spend customers’ money appropriately and efficiently to deliver necessary services and make necessary investments in infrastructure. The CRU does this through what is called a Price Review which is carried out every five years. The current Price Review (PR4) started in 2016 and will end in 2020. PR5 will follow PR4 and will determine the use of system charges for the period 2021 to 2025, and therefore, will have an impact on customers electricity bills over that period. PR5 comes at an important time for the evolution of the electricity networks and will play an important role in enabling the transition to a low carbon system by 2030. We can expect significant changes over this period which will transform the way electricity customers think about and use electricity. Advancement in smart technologies such as smart meters will increase customer participation rates where electricity customers will become more active in energy markets. x
An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Table of Contents
Glossary of Terms and Abbreviations.................................................................... 4
Part 1 – Introduction ................................................................................................ 5
1. Introduction .......................................................................................................... 6
1.1 Background ................................................................................................................... 6
1.2 Legal Context ................................................................................................................ 6
1.3 Related Documents ....................................................................................................... 7
1.4 Purpose of this Paper .................................................................................................... 7
1.5 Structure of Paper ......................................................................................................... 8
1.6 Responses to this Paper................................................................................................. 8
2. Context ................................................................................................................ 10
2.1 Historical context (summary of previous price reviews) ................................................ 10
2.1.1 2001 to 2015 ................................................................................................................. 10
2.1.2 2016 to 2020 – PR4 ....................................................................................................... 11
2.2 Context for PR5 and beyond (2021-2030) ..................................................................... 11
2.3 Objectives for PR5 ....................................................................................................... 12
2.4 Key Assumptions for PR5 .................................................................................................. 13
2.5 Unbundling of System Operator and Owner Functions ....................................................... 13
Part 2 – The Regulatory Framework ..................................................................... 15
3. Regulatory Framework ...................................................................................... 16
3.1 Current Regulatory Framework.................................................................................... 16
3.2 DSO’s Proposals .......................................................................................................... 17
3.3 CRU’s Views ................................................................................................................ 17
3.3.1 Outcomes, outputs and incentives ............................................................................... 18
3.3.2 Cost incentive, including associated outputs ................................................................ 20
3.3.3 Return adjustment mechanism..................................................................................... 20
3.3.4 Flexibility between allowances ..................................................................................... 21
3.3.5 Uncertainty mechanism ................................................................................................ 21
3.4 PR5 Proposed Regulatory Framework .......................................................................... 22
3.5 Ex-Ante Output Setting ................................................................................................ 23
3.6 Incentives ................................................................................................................... 24
3.7 Agile Investment Framework ....................................................................................... 25
3.8 Reporting Monitoring, and the Ex-Post Review ............................................................ 25
Part 3 – Allowed Expenditure ................................................................................ 27
1An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
4. Regulatory Review Process .............................................................................. 28
4.1 Overview .................................................................................................................... 28
4.1.1 Review of historic capital expenditure ......................................................................... 28
4.1.2 Review of historic operational expenditure ................................................................. 28
4.1.3 Review of forecast capital expenditure ........................................................................ 28
4.1.4 Review of forecast operational expenditure ................................................................ 28
4.1.5 Determining appropriate regulatory framework and performance incentives............ 28
4.1.6 Determining the regulatory asset base......................................................................... 29
4.1.7 Determining the appropriate cost of capital ................................................................ 29
4.1.8 Determining the allowed revenue ................................................................................ 29
4.2 Conduct of this Review and Process ............................................................................. 29
4.3 Expertise Procured ...................................................................................................... 30
4.4 Scope of this Price Review ........................................................................................... 31
5. Review of Historical Operational Expenditure ................................................. 32
5.1 Objectives for Review of PR4 Operational Expenditure ................................................. 32
5.2 Review of DSO’s PR4 Operational Expenditure ............................................................. 32
