Energy network and system operators have invested considerable intellectual and financial capital to facilitate the transition to net-zero during the current price control period. Freeing up network capacity through reinforcement and innovative flexibility solutions as a response to the changing energy system, in combination with deploying smart technologies, has enabled the connection of more renewables and low carbon technologies (LCTs) than ever before. Comparable activity within gas networks has considerably advanced our understanding of practicalities of the future role of hydrogen.
Network companies have also projected the impact of low carbon policies on future network usage, and National Grid’s Future Energy Scenarios (FES) have become an established reference point for framing business plans. Distribution Network Operators (DNOs) have all created their own distribution-level FES (DFES).
However, at a time when we are increasing our reliance on electricity to drive decarbonisation, thinking beyond just facilitating the energy transition and policy effects is key. Understanding the direct and indirect impact of climate change on the physical infrastructure of the energy system is crucial.
Through the Adaption Reporting Power (ARP), individual network operators have begun to focus on the physical impacts of climate change on their assets. However, a holistic climate change strategy is necessary, and must consider the impact of more frequent and extreme weather events caused by climate change on the physical infrastructure and reliability of the energy system. Having clarity around this, supported by the ongoing areas of focus, will help companies adopt pre-emptive measures and strategies which could be more cost-effective in the long-run.
Background and context
Changes in weather patterns and sea level rise will have far reaching impacts. According to the Climate Change Committee’s (CCC) Climate Change Risk Assessment 2017 Evidence Report, around 2.6 million of the UK’s population will be at a significant risk of flooding by 2050 in a 2°C scenario, rising to 3.3 million in a 4°C scenario. This will not only have severe implications for people’s homes, but will also threaten the reliability of the UK’s energy infrastructure.
Ofgem has made it clear that it is expecting network companies to understand and act on their role in addressing the risks presented by climate change. In its Decarbonisation Programme Action Plan published earlier this year, Ofgem stated, ‘We would like to see the development of better and more systematic climate adaptation strategies and risk assessments from all network companies, and the development of widely-shared industry best practice.’
The message is clear – the time is now for networks to produce holistic business plans to tackle climate change, not just facilitate decarbonisation, but maintaining network resilience in the face of more extreme weather events that are no longer avoidable even if net-zero is ultimately to be achieved by 2050 (or 2045 in Scotland).
The challenge energy networks face
Climate change will have a significant impact on network operators over the coming decades. The UK is expected to experience increased frequency of heavy rain and floods, as well as storms, and rises in average temperate. Individually and collectively these changes increase the risk of cable, pipe, pylon and transformer damage. Coastal erosion, landslides and storm surges will fundamentally change the normal operating conditions of network assets and risk damage to substation and gas governor locations.
Planning for high-impact events, whose probability is currently low but increasing at an uncertain rate, is difficult within the 5-year regulatory cycle. Questions on charges to current customers for investments that predominantly benefit future customers, and the justification for potentially expensive adaptation responses with long amortisation periods are challenging under the current regulatory regimes.
However, failure to act early enough could lead to higher occurrences of outages and, as the cost of remedial action starts to exceed the adaptation costs, prove costlier in the long run. Furthermore, investments in replacement or upgrades to existing assets may prove to have been the wrong call if, for example, a whole substation needs to be moved ten years later due to increasing flood threats.
The simple answer is that network operators should be factoring in physical risk associated with climate change in their business planning, and they should be incentivised to make timely investments in adaptation measures that will benefit customers in the long run.
To do this, network operators will need to model, supported by science-based targets, the potential future impact of a range of climate scenarios across their asset portfolio. This information needs to be used as an input to developing common and bespoke outputs for the purpose of understanding the climate change impact on their customers and bottom line. To date, network companies have developed their own individual scenarios of future demand and generation growth. As part of RIIO2 there is discussion in the industry whether a common scenario should be adopted by all companies for baseline business planning. Likewise, there is an argument that all network companies should be basing their physical resilience plans on a common climate scenario.
