Scotland special part 3: Untangling energy will be no easy task

Independence for Scotland would pose a conundrum for energy regulation. It would erect barriers across a power transmission network where barriers had been deliberately removed under the British Electricity Trading and Transmission Arrangements. It would split a single regulator in two when the European Commission has laboured to bring regulators in member states closer together. And it would add to regulatory complexity when Ofgem is trying to simplify the whole show. But how insurmountable would these problems be?

A recent report by the Expert Commission on Energy Regulation set up by Scotland identified the biggest issues that policymakers on either side of the border would face, and came up with proposals on how to address them.

The chief changes resulting from Scottish independence would be:

•    under European law, Scotland would need an independent national regulatory authority (NRA);

•    the NRA would be a multi-utility regulator in line with current Scottish government plans;

•    a Scottish system operator would be established;

•    there would be a single, GB electricity and gas market with unified networks for both.

Scottish independence, as drafted, would leave each regulator taking its policy steer from its government while trying to maintain the coherent operation of a single market. Even if both governments wanted to leave a single pan-Britain energy system intact, there would be profound difficulties.

No-one is arguing for wholesale gas and electricity markets to be split, and the expert commission agrees that any physical separation would incur “significant cost, but deliver no material benefit”.

Nevertheless, it says there is every likelihood that political ambition will lead to government interventions from one country that will not be welcomed by the other. For example, political clashes would be inevitable over the continuing socialisation of Scottish transmission and distribution network costs across all Britain’s consumers. Similarly, hostilities must arise over renewables subsidies.

The report says policy differences could be resolved by “effective consultation and joint agreement to minimise market distortions and other unintended consequences”, but it concedes that the continuation of a single British market might prove a tough proposition. “An independent Scotland and the rest of GB would have different policy objectives, making it difficult to agree a common approach, which would be required to maintain a fully integrated system,” it says.

The bottom line is that if a common vision could be agreed at ministerial level, and clear lines of communication established, anything is possible. But given the political antagonism between Westminster and the SNP, this can by no means be guaranteed.

Examples abound of separate regulatory regimes co-operating in single markets (such as the Irish, Nordic and Iberian markets), but these conglomerations of previously separated markets arose where the two sides recognised the advantages of union. Leading Scottish energy lawyer and chairman of the expert commission, Robert Armour, says the situation for Scotland and the rest of the UK would be different. Spitting up a previously single market breaks new ground.

However, he also says that “once you get past the heat and the furore from the [Scottish independence] referendum and into the settlement, I suspect it will be in the common interest to try to find something that works”.

Less optimistically, Scottish independence would find disparate political parties and special interest groups working to their own agendas. The default position would be a continual effort to rescue the situation.

Not only would a divided UK be seeking to pluck its energy sector from the flames sparked by the division, it would be doing so at the worst possible time. As well as fundamental market reform, the sector is going though a competition authority referral, undertaking a smart meter rollout, facing a looming generation capacity crisis and working out what to do with shale gas. An independent Scottish market would add another layer of complexity. That would be complicated further by the Scottish government’s pledge to create a multifunction regulator with jurisdiction over water and energy.

To add yet more convolution, the Scottish government envisages stage-by-stage fusion of other regulatory functions, such as telecoms, to form first a combined utility regulator, and finally a combined economic regulator presiding over rail and airports.

The expert commission says a multi-utility regulator has been adopted by many smaller nations and it “makes sense in Scotland”, but it is less enamoured of making it a one-stop regulatory shop. It warns about the “competing demands on the expertise and capacity of the regulator, especially at a time of energy system investment and change”. Armour elaborates, saying a Scottish NRA would need “a degree of expertise, which it can’t achieve if everyone is a generalist”.

How will investors in the two Scottish energy companies operating either side of the border view the risks of double exposure to regulatory and political interventions? Would there be a new independent Scottish system operator or would National Grid be hired as a service provider? Were there to be a Scottish system operator, would the network companies in Scotland want to take on the role? If so, as vertically integrated companies, would they be able to?

As the energy policies of an independent Scotland and Westminster diverge, there would be huge potential for frustration, cost and conflict. All the problems would be solvable, of course, and it would be in everyone’s interests to do so; the great unknown is whether there is the political will.TL

Scotland special part 1: Last days of the union?

Scotland special part 2: Ed Davey and Fergus Ewing

Scotland special part 4: Turbulent times lie ahead for retail sector

Scotland special part 5: Pioneering example

Scotland special part 6: What it could mean for utilities