5.3 Conclusion .................................................................................................................. 33
5.4 Summary of PR4 Operational Expenditure Proposals .................................................... 33
6. Review of Forecast Operational Expenditure .................................................. 35
6.1 Objectives for Review of PR5 Operational Expenditure................................................. 35
6.2 Review of DSO’s PR5 Operational Expenditure ............................................................. 35
6.3 Ongoing Productivity ................................................................................................... 38
6.4 Conclusion .................................................................................................................. 38
6.5 Summary of PR5 Operational Expenditure Proposals .................................................... 39
7. Review of Historical Capital Expenditure ......................................................... 41
7.1 Objective of PR4 Capital Expenditure Review ............................................................... 41
7.2 Review of DSO PR4 Capital Expenditure ....................................................................... 41
7.3 Conclusion .................................................................................................................. 42
7.4 Summary of PR4 Capital Expenditure Proposals ........................................................... 42
8. Review of Forecast Capital Expenditure .......................................................... 45
8.1 Objectives for Review of PR5 Capital Expenditure ........................................................ 45
8.2 Review of DSO’s PR5 Capital Expenditure..................................................................... 45
8.2.1 Load related capital expenditure .................................................................................. 46
8.2.2 Non-load related expenditure ...................................................................................... 47
8.2.3 Non-network capital expenditure ................................................................................. 48
8.2.4 ‘Other’ – capital expenditure ........................................................................................ 49
8.3 Conclusion .................................................................................................................. 50
8.4 Summary of PR5 Capital Expenditure Proposals ........................................................... 50
2An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Part 4 – Allowed Revenue & Finance.................................................................... 54
9. The Regulatory Asset Base ............................................................................... 55
9.1 Context ............................................................................................................................ 55
9.2 Value and Composition of RAB .......................................................................................... 55
9.3 Valuation of Regulatory Asset Base.............................................................................. 56
9.4 Assets Lives Applied to RAB ......................................................................................... 56
9.5 DSO Request on Treatment of Secondary Assets .......................................................... 57
9.6 Smart Meter Assets Lives............................................................................................. 57
9.7 Depreciation Method .................................................................................................. 58
9.7.1 Context .......................................................................................................................... 58
9.7.2 Proposal ........................................................................................................................ 58
9.8 Replaced Asset ............................................................................................................ 59
9.9 Capital Expenditure Approved but not Incurred ................................................................. 59
9.10 Additions to RAB............................................................................................................. 59
9.10.1 Introduction .................................................................................................................. 59
9.10.2 Interest During Construction (IDC) ............................................................................... 59
9.10.3 Capital Contributions and Grants.................................................................................. 60
9.11 Summary ........................................................................................................................ 60
10. Cost of Capital .................................................................................................. 62
10.1 Context........................................................................................................................... 62
10.2 Methodology for Setting Cost of Capital .......................................................................... 63
10.3 CEPA Point Estimate ....................................................................................................... 63
10.4 Financeability ................................................................................................................. 65
10.5 Pensions ......................................................................................................................... 67
10.6 The CRU’s proposal ......................................................................................................... 68
11. Allowed Revenue.............................................................................................. 69
11.1 AUP Impact Analysis ....................................................................................................... 70
Part 5 – Conclusion and Consultation Questions ............................................... 73
12. Conclusion ........................................................................................................ 74
13. Consultation Questions ................................................................................... 75
14. Next Steps ......................................................................................................... 76
3An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Glossary of Terms and Abbreviations
Abbreviation or Term Definition or Meaning
ADMD After Demand Maximum Diversity
CAP Climate Action Plan
CAPM Capital Asset Pricing Model
CEPA Cambridge Economic Policy Associates
CPI Consumer Price Index
DAC Designated Activity Company
DAO Distribution Assets Owner
DSO Distribution System Operator
GHD Gutteridge Haskins and Davey Ltd.
