Ofgem considers rolling over gas price controls

The energy regulator has suggested introducing a two-year interim price control for gas distribution networks from 2026.

Ofgem cited existential uncertainties facing the gas sector, namely the scale of hydrogen conversion and the role of green gas in decarbonising heat, as potentially requiring a “simplified short-term” price control before choosing an appropriate form of long-term regulation. It said it could prove “sensible” to align gas distribution price controls with peers in electricity.

This is one of a number of options being considered by Ofgem as part of a consultation on the future of network regulation.

It follows on from an open letter by interim executive director of infrastructure and security of supply Akshay Kaul last September in which possible alternatives to the RIIO model were sketched out. Alongside an evolution of the existing process, the letter suggested four alternative models.

At the core of these alternatives is the challenge of how a regulator can solve the problem of information asymmetry – the assumption that companies are best placed to specify the needs for the price control period because they gather the necessary data through the normal course of business. Ofgem argues that whole system planning, the development of the future system operator (FSO) and increasing digitalisation of networks mean these traditional assumptions should be challenged.

Six months on, and having digested 42 responses, the regulator has dismissed one option – negotiated settlement – as a standalone model. It now says this approach would be better described as a governance and information-gathering feature which could be integrated into other regulatory models.

This leaves three prospective models:

• Plan and Deliver – Under this approach the need for investment and the most efficient delivery model would be identified by the system planner rather than the networks. Ofgem would then be responsible for ensuring delivery at lowest cost through encouraging good procurement processes, such as competitive tendering.
• Ex-ante Incentive Regulation – Essentially an incremental evolution of RIIO. Options under consideration within this model include simplified incentives for ongoing ‘business-as-usual’ costs or where digitalisation allows for more frequent and accurate monitoring of network performance. Ofgem is also seeking views on simplified assessments of costs for one-off investments.
• Freedom and Accountability – Rather than requiring detailed business plans and upfront targets for costs and efficiency, this model would focus on broader objectives (such as an affordable path to net zero milestones) with Ofgem determining the appropriate outputs which would be judged after the fact. Under this model customers would be protected against companies earning excessive returns by the anticipation of regulatory interventions – from bonuses to the threat of disallowance.

While Ofgem is seeking views on each of these regulatory archetypes, its consultation stresses that they could ultimately be merged as “building blocks” towards optimal approaches for different activities across each of the energy network sectors.

Pressing questions

The consultation calls the timetable for gas price controls “perhaps the most pressing regulatory question for the sector today”.

It adds: “There are two large-scale uncertainties hanging over the sector: what scale and type of hydrogen conversion should we plan for; and what heating decarbonisation solutions are envisaged on what timetable? These have such a fundamental impact on the future of gas networks that there is an argument for delaying a completely new price control until these uncertainties are resolved to a greater extent. This could suggest a role for a simplified short-term price control.”

While citing the potential to synchronise all four price controls, Ofgem says the importance of system planning capabilities for the new regulatory models and realistic assumptions about institutional capability have led it to view alignment along transmission and distribution lines as the optimal approach.

Introducing the consultation, Kaul said: “System planning should allow us to move away from the approach followed under the ‘Connect and Manage’ regime where market-led increments to transmission grid capacity perpetually lagged accelerating renewable generation. This approach has led to high constraint costs for consumers and lengthening delays in connecting new generation. We propose that the future of the grid should be based on a modern version of ‘Invest and Connect’, where programmatic grid expansion occurs in line with top-down system plans prepared by the FSO, in anticipation of generation and demand.

“These system plans will specify the network infrastructure needed to meet long-range net zero targets at the least overall cost to consumers, while meeting security of supply standards, and minimising grid congestion. They will identify the system-wide generation assets that are likely to be needed at the transmission and distribution levels; but also how best to anticipate new sources of demand at the distribution level (such as electric vehicle charging and heat pumps). The task of the regulatory regime will then be to get this infrastructure built as rapidly and efficiently as possible, so that when the wind farms or nuclear power stations or electric vehicles are ready to connect, the grid capacity is already in place.

“It is appropriate therefore to consider how such a foundational shift might impact various aspects of network regulation. This includes the way we set network price controls; the way we allocate system costs through network charges; the policies that govern how users connect to the grid; and the way system planning interacts with energy markets to produce the best outcomes for consumers.”

Responses to the consultation can be submitted until 19 May. Ofgem intends to decide on the overarching framework approach for transmission and gas distribution networks by the autumn. A decision on a framework for electricity distribution networks post ED2, which begins next month and runs until 2028, will not be made at the same time. However, the regulator it hoped to provide a “broad direction of travel” for DNOs at this point.