Duty bound: What Ofgem’s SPS should say

Ofgem has made clear that decarbonisation is at the heart of its strategy but without updated guidance from government, how can it tackle the trade-offs net zero will inevitably present? Utility Week asked experts in energy regulation what they want to see in the promised strategic policy statement (SPS) from government, as well as where unintended consequences could lie and if there is a better way to provide clear direction on Ofgem’s role in a future energy system.

Seeking a clear definition of Ofgem’s role is no easy task. Even Ofgem doesn’t seem entirely sure.

Under the ‘Who we are’ section of its website, the regulator describes its role as to “protect energy consumers, especially vulnerable people, by ensuring they are treated fairly and benefit from a cleaner, greener environment”.

In the footer of the same page the wording is to “protect consumers now and in the future by working to deliver a greener, fairer energy system”.

Introducing the regulator’s latest annual report, chief executive Jonathan Brearley described Ofgem’s principal objective simply as “to protect the interests of consumers today and in the future” but two pages on the document outlines its role as “delivering a smarter, greener energy system in the interests of energy consumers and the climate”.

To go by the exact definition of Ofgem’s statutory duties, its principal objective is to “protect the interests of existing and future” gas and electricity consumers. It adds that: “The interests of such consumers are their interests taken as a whole, including their interests in the reduction of greenhouse gases (and) in the security of the supply of gas and electricity”.

This may be semantics but the different emphases do highlight the competing priorities within Ofgem’s core responsibilities. As the net-zero journey progresses, these trade-offs – between future and current consumers, resilience and affordability, a greener and fairer energy system – will become increasingly important.

Since 2014 there has been talk of government providing Ofgem with a strategic policy statement (SPS), to set out the regulator’s role within the government’s vision for a future energy system. In its energy white paper last year, the Department for Business, Energy & Industrial Strategy (BEIS) promised to consult on an SPS this year.

But, what should it include and where is there potential for unintended consequences? Utility Week spoke to former regulators and energy experts to get their views.

Foundation stone

Rachel Fletcher has first-hand experience of the impact of an SPS, having joined Ofwat as chief executive in 2017 just as the original 2013 publication was being updated.

She describes the government steers (there were sperate publications from the UK and Welsh governments) as “incredibly helpful and allowed us to set out an ambitious vision for the water sector and a new strategy for ourselves as regulator”.

The SPS provided “an excellent foundation stone” for its 2019 strategy “Time to Act, Together, Fletcher tells Utility Week, emboldening the regulator to put social and environmental outcomes at its heart rather than being constrained to focus on price and customer service.

Fletcher points out the revision to the SPS emerged shortly before the water sector became a political football thanks to Jeremy Corbyn’s nationalisation agenda.

She adds: “The reshaping of the industry to focus on its social and environmental purpose has helped the industry weather that storm and looks set to become an enduring feature of the water industry.”

Fletcher, who has now returned to the energy sector as director of regulation and economics at Octopus, believes one of the reasons an SPS for energy has not appeared so far is that a “calm moment to be reflective and strategic” has never occurred.

However, she hopes that BEIS is able to “lift themselves out of today’s noise and the clamour from the various lobby groups to give the clarity and the strategic direction that will help Ofgem as it plays its part in achieving net zero in a speedy, affordable and fair manner”.

Specifically, Fletcher expects an SPS for energy to have zero carbon at its centre but to make clear there are multiple objectives for the sector, including security of supply, customer affordability and fairness.

“I’d expect the SPS to leave it largely – though not entirely – to Ofgem to figure out how to optimise across those objectives.”

Fletcher points out that the affordability and fairness agenda will be one of the most interesting areas to watch, namely “what is left to Ofgem’s judgement and what does government want to be in control of and take responsibility for”.

Back-up required

In 2019, the National Infrastructure Commission (NIC) produced a report which called for government to update regulator duties to support investment in resilience and net zero.

The group’s director of policy Giles Stevens stresses that the regulatory model has done the job it was designed to do but must now adapt to serve a changing world.

Having previously worked at both Ofwat and Ofgem, Stevens understands the risk of adding more complexity but worries regulators “don’t necessarily have the direction or the back-up” to play a leading role in decarbonisation.

He tells Utility Week: “Ofgem clearly knows it has a part to play in net zero and made that clear to industry and to consumers. The SPS can be a useful vehicle to support Ofgem’s tilt towards that and specifically in terms of greater investment towards net zero.

“There’s always this balance of how much risk you expose customers to and having this SPS can give that tilt, where it is appropriate, a bit more backing. It has to be clear that this is an appropriate stance for the regulator to take.”

Former Ofgem chief executive Dermot Nolan agrees with the need for clarity on certain trade-offs but does not see an SPS as automatically the best route to take.

“I would prefer an amendment of the statutory duties. It is legally clearer, less meddling and is something where Parliament has given the steer rather than a particular ministerial department. I’m not sure it needs that amendment of statutory duties and I don’t know if it would want it but I would prefer that.”

Expanding on his objection to an SPS, Nolan cites the potential for political interference and for it to be “used as an offensive weapon by the companies at a CMA appeal”.