GDP Gross Domestic Product
HICP Harmonised Index of Consumer Price
HV High Voltage
LCT Low Carbon Technologies
LV Low Voltage
MV Medium voltage
O&M Operational and Maintenance allowance
PAYG pay-as-you-go meters
PR1 Price Review 1
PR2 Price Review 2
PR3 Price Review 3
PR4 Price Review 4
PR5 Price Review 5
RAB Regulatory asset base
RPE Real Price Effects
TAO Transmission Asset Owner
the Act Electricity Regulation 1999 Act, as amended
TSO Transmission System Operator
WACC Weighted average cost of capital
4An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Part 1 – Introduction
5An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
1. Introduction
This section summarises the relevant context and legal background for Price Review 5. It
explains the CRU’s role in setting the allowances for, and the roles of EirGrid, ESB Networks
and ESB. It also details the purpose of, and how to respond to, this paper.
1.1 Background
The CRU is responsible for the economic regulation of the system operators and asset owners
for electricity transmission and distribution systems in Ireland. To do this, the CRU carries out
reviews of the allowed revenue for the transmission and distribution businesses through price
reviews. Price reviews set the revenue that the relevant network company can recover from
electricity consumers and are set every five years. The transmission business consists of
EirGrid, licensed by the CRU as the Transmission System Operator (TSO) and ESB, acting
through its ESB Networks business unit, is the licensed Transmission Asset Owner (TAO).
ESB Networks DAC is licensed by CRU as Distribution System Operator (DSO), and ESB,
acting through its ESB Networks business unit, is the licensed Distribution Assets Owner
(DAO). In December 2015, the CRU set its price reviews for the Price Review 4 (PR4) period
for EirGrid as TSO, and for ESB Networks as TAO and DSO/DAO, PR4 comes to an end in
2020. Therefore, the CRU has commenced the review of the allowed revenue for the
transmission and distribution businesses for the next price review period (PR5). PR5 will cover
the five-year period from 2021 to 2025. This Draft Determination outlines the proposed
revenue that the ESB Networks as DSO is allowed recover from customers during a the PR5
period.
1.2 Legal Context
Under Section 36 of the Electricity Regulation 1999 Act, as amended (‘the Act’), the CRU
approves charges for the use of, and connection to the electricity system. In accordance with
Section 35 (4) these charges are to be calculated to enable the network companies recover the
efficient costs of operating the system and discharging their licensed activities.
6An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
1.3 Related Documents
Further background relevant to this paper can be found in the following documents:
CRU/20/077a Consultancy Support for Electricity Distribution Advisors’ Report
Revenue Control (2016 – 2025)
CRU/20/077b ESBN PR5 Submission Business Plan Overview ESBN Report
CRU/20/077c PR5 DSO Revenue Model (Incl. Cost Challenge) CRU Model
CRU/20/077d PR5 DSO Revenue Model (Excl. Cost Challenge) CRU Model
CRU/20/078 PR5 Regulatory Framework, Incentives and Consultation
Reporting
CRU/20/078a Options for PR5 Regulatory Framework Advisors’ Report
CRU/20/080 Real price effects and ongoing improvements for Advisors’ Report
PR5
CRU/20/079 PR5 Cost of Capital Estimation Advisors Report
CRU19152 Discussion Paper on the Approach for Consultation
Transmission & Distribution Price Review Five Paper
CER/18/087 Reporting and Incentives under Price Review 4 Decision Paper
CER/17/335 Consultation on Reporting and Incentives under Consultation
Price Review 4 Paper
CER/15/295 Decision on DSO Distribution Revenue for 2016 to Decision Paper
2020
CER/10/198 Decision on DSO distribution revenue for 2011 to Decision Paper
2015
1.4 Purpose of this Paper
This paper sets out the CRU’s proposals for allowances for the DSO over the PR5 period
(2021-2025). We are seeking comments from members of the public, the industry, customers
and all interested parties on proposals put forward in this paper. These include the proposed
operational expenditure allowance, and capital expenditure allowance over the PR5 period.
The CRU is also seeking stakeholders’ views on the cost challenge applied to the DSO’s
revenues request and the proposed uncertainty mechanism.
These comments will assist and inform the CRU in reaching its final decision on the DSO’s
revenue allowance for the PR5 period.
