SSE: Case study CAPEX reduction & new operating model implementation

SSE preparing for the TOTEX regulation from Ofgem

SSE plc (formerly Scottish and Southern Energy plc) is a FTSE 100 company based in Perth, Scotland. It took shape out of the privatization and merger of Scottish Hydro-Electric and Southern Electric. Today, SSE is the UK’s second largest supplier of electricity and natural gas, the largest generator of renewable energy, and the only UK energy company involved in electricity transmission and distribution and gas distribution.

The UK has an 813,000 km transmission and distribution network, longer than the distance to the moon and back. Scottish and Southern Energy Power Distribution (SSEPD), a division of SSE, is responsible for maintenance, service quality, and regulatory compliance for a 182,895 km distribution network which feeds power from local substations directly into the homes and businesses of 3.7 million residential and commercial customers in the UK.

SSEPD is one of six electricity Distribution Network Operators (DNOs), which service communities in England, Scotland & Wales. The UK Office of Gas and Electricity Markets (Ofgem) regulates them. SSEPD assets regulated by Ofgem include one electricity transmission network (high voltage) and two lower voltage distribution networks comprising 130,000 km of overhead lines and underground cables and 106,000 substations.

The TOTEX regulation project

In August 2013, members of SSEPD’s senior management team expressed concerns that the division was being overtaken by other DNOs in the face of significant changes affecting the industry and how the regulator judged companies. The most obvious concern was the pace of change to prepare for RIIO-ED1, the eight-year Ofgem price control model, which came into effect 1 April 2015 and ends in 2023.

The RIIO-ED1 Network Regulation Model, (Revenues = Incentives + Innovations + Outputs) is the most radical change in UK electricity distribution regulatory policy since privatisation and Ofgem’s most market-driven, customer-focused model. While Ofgem financial incentives are nothing new, RIIO-ED1 pushes DNOs much harder to deliver on all the outcomes customers care about-keeping the lights on, keeping bills low and making sure people are safe-with tougher penalties if DNOs don’t. For instance, RIIO penalties for planned and unplanned interruptions are more than double what they were during the last regulatory period. Previously, customers received reductions in their bills if the electricity was off 18 hours or more. Now the threshold is 12 hours. Savings from better management of unplanned service interruptions and planned shutdowns are now split between consumers and their DNO. For example, a £100k of operational savings would be split with £60k for SSEPD and £40k savings for its customers.

Ofgem’s TOTEX (total expenditure) accounting requirement is another game changer for the DNOs. TOTEX accounting, which eliminates the distinction between capital expenditures (CAPEX) and operational expenditures (OPEX), is designed specifically for capital-intensive, regulated industries. Ofgem regulators believe the TOTEX approach for utilities will result in more efficient use of capital to maintain the quality of the electricity network and reduce bills for customers. For SSEPD and other DNOs, TOTEX accounting has implications for long-term infrastructure investment planning, budgeting and routine spending decisions and for increasing shareholder value.

The RIIO-ED1 message from Ofgem to DNOs is clear: if your company puts the customer at the heart of operational decisions, it can perform better financially and deliver better service. Conforming to that message is hard. It is professionally and emotionally difficult for any business to change its definitions of success and drive that shift through an entire workforce. It is especially challenging for the UK utility industry. Even post-privatisation, the vestiges of its regulated monopoly roots remain.

In October 2013, SSEPD asked VISION to help the division get ready for RIIO, and to use this transition to make a larger change in its operations and culture. The goals of the project were to design a TOTEX-based capital management model and implement processes to alter how SSEPD manages network maintenance. To do this, VISION partnered with SSEPD to drive broader organisational and behavioural changes, and build new competencies. With VISION’s arrival, senior management made a commitment to drive out elements of the firm’s legacy culture that were unfit for purpose and to ensure it remains the leader in the UK’s electricity sector and the energy industry as a whole.

Results for SSE

The impact of the first year of VISION’s work reveals itself in financial returns, culture change, and industry leadership:

• Financial returns: The VISION and SSEPD project’s incentive value, created over the regulated period, will be in excess of £100 million. Prior to VISION’s arrival, SSEPD was projecting a loss of £1.2 million a month as measured against Customer Interruptions or Customer Minutes Lost. TOTEX savings on each circuit is averaging 15%. Circuit work completed so far has generated about £2 million in savings with £7 million more projected for the next 12 months.
• Organisational and cultural change: The TOTEX-based Value Model has become the common frame of reference for investing, maintenance and compliance budgets. SSEPD managers use the Value Model to explain to the regulators work priorities and delivery plans. Before there were CICs, when a field unit manager started a project, he would simply say, ‘I’m starting now. I will tell you how much it costs when I’m finished.’ CICs create a promise based on six key variables: manpower, cost, resilience, compliance, health and safety and date of completion. Field unit managers now make promises on each. The growing use of CICs has instilled a new ‘culture of completion’ for network maintenance that encourages looking at the big picture and confidence in achieving big goals. Managers take a broad view and develop in their CICs plans to mitigate all the situational challenges. That planning discipline gives the managers the confidence they can deliver what they promise.
• Industry leadership. The VISION project is one of the first in the electricity industry to create a TOTEX-based investment management model. The approach is already showing results that give SSEPD leaders and teams a high degree of confidence they can achieve RIIO’s new and challenging goals and sustain the firm’s future leadership in the industry.

Read the full case study here.