Regulation needs innovation

Regulatory remits are not always aligned with supporting innovation, but this will have to change if utilities are to meet the far-reaching challenges of decarbonisation.

Regulation and innovation are not ­generally seen as natural bedfellows.

However, the far-reaching ­challenges that decarbonisation throws up for utilities, particularly those in the energy sector, means the sector’s watchdogs are having to venture into what may be uncomfortable territory.

Ofgem in particular has recently come under fire for being slow to respond and vetoing potentially risky projects – ­admittedly, often because its own statutory remit remains firmly wedded to keeping down prices for today’s consumer.

This issue was under the microscope last week in London at a conference on essential services regulation organised by ­Westminster Forum.

The National Infrastructure Commission’s recently published study on innovation and regulation pointed to how the issue is being pushed up the agenda of the industries’ watchdogs.

The problem for regulators is that they often don’t understand how to respond to innovation, said Harry Armstrong, head of technology futures at think-tank NESTA.

“Regulatory remits are not always aligned with supporting innovation. Innovation tends to come at the bottom and very few regulators have specific remit to support innovation,” he said, adding that there are often good reasons for regulators to shy away from innovation.

“Not all innovation is good,” Armstrong said, looking back to 2008 when innovation in financial services famously contributed to the crash.

Doing things differently

Chris Pickard, senior consultant at Economic Insight, agreed: “Because it is about doing things differently to how they are done now, innovation is by definition riskier than business as usual. A high-innovation world is also high risk: things might not work as well as hoped for and might fail.”

These issues are particularly acute surrounding the treatment of vulnerable customers, who tend to be less likely to access services digitally.

Rich Sullivan-Jones, a regulation expert at the National Audit Office, said: “What may work for the average consumer doesn’t always work well for vulnerable consumers who are typically less likely to engage. Market mechanisms that rely on engagement don’t necessarily work so well for them.”

Audrey Gallacher, director of policy at Energy UK, told delegates the energy trans­ition raises “huge distributional effects”, which mean better off and more tech-savvy consumers may benefit much more than their poorer and less engaged counterparts.

“We have constant debates about whether we want Granny to be paying for your Tesla; vulnerable consumers shouldn’t be writing the cheque for all of this.”

The growth of intermediary services is an example of the dilemmas the digitalisation of the sector is throwing up increasingly for regulators, said Pickard.

“It is unlikely that they will want to pay upfront to use automated or digital switching services, but may be more likely to use free services that are paid for by commission.”

Command and control

But Gallacher pointed to a flipside concern that the current “command and control” nature of regulation will nip innovation in the bud.

She said: “If we truly want to see innovation in the sector, I don’t think we will see it under the current regulatory regime, which is very much command and control.

“If we want to bring forward innovation, that brings with it significant risk of failure. As a society we have to be prepared to accept that for all the benefits it will bring, but I can’t see how that will happen.”

Chris Harris, head of retail regulation at RWE Npower, told delegates that regulators should adopt a much more permissive approach to innovation. The discourse on regulation must change, he said, arguing that the present system leads to a “red light” approach based on stopping things from happening.

“We need to take a green light and not a red light approach to how we are going to do this.”

The problem for regulators is that they are not best placed to manage the social trade-offs, noted Rob Salter-Church, director of energy and utilities at PwC. He said regulators often aren’t very clear about what they are trying to achieve, with their objectives tending to be quite high-level.

Salter-Church, who was until earlier this month a senior director in Ofgem’s retail team, said it will become increasingly important for regulators and the government to collaborate on working out these objectives.

Shift in approach

He said Ofgem’s recently issued public strategy document, which he described as chair Martin Cave’s “manifesto”, marks a “real shift” in approach by the regulator.

And there is a “greater willingness” from Ofgem to strike a balance between the interests of the consumers of today and tomorrow, Salter-Church said: “In this strategy, I can see a definite shift in mood music.”

“Over time, we will see the impact unfolding in Ofgem’s decisions,” he said, adding that a change in tone on decarbonisation can already be seen in the network price control review announced during the summer.

Regulators may not always be able to wait for a steer from policymakers, especially when they are distracted by more immediately pressing issues, said NESTA’s Armstrong: “Relying on government to make policy decisions is not always enough.”

He said one possible solution would be to adopt a new approach of “anticipatory regulation”, involving being “more future-facing, more proactive, more experimental”. But this could mean regulators making more “value-based decisions”, which could put them at greater risk of legal challenge.

Armstrong said that to secure more leeway, regulators could engage with the public more directly than they do currently.

Getting the public to engage with an issue as dry as utilities regulation may be tricky terrain for regulators, but one that they will have to become nimble at negotiating.