7An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
1.5 Structure of Paper
The structure of this consultation paper is outlined in this section:
• Part 1: Introduction
• Introduction
• Context
• Part 2: The Regulatory Framework
• Part 3: Allowed Expenditure
• Review of Historical Capital Expenditure;
• Review of Historical Operational Expenditure;
• Review of Forecast Capital Expenditure;
• Review of Forecast Operational Expenditure;
• Part 4: Allowed Revenue and Finance
• The Regulatory Asset Base;
• The Cost of Capital;
• Allowed Revenues;
• Tariffs;
• Part 5: Conclusion and Consultation Questions
• Part 6: Appendices
1.6 Responses to this Paper
The CRU invites responses to the specific aspects and consultation questions as set out in
this paper, along with any general comments. Responses should be sent by 17.00 Friday 18
September 2020 to Pricereview5@CRU.ie.
Submissions on any of the points listed in this paper should be clear and specific, with analysis
or rationale to support the views provided. Unless marked confidential, all responses may be
published on the CRU’s website. Respondents may request that their response is kept
confidential. The CRU shall respect this request, subject to any obligations to disclose
information. The CRU intends to publish all responses received on the CRU’s website.
Respondents who wish to have their responses remain confidential should clearly mark the
document to that effect and include the reasons for confidentiality. Responses from identifiable
individuals will be anonymised prior to publication on the CRU website unless the respondent
8An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities explicitly requests their personal details to be published. Our privacy notice sets out how we protect the privacy rights of individuals and can be found on the CRU Website7. 7 Privacy Notice - https://www.cru.ie/privacy-statement/ 9
An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
2. Context
This section summarises, at a high level, the relevant historical context by outlining key
outcomes and events beginning at PR1 up until the close of PR4. It also outlines some of the
major changes that can be expected over PR5, the PR5 objectives, the PR5 assumptions and
unbundling of the DSO.
2.1 Historical context (summary of previous price reviews)
The following sub sections provides readers with a brief look back at all Price Reviews that
have been undertaken by the CRU. We begin by reviewing PR1 (2001-2005) and end with a
forward-looking view of PR5.
2.1.1 2001 to 2015
The first five-year review covered the period from 2001 to 2005. This period saw many
fundamental changes in the Irish electricity system relative to the preceding period. The
revenue control set in 2001 was intended to support the substantial new investment required
while at the same time incentivising efficiency improvements in the DSO’s business.
Significant improvements were achieved in addressing the effects of the historical lack of
investment in the distribution system, with good progress made in increasing reliability and
safety.
The second five-year review covered the period from 2006 to 20108. This was a period of
major change in Ireland. Construction and connections increased significantly, before falling
at the fastest rates ever seen. This review was considered successful as the DSO responded
to the PR2 incentive mechanisms by increasing the quality of its service to customers,
reducing operating costs and delivering the capital programme.
The third five-year review covered the period from 2011 to 20159. This was a period of
continuing major change in Ireland and a particularly difficult economic environment.
Construction and connections fell to well below forecast, before slowly bottoming out and
starting to revive somewhat in the second half of the period. The ongoing effects of the global
financial crisis caused a major financing freeze for Irish and other corporate borrowers on
international markets. In this context the CRU undertook an expenditure review in 2012
resulting in reduced proposed capital expenditure for the period and a prioritisation of
transmission capital expenditure. This approach limited the cost to the consumer during the
recession and ensured that the most essential capital projects were progressed. Despite the
significant funding constraint, the while continuing essential improvements and expansion of
the distribution network, on average, the DSO showed improved levels of performance over
PR3.
8 The decision on DSO revenue for the PR2 period 2006 to 2010
9 The decision on DSO revenue for the period 2010 to 2015 is CER/10/198.
10An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
2.1.2 2016 to 2020 – PR4
When setting the PR4 allowances, the follow-on effects of global financial crisis were expected
to be felt. Therefore, in order to ensure quality of supply was maintained at a high level
throughout the PR4 period, the allowances were set to recover lost ground from the PR3
deferral of necessary distribution investment. Accordingly, objectives for PR4 remained:
• maintenance of an efficient and effective distribution network;
• fair and cost reflective prices for electricity consumers in Ireland;
• appropriate incentives to improve the efficiency and standards of service by the DSO;
and
• effective and cost-efficient funding of its capital expenditures by the DSO.
