In 2022, Ofgem will undertake a review of Distribution System Operator (DSO) governance arrangements, building on the prior experience of the separation of the Electricity System Operator (ESO) and Transmission Owner (TO) roles in transmission.

In this context, NERA Managing Director Richard Druce, Associate Director James Grayburn, and Senior Consultant Leen Dickx, supported by Economic Analyst Kardin Sømme and Research Officers Siying Wu, Riccardo Paccioretti, and Christopher Jackson, identify and assess alternative DSO governance models, perform a top-down assessment of the costs and benefits associated with alternative models, and evaluate their impact on economic welfare. The NERA team was retained by Scottish and Southern Electricity Networks (SSEN) to prepare a report in light of the forthcoming Ofgem review.

To the extent there are benefits associated with DSO separation, they arise from avoiding perceived conflicts of interest the integrated DSO-Distribution Network Operator (DNO) may have to favour network solutions over alternatives provided by Distributed Energy Resources (DERs). However, these benefits would likely be small, mainly because regulatory mechanisms in Great Britain already exist to mitigate any such conflicts of interest. Hence, the NERA team finds that any form of separation beyond ring-fencing will likely lead to negative net welfare effects, because the costs from legal separation or ownership unbundling would be significant.

Overall, while the NERA team finds that the most cost-beneficial solution is DNO and DSO integration (i.e., maintaining the status quo), our report recommends pursuing ring-fencing over the coming electricity distribution price control period. Ring-fencing would help avoid the perception of conflicts of interest, giving DER providers greater confidence in flexibility markets. It would also allow time for DNOs to develop their DSO capabilities in the coming years, without the loss of management time that would be caused by more severe business separation. Finally, as the NERA team explains, it would also leave open the option for Ofgem and government to pursue other separation options in the future, if evidence emerges that conflicts of interest exist, and the benefits of separation are material.

After this March 2022 report was completed, Ofgem published a Call for Input on the future of local energy institutions and governance on 26 April 2022. Ofgem requested input regarding alternative future governance arrangements for local energy markets to support delivery of net-zero at least cost. To respond to Ofgem’s Call for Input, SSEN asked NERA to assess alternatives to the DSO governance models proposed in Ofgem’s Call for Input, in light of the findings from the earlier report. Our second report is available on this page.