Utility Week editors look at work the separation of Scotland from the rest of the UK might mean for networks, markets and the utility world in general.

Mum’s the word on transmission and distribution

The SNP wants to retain a single wholesale energy network, but working out who pays for what will be complex.

Religion and politics: there are some things you just shouldn’t talk about. What would happen to the transmission and distribution networks in Scotland in the event of a “yes” vote is apparently another. System operator National Grid and the distribution network operators, Iberdrola-owned Scottish Power and SSE, all maintain a stony silence when quizzed on the subject. It’s sensitive: any comments on life after independence could be construed as support for the yes campaign, and these crucial infrastructure providers are studiedly neutral.

The Scottish government is not so reticent, however. Last month, it published a paper on energy by its Expert Commission on Energy Regulation, Energy Regulation in an Independent Scotland. This is the only available blueprint for the messy work of untangling Great Britain’s transmission and distribution networks. It sets out the immediate steps that would need to be taken (a system operator appointed, operating agreements established) and highlights the many questions that need to be answered. Among these are the role of National Grid, the reallocation of Scotland’s higher transmission and distribution costs, which are currently socialised across Great Britain, and the steps that needed to manage such a huge programme of change.

Today, there are three key players in Scottish transmission and distribution. National Grid is the system operator, although it does not own the physical networks as it does in the rest of Great Britain. These are owned by SP Transmission Limited, part of Scottish Power, and Scottish Hydro Electricity Transmission Limited, part of SSE. Scottish Power and SSE also own and operate the distribution networks, through their subsidiaries SP Energy Networks and SSE Power Distribution (see map).

On 18 September, that could all change. The expert commission’s report sets out the first steps the Scottish government would take. Number one: establish a national regulatory authority, which would appoint a system operator. This could be National Grid, one of the networks or a newly created body.

The system operator, whoever it might be, would quickly have to establish agreements with National Grid, in its role as system operator for the rest of Great Britain, around “critical interdependencies for supply, demand and grid services”.

Step two would be some tough decisions on transmission and distribution costs. Because Scotland has more rural areas than the rest of Great Britain, its network costs are significantly higher. When transmission upgrades planned for this year have been completed, Scotland will account for 12 per cent of Great Britain’s transmission capacity, but 21 per cent of its cost. These costs are currently spread across the union and are under review by Ofgem’s Project Transmit.

Scotland’s distribution costs are also subsidised, through schemes such as the Hydro Benefit Replacement Scheme and Common Tariff Obligation. If these subsidies were removed, Scottish customers’ annual energy bills would rise by about £38 per household.

The Scottish government acknowledges the scale of the task, but says “both positions can be expected to adjust in the negotiation that would follow a vote for independence”. If the Scots vote “yes” on 18 September, what was once a matter for silence will become the subject of a whole lot of talking.

Market split could cost Scottish consumers more

Creating a separate wholesale electricity market for Scotland would be so fraught with regulatory, technical and economic complexity that it’s small wonder Scotland has called for a single energy market (SEM) regardless of the referendum result.

Although this SEM model may have worked in Ireland to unite electricity markets on either side of the border, Westminster has warned that the subsidy and supply arrangements between Scotland and rUK mean that things would have to change in the event of independence.

Ed Davey has repeatedly warned that Scotland might not only lose funding for its renewables output, but could also lose revenue from exports should the UK find cheaper alternatives from continental Europe.

In the event of a break-up, rUK would import electricity based on the prevailing market price, as is currently the case with French and Dutch imports, a UK power trader told Utility Week.

“Currently £115/MWh is being paid to Scottish windfarms by consumers. If there was a separate energy market, rUK could import at, say £40/MWh, because Scotland will generally have too much energy relative to its demand,” the trader said.

He pointed to the German and French market dynamic as an example. “When the wind blows, Germany exports to France because the market price in France is higher than in Germany, despite the fact that given subsidies, wind generation costs more than French nuclear,” the trader said.

“That’s the reason retail prices are about €325/MWh in Germany and about €180/MWh in France,” he added.

So an independent Scottish market could saddle its consumers with higher payments to subsidise renewables, due to the smaller consumer base, while exporting at a lower price to major demand centres further south.

As far as the wholesale market is concerned, Scotland might find it really is ‘better together’.