However, during PR4 Ireland’s economic growth exceeded the assumptions made when
setting the PR4 allowances; average 2.5% annual growth in GDP. 10 Looking back, annual
GDP growth averaged over 6% for the period 2016 to 2019.11 This meant that the DSO
repositioned its investment to serve a higher demand and to accommodate a higher number
of connections than had been envisaged when setting PR4 allowances. As a result, the PR4
period was characterised by a reprioritisation of expenditure, particularly the non-load related
capital expenditure was reprioritised towards load related capital expenditure to facilitate new
connections. For example, the outturn (2016-2018) number of demand connections provided
by the DSO is approximately 71,527, which corresponds to a 25.5% increase relative to PR4
forecast. The 5-year total outturn is forecast to be 134,998, which is 26,294 (24.3%) higher
than PR4 forecast. Furthermore, ESB Networks connected 0.5GW of data centre demand -
the equivalent of two million new homes; connected up to 0.5GW of new renewable
connections each year; and served 25% higher electricity demand than forecast for the period.
In relation to project delivery, the review indicated that the DSO is able to successfully and
safely deliver complex projects that meet the scope requirements. In addition, the DSO has
demonstrated that they are able to work closely with customers to provide new connections
within challenging timescales. Furthermore, recent projects appear to have less scope creep
compared to those in PR3 and PR4 demonstrating improvements in the planning and design
phases.
Innovation, smart meters and a greater focus on consumer outcomes were a core features of
the incentive and reporting framework established in PR4. The PR5 Regulatory Framework
builds on this success to facilitate the CAP.
2.2 Context for PR5 and beyond (2021-2030)
10 Jacobs - Consultancy Support for Electricity Transmission and Distribution Revenue Controls (2016-
2020)
11 CSO - Quarterly National Accounts - CSO statistical release, 06 March 2020, 11am
11An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
Major changes can be anticipated over the PR5 (2021-2025) and PR6 (2026-2030) periods.
These include an increase in renewable generation, an increase in the use of electricity for
heat and transport, an increase in distributed generation, an increase in participation rates
from more active consumers (micro-generation, demand response etc.) and the participation
of Citizen Energy Communities. An implication of these changes is that the role of the DSO
will become increasingly central to delivering the transformation. The DSO will play an
increasingly active role where its principal task will be to facilitate the electricity market and
wider energy sector in a neutral manner.12
In addition, the CRU considers that it is appropriate during the PR5 period to include more
output-based reporting by the regulated companies (output-based regulation). The CRU’s
proposals on the PR5 reporting requirements are set out in the consultation on the PR5
Regulatory Framework. This will build upon the monitoring and reporting requirements put in
place in PR4. In light of the transformational change expected over PR5 and PR6, the CRU
considers that a degree of output-based regulation is required to meet climate action
objectives while delivering better outcomes for consumers and market participants.
2.3 Objectives for PR5
As set out in CRU’s PR5 Approach Paper (CRU/19/152)13, the CRU has set the following
strategic objectives for PR5:
1. Facilitating a Secure Low Carbon Future
2. Transforming the Role of the DSO
3. Increasing Efficiency and Protecting Consumers
4. Resolving Local Security of Supply.
The CRU has chosen its four strategic objectives for PR5 in order to deliver a secure and
sustainable system in a cost-effective manner that prepares the system for further development
after the PR5 period. These strategic objectives will seek to ensure that:
• the PR5 period fosters an environment that facilitates Ireland’s transition to a low
carbon energy future as Ireland aims to meet its 2030 renewable energy targets;
• the role of the DSO is transformed, and industry has confidence in the DSO’s capacity
to deliver independence and guaranteeing this independence into the future;
• there is a systematic focus on increasing efficiency in the operation of the network
companies while continuing to meet the needs of the network and protecting the long
and short-term customer interest; and
12 New Services and DSO Involvement – CEER Conclusions Paper
13 Discussion Paper on the Approach for Transmission & Distribution Price Review Five
12An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities
• the network companies are given sufficient incentives to solve the Dublin Security of
Supply issues before 2025
2.4 Key Assumptions for PR5
Inevitably, given the five-year scope of the review, it has been necessary to make some
assumptions regarding the environment within which the DSO will operate for the price review
period. Changes in the assumptions outlined in this section could lead to a reopening of the
distribution price review (or aspects therein), where the CRU considers this appropriate. The
key assumptions made by the CRU are as follows.
