Network competition – the answer to yesterday’s question?

The Energy Security Bill announced in the Queens Speech included a number of crucial new powers including regulation of heat networks, and support for hydrogen and CCUS. However, out of the long list of things the Bill will include, one stands out for me as being of questionable value and that is the introduction of competition in onshore networks.

The idea of competition in networks is one that Ofgem has championed for over a decade. Indeed back in 2016, when I was at Ofgem, I remember giving evidence to a pre-legislative scrutiny committee looking at a draft Energy Bill that included provisions to introduce such competition.

But the world has moved on a long way since 2016 and with net zero and energy security now top priorities is this still really the right path to go down? …If indeed it ever was.

Back at the start of this year energy secretary Kwasi Kwarteng in an open letter to the sector regulators reiterated the importance of the role of competition in infrastructure delivery across energy, telecoms and water. This reflected the government’s free market ideology with the letter stating that “for the design and delivery of infrastructure, we continue to see competition as the most reliable means of promoting growth, efficiency, and innovation in the regulated sectors”. It also cited a 2016 CEPA report on the benefits of tendering in the offshore transmission sector.

However, in the most recent Energy Security Strategy, government talked about the importance of having the network infrastructure to deliver on the huge increase in renewable generation that is now being promised. It set an explicit goal of halving the time it takes to approve new network infrastructure including by streamlining the regulatory decision-making process. Introducing an additional competitive tendering step in the process is not the way to achieve that and the strategy said that certain infrastructure covered by the ESO’s new central plans would be exempt from the introduction of network competition.

It’s not clear what that means or what is left, but there would seem to be real tensions between the government’s broader market philosophy and its ambitions for more home-grown green energy fast.

Moreover – even absent those tensions – I am sceptical about the benefits of network competition.

Calculating risk

The enthusiasm for network competition over the past decade has been driven by reports such as the CEPA one (commissioned by Ofgem) highlighting the cost savings achieved. However, the CEPA report and an earlier NAO report both acknowledge the lower risk that the companies are taking on, with, for example, a 20-year framework and guaranteed return. Under the OFTO regime the assets are only tendered once they are built so there is no construction risk and Ofgem’s regime of “income adjusting events” was expected to protect OFTOs against any “exceptional events” resulting from construction faults that were outside their reasonable control.

However, since 2016 the operation of these networks has not been plain sailing. The Gwynt y Mor cable in particular suffered a number of faults. Ofgem looked like it might be taking a tougher line on income adjusting events but then Gwynt y Mor was downgraded by Moody’s last year and Ofgem found itself under pressure to accept another application for a prolonged outage caused by failed fibre optics. There have also been legal battles aimed at establishing where liability sits as between the developer and the OFTO where Ofgem has not supported a claim and insurers are seemingly stepping back from the sector. There clearly is a need for an updated review of the OFTO regime and in particular the risks that consumers are being asked to carry, if that is the example being relied on to support competition onshore.

Once account is taken of the allocation of risks, and Ofgem’s recent tougher stance on the cost of capital under RIIO, it is not clear how far competition is really delivering a lower cost of capital.

And in terms of the wider benefits of competition in driving down costs and finding new solutions it must be remembered that the network companies already take advantage of this. Although they are monopoly providers they make use of contractors, appointed through competitive tender, to deliver a large majority of the work and the efficiency incentives in the price control drive them to do so.

The benefit of this in-house competition model over what is proposed is that the networks still retain responsibility for, and the licence obligations around, the quality of service that is delivered, helping mitigate the unintended consequences of competition that can be hard to manage otherwise. If contractors cut corners under today’s model the networks are on the hook and Ofgem can and does take enforcement action. In the world of tenders managed by the FSO who would carry that risk?

Unintended risks of competition

Following the debacle that we have seen over the past year in the retail market, policy makers should be in no doubt that there can be unintended consequences of competition that need to be thought about. The recent Oxera report on lessons learned concluded that defining the risks was key, that the success criteria should be set in terms of outcomes that should be monitored and that qualitative and quantitative evidence is needed to make the trade-off between competition and resilience. All lessons that could and should be applied in thinking about the extension of network competition. However, worryingly, the Oxera report also noted concerns that Ofgem was “galvanised into action to fix yesterday’s problems rather than seeking to understand tomorrow’s.” Has anyone actually done the exercise of thinking through what the unintended consequences of network competition might be? It seems unlikely.

Indeed, I have been arguing for some time that before pushing for more network competition Ofgem should at least carry out a proper review of the benefits (or not) of the competition regime that already exists onshore – the “independent network operators”. Where new housing developments are built there is competition for the provision of these new connections. A report by Citizens Advice in 2019 flagged that close to 3 million customers were on these independent networks (2 million on gas and 600k on electricity). Developers like the independent networks because they typically offer cheaper connections and provide a pan utility service. But the Citizens Advice report raised serious questions about whether customers actually saw any benefit. They pay a similar price for ongoing charges (because of Ofgem’s relative price control regime) but have fewer obligations to support vulnerable customers or to deliver environmental benefits and Ofgem does not monitor their customer service so it is not possible to compare.

As a personal anecdote, I recently experienced a major blackout at home and when I entered my postcode into the UKPN website it said I was with ESP Electricity (an IDNO). Needless to say, there was nothing on their website about the outage. It didn’t matter in this case as the problem was widespread enough for me to be able to rely on the UKPN information but I have no confidence that a more local problem would be swiftly dealt with. They have no incentive to do so.

Don’t get me wrong. Competition has its place. We need it to deliver innovative new flexibility services and to support the wider delivery of our net zero ambitions. But I remain unpersuaded that it is the right way forward for networks.

Having been mentioned in the Queens Speech and with draft legislation ready to go I think it’s unlikely the idea will be dropped. However, I hope that during the passage of the Bill Parliament will have a chance to debate whether this really is the right approach for today’s world. It may be a useful additional tool for Ofgem to have in its toolkit but it should only be used if is clear that it will not create delays in building the infrastructure we need, that consumers will actually benefit and that any unintended consequences have been fully thought through.  That case has not yet been made.

Maxine spent 15 years at Ofgem, latterly taking on responsibility for all aspects of the regulation of distribution networks. Since leaving Ofgem she has been working as an independent consultant for a mix of regulated company and consumer / community group clients.