He adds: “The clarity of an objective duty over 30 years gives a clear view and allows the regulator to have discretion within that time period to still make decisions and trade-offs that are consistent with that. An SPS that could be changed more regularly and might be changed for potentially rather political reasons seems less pure for achieving a 30-year plan.”

Nolan, who is now a consultant for Fingleton, also airs his concern that both mechanisms “cut the regulatory discretion”.

A clearer picture

For another former Ofgem executive, Maxine Frerk, there is value in the ability to update the priorities on a five-yearly basis, saying this allows the regulator to remain agile and to adapt to changing trends.

An SPS also has the benefit of taking up less Parliamentary time than a full revision of duties, she adds.

Dr Jeff Hardy, senior research fellow at the Grantham Institute – climate change and the environment at Imperial College London, agrees that there is no time to waste but has two key requirements for government direction:

“I could see value in an SPS if it causes government to work out what its net-zero strategy is and therefore the role of the regulator in delivering that. And, if it helps Ofgem untangle the myriad of duties it has on it, which often makes it difficult to make very clear decisions or very complex decisions.

“If an SPS could sort out the most important things Ofgem should be taking into account when making decisions and having less emphasis on the other myriad responsibilities and a clear articulated strategy from government, then it’s useful.

“If not, then just change Ofgem’s duties so they’re really clear.”

For the NIC, there is benefit in aligning duties across sectors, or at least ensuring that strategies are complementary.

Stevens says: “We did not go down the route of suggesting merging regulators because the evidence wasn’t there. However, we believe there should be a duty to collaborate. The regulators should all be going in the same direction and there should be an all-customer view.”

Hardy agrees that collaboration between regulators should be encouraged and suggests it could go even further into a cross-sector net-zero SPS.

Another area of focus for the NIC, and one of the words that creeps in and out of descriptions of Ofgem’s duties is “fairness”. The 2019 report suggested that where there were future regulatory proposals with “significant distributional consequences”, regulators should have to produce an analysis on the possible consequences for customers and be able to seek explicit guidance from ministers on distributional choices.

It is an area of concern for Frerk, who says the inter-generational impact of paying for net zero is “a forgotten subject” because “everyone’s time horizons are too short”.

‘Least cost’ can be problematic

Putting aside the vehicle for the message and returning to the devil within the detail, how should Ofgem’s primary duties to be worded?

Nolan says he has previously used a variation of “achieving net zero at lowest cost” put appreciates that this could be problematic further down the line, with the interpretation open to legal challenge.

Hardy points out that “lowest or least cost” also risks “taking a load of options off the table”. He points out, for example, that community energy is unlikely to be considered the lowest-cost option but is a clear preference for some consumer segments.

He would prefer a definition of “reasonable or acceptable” cost because it “allows people in different places to pursue energy that suits their needs, preferences and values”.

Despite the lack of a formal updating of its obligations, Ofgem already has government steers to work with. The prime minister’s 10-point plan set the framework for his vision of a future energy system. Meanwhile, last year, Kwasi Kwarteng, now the BEIS secretary but at the time energy minister, wrote to Jonathan Brearley to outline government policy for reference ahead of the draft methodology for RIIO-ED2.

The five-page letter was inevitably high level but the following sentence is likely to have been heavily highlighted: “Appropriate investment in physical infrastructure by distribution companies, including ensuring efficient and timely connection, will be important for the deployment of these technologies, and Ofgem’s price controls will be fundamental to this, with RIIOED2 setting the methodology under which distribution networks will invest ahead of need.”

This letter was broadly welcomed by everyone interviewed for this piece, with Frerk saying it provided clarity “without telling Ofgem what to do”.

“The imperative was to ensure that you were not closing off pathways to net zero through infrastructure investment.”

Nolan too prefers the tone of the Kwarteng letter to Defra’s latest draft for Ofwat’s SPS, calling the latter “far too specific”.

While it may have been helpful, the Kwarteng letter of course has no legal basis, hence the need for an SPS or change to the duties.

Frerk warns that while the SPS will have weight it is “unlikely to contain any surprises” and will probably align with the spirit of the Kwarteng letter.

She adds: “Government has always been wary of telling Ofgem to make trade-offs but that’s exactly what would be most helpful.”

However, there is a precedent for government giving a very clear steer on where priorities should lie if a conflict emerges.

In the 2019 SPS to telecomms regulator, Ofcom, the Department for Digital, Culture, Media & Sport wrote: “The government’s view is that promoting investment should be prioritised over interventions to further reduce retail prices in the near term.”

Of course, clear guidance on Ofgem’s role in net zero requires the government first to flesh out its thinking in multiple areas. Nolan notes that the delay in publication of the Treasury’s Net Zero Review is now “embarrassingly long” and Hardy points to the still-delayed Heat & Buildings Strategy as an important part of the puzzle.

While there is no shortage of suggestions as to what should be in an SPS, Utility Week also asked what would worry our experts.

Hardy cites “anything that picked winners or that set you on a pathway that you might later regret”, while Nolan says he would be perturbed by anything that “said you should focus on particular regions, industrial development or employment”.

Meanwhile, Frerk’s comments summarise a collective concern that “the real risk is these things can turn into a very extensive shopping list from government”.