Distribution System Operator
As with PR4, the distribution system operator and owner functions will continue to remain as
a commercial semi-state enterprise for the duration of the review and there will be no
substantial changes made to its structure although improvements in its independence and
governance are expected over the period. The role of the DSO is also expected to change
due to the requirements of the Clean Energy Package and the changes associated with the
CAP.
Therefore, the distribution allowed revenues for 2021 to 2025 have been set on the basis of
the current industry structure and the CRU is assuming that this structure will be in place for
the entire PR5 period, allowing for the expected changes in the role of the DSO noted above.
Should this position change, or is likely to change, at some point over the five years of this
price review period (2021 to 2025), the CRU will take the appropriate steps to review the
regulatory structures and revenues in place for transmission.
Therefore, the policies outlined in this Draft Determination Paper are on the basis that ESB
Networks DAC will remain as DSO and ESB will remain DAO for the 2021 to 2025 PR5 period.
Information is provided below regarding the effective unbundling of the distribution system
operator and distribution asset owner functions during PR4.
Please note that the impact of COVID-19 has not been considered as it is not possible at this
time to accurately predict the impact this will have. The CRU will consider this further in the
Final Determination.
2.5 Unbundling of System Operator and Owner Functions
Under Article 15 of EU Directive 2003/54/EC (superseded by Article 35 of EU Directive
2019/944 (Recast Electricity Directive)), where a distribution system operator is part of a
vertically integrated undertaking it must be independent in terms of its legal form, organization
and decision making from other activities of the vertically integrated undertaking not relating
to distribution. The distribution unbundling requirements have been transposed into Irish law
through European Communities (Internal Market in Electricity) (Electricity Supply Board)
Regulations 2008 (SI 280 of 2008) (the “Unbundling Regulations”).
13An Coimisiún um Rialáil Fóntais Commission for Regulation of Utilities The model for distribution unbundling adopted in SI 280 provides for a separate operator and owner. ESB remains the owner of the distribution system assets, and its wholly owned subsidiary, ESB Networks DAC, is the licensee to undertake the functions of the distribution system operator.14 The unbundling arrangements are additionally defined through the European Commission’s certification decision in relation to the TSO which cover the network arrangements generally and therefore the DSO’s obligations regarding unbundling. Therefore, the CRU considers it important that progress continues to be made on the implementation of EU Commission Decision of 12th April 201315 and of the SEM Committee Preliminary Decision of 12th February 201316 during the PR5 period. In addition to the legal requirements set out above, the CRU considers that improving the independence of ESB Networks will be necessary to fully implement the new market innovations envisaged by the Clean Energy Package particularly those that require the DSO to act as a neutral market facilitator. This will be necessary to fully utilise the potential of a decentralised system of micro-generators, demand response, and smart services with active consumer participation. Further independence will also improve transparency, particularly in relation to the relationship between ESB group and ESB Networks. As part of the PR5 process the CRU has been concerned by the difficulty in gaining a concrete understanding of the actual financial position and cost of debt faced by ESB Networks as distinct from the position indicated by the notional metrics produced by the notional model. Therefore the CRU considers it important that the financing of networks investment is clearly separate to the financing of the commercial ESB businesses. 14 The DSO licence is available on the CRU website - https://www.cru.ie/document_group/esb- licences-dao-and-dso-licences/ 15 EU Commission Decision of 12th April 2013 – C(2013) 2169 16 SEM Committee Preliminary Decision of 12th February 2013 TSO Certification under Article 10 of Directive 2009/72/EC 14
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