Investment dries up as independence looms

Renewable subsidies could be financed by an independent Scotland, but this would almost certainly mean sharp price rises.

Within Scotland’s utility provision, the electricity sector is particularly vulnerable to major changes if the Scottish electorate votes for independence. In particular, investment in electricity generation is expected to be adversely affected.

In any event, current investment levels in the UK are worryingly low for several reasons – political uncertainty, low returns from gas plant, seemingly endless changes to the renewables subsidy regime and the weakness of many utility balance sheets.

Indeed, not only has SSE put a virtual cap on major energy investment until after next May’s general election, but it also argues that the forthcoming referendum “increases the risk of regulatory change and legislative change with regard to the electricity and gas industry in Scotland”.

Significantly, the SNP has espoused renewable power generation and has set aggressive targets for output from such sources. However, with the possible exception of onshore wind, major subsidies will be needed for the foreseeable future. Of course, they could be financed by an independent Scotland, but this would almost certainly mean sharp price increases.  

Currently, Scotland receives almost 30 per cent of all consumer-funded renewable energy subsidies despite just one-tenth of UK households being located there.

Hence, there are real concerns about the durability of renewable power subsidies under the Energy Act 2013 and the level per megawatt-hour that would be paid if Scotland were to become independent.  

Nonetheless, Spain-based Iberdrola, owner of Scottish Power, seems relatively relaxed and has committed itself to an ambitious long-term investment programme in Scotland, seemingly irrespective of the referendum result.

Inevitably, the trend in energy prices will be a key political issue in Scotland, especially in view of the 18-month price freeze pledge made by Labour leader, Ed Miliband.  

While SSE has confirmed that its utility prices will not rise until 2016 at the earliest, it will be heavily affected by the referendum result; after all, most of its profits are earned in Scotland.

Furthermore, SSE’s heavy investment in recent years in Scottish renewable generation capacity means it is heavily exposed to any material changes in subsidy payments. Similar criteria apply to Scottish Power.

The Centrica scenario is quite complex given the wide-ranging Competition and Markets Authority (CMA) inquiry, which seems to be focusing specifically on Centrica and its dominant share of the UK retail gas market.

The CMA is expected to recommend some divestments by Centrica and the sale of its Scottish Gas operations is a possible outcome. Certainly, Scottish Power and SSE would be very interested if this came to pass.

Vote steers utilities into uncharted territory

If, when the UK wakes up on 19 September, the Scottish electorate has voted in favour of independence, a messy period of negotiation will begin between ministers in Westminster and Holyrood. The negotiations will aim to clarify some of the issues to which we have not yet had a definitive answer. These issues go beyond the utilities: what currency will an independent Scotland use? Will it be granted EU membership?

For energy and water, the answers are likely to come further down the line once those significant issues have been resolved.

If, as the SNP has stated is its aim, a single pan-utility regulator is created, the scope for divergent energy markets has been created – regardless of whether the single market is maintained. And if the major UK political parties have their way – it won’t.

This has implications for trading, retail and the networks. Nothing can be worked on here until the bigger, over-arching issues have been settled.

If the regulatory regime is different, and there is a separate market, the transmission links between England and Scotland could become focal points for disagreements. How will National Grid link into the Scottish network – especially if everything really is up for grabs?

Will rUK and Scotland end up replicating the trading model experienced by Germany and France – with cheap, maybe even negatively priced – electricity flowing south?

With retail, everything will remain up in the air. Will the suppliers decide it is too complicated and exit Scotland, or will they set up a regional subsidiary? How much will costs go up to compensate for the loss of subsidies from the UK?

And how will the ongoing CMA inquiry and the issues of competition – with the prospect of a Scottish big two – be affected?

So far, there are more questions than answers – with both political parties still pushing their campaign cases, and the companies involved keeping quiet for fear of being seen to back one side or the other. The campaigns have become the SNP wishlist against the Westminster warnings.

There is relatively little information on what would happen after a yes vote. There is only one way to find out and that is as it happens, should Scotland decide to go it alone.

However, the big question – and the one the referendum rests on – is will the Scottish electorate be willing to take that gamble?

Scotland special part 1: The last days of the union?

Scotland special part 2: Ed Davey and Fergus Ewing

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

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

Scotland special part 5: Pioneering example