Another consideration is, of course, that electricity networks are not unique in facing the challenges of climate change. Gas, water, waste, telecoms and transport are also at risk, and not least because of the interdependencies between them. Whole systems thinking is a key theme in RIIO2 and Ofgem has proposed mechanisms to incentivise companies to work across the energy vectors to identify the lowest cost solutions for customers overall. Thus far, that thinking has not extended to climate adaptation measures, but it merits consideration as part of net-zero plans. For example, the same flood defence scheme could benefit an electricity transformer, gas compressor and waste water treatment plant.
There is also a system operation aspect to consider, as the power outages across the UK on 9th August 2019 demonstrated. With the emergence of the Distribution System Operator (DSO), and the rapidly changing generation-mix, operating increasingly complex networks is a challenge that is exacerbated by extreme weather. The industry has invested considerable time in thinking through potential future models for system operation, and work is ongoing within the government and Ofgem. Any future model should be stress-tested for climate change impacts on the path to net-zero system operation.
For the financial sector investing in and lending to the energy industry, understanding the impact climate risk has on financial performance is becoming increasingly important. Banks, for example, are now required to publish the future impact of transition and physical risk on their lending and investment portfolios through the Task-force on Climate-related Financial Disclosures (TCFD) obligations. Consequently, investors and lenders to network businesses will increasingly be looking for clarity on planning for adaptation by directing investment to sustainable and resilient solutions, opportunities, and business models. Network businesses with strong disclosure and climate risk adaptation strategies will likely be able to attract lower cost of finance.
What does this mean for network businesses?
Facilitating a transition to net-zero is already central to network businesses’ thinking. Now is the time to take a holistic and longer term view on the impact of climate change on their customers and business performance, and start placing more emphasis in their business plans on adaptation and concrete responses to physical risk. This is particularly relevant given Ofgem’s expectation for networks to take a lead on managing physical risk associated with climate change.
This will require developing and integrating comprehensive climate change scenarios, using asset and geospatial modelling to assess risks in each scenario, and developing adaptation strategies. A common climate change scenario to plan across the industry would be helpful.
For UK DNOs working on their RIIO-ED2 business plan submissions, a well-evidenced and customer-supported section on plans on how to maintain physical resilience in the face of climate change is likely to be well received by the regulator. As a key facet of developing business plans, expectations will be centred around continued engagement with customers and understanding their expectations and opinions on improving network resilience.
Finally, further thought should be given to the level of disclosure to the investment community on earnings resilience to climate threats. This could become increasingly important in attracting lower cost investment and financing.
How Baringa can help
Baringa, in partnership with XDI, has developed an award winning Climate Change Scenario Model that is currently being used:
To help organisations create high quality disclosures (TCFD) on their impact on the climate and future commitments
To shape and deliver our clients’ strategy to address climate change, and determine what the realisable business opportunities and likely threats from climate change are.
We are currently extending the functionality of our model to undertake more granular analysis of the physical risks of climate change on network utilities, and to produce outputs required for business plans, regulatory reporting and investment needs cases.
Baringa’s Climate Change Scenario Model
Baringa’s Climate Change Scenario Model is the only one that enables you to:
Measure and report physical and transition risk, as well as temperature alignment in one integrated model
Zoom from regional to individual asset level, as well as assess the cross dependencies of critical infrastructure that service an asset
Understand the physical impacts of climate change under different scenarios. Our model uses 500,000+ data points to model the energy transition and covers over 70 million physical assets mapped to 4 million companies globally
Identify the impact of projected climate hazards on physical assets, including:
Physical damage costs
Asset risk to different weather events such as fire, wind, flood and sea level rises
Temporal evolution of climate risk
Understand the climate impact across a region or asset in order to meet regulatory requirements such as TCFD, manage climate risk and use the data to originate new investment strategies and products.
Baringa is uniquely placed to support clients on climate strategy based on 20 years of experience advising governments, the energy industry, and financial services. Our Climate Change Scenario Model was awarded the global Energy Risk Climate Risk Innovation Award in 2020.