For the next instalment of our Regulation pillar, we asked our Utility of the Future Advisory Board how they would recast the regulatory framework to help achieve net zero and ensure a good deal for consumers in the energy retail sector of the future.
Buying white goods in the future won’t just come with the option of maintenance and service contracts, but also with a contract for the energy it consumes – and possibly even the water. This was one of the predictions thrown up by the group of experts who form the advisory panel for the Utility of The Future (UOTF) campaign. When asked to discuss how regulation might need to change in future, they said the starting point was to look at what services might be delivered and how business models might change, which might mean a blurring of regulatory territories.
That report, Strategic Investment and Public Confidence, took a pragmatic approach to how regulators could be strengthened under the current system, and its recommendations addressed some of the concerns of our panel. Unsurprisingly, our discussions turned out to be in the same orbit as the NIC’s on a number of fronts – particularly around the need for greater long-term planning for resilience and a greater formal footing to be established when it came to putting zero carbon at the heart of regulatory decisions.
One difficulty highlighted by the UOTF advisory board was the fact that Ofgem’s principle objective is silent on carbon, so when it comes to choosing between focusing on consumer bills or acting on climate change, it was bound to choose the former. The NIC agreed and in its report said Ofcom, Ofgem and Ofwat should have new duties to promote achieving the target of net zero emissions by 2050, as well as improving resilience.
Outgoing Ofgem chief executive Dermot Nolan has acknowledged too that although Ofgem had taken a board decision to be more proactive in this regard, “it would not be unhelpful to have further clarification of our statutory duties”.
However, such is the pace of change and innovation needed to decarbonise the energy system that this will require in places more than strengthening what is already there, say our experts. It could call for a completely different approach.
Here we explore in more detail three of the ideas they proposed.
1. Set up a body to provide energy systems oversight
The transition to a net zero energy and transport system is creating a plethora of new requirements, companies and services. Distribution network operators (DNOs) will need to transform themselves into distribution system operators (DSOs), while electricity generation becomes more decentralised and consumers switch to electric vehicles and use many more connected home devices. And all of these things will be interacting with each other in more price-sensitive markets. Energy processes and new practices will cross current commercial, organisational and governance boundaries, and this will mean new data, IT and communications requirements, resulting in design, standardisation, privacy and cyber-security challenges.
The Future Power Systems Architecture project between the Institution of Engineering and Technology (IET) and the Energy Systems Catapult identified 35 new or significantly modified functions that will be required to meet the 2030 power system objectives – and pointed to the need for a whole-system view, from the large power station down to the smart kitchen appliance.
Our board, of whom John Scott was involved in the Future Power Systems Architecture project, suggested a new organisation was needed that could oversee standards and ensure interoperability in areas such as electric vehicle charging – in much the way the telecoms sector had an overseer to facilitate open data and interoperability and provide coherent approaches to the use of data.
“The Future Power Systems Architecture project has identified that there’s a missing role: nobody is the technical co-ordinator. That’s not a regulator, not a central planner, but a technical co-ordinator role, which in other industries they call the system architect,” says Scott, who is also a director of consultancy Chiltern Power. “The system architect doesn’t own the assets, doesn’t profit from the assets, but makes sure all the different parts join up.
“In other sectors, for example telecommunications, we get great choice with our mobiles. But hang on, they work anywhere in the world, without us having to do anything. And how’s that done? By top class systems engineering, a coherent approach to data and protocol, and the creation of open systems that enable the interoperability that we as customers expect.
“There is nobody accountable for that ‘system of systems’ co-ordination in the energy industry. We need a party that has engineering vision and technical competence, that has a thread of data and complex systems running through it, which is just not Ofgem’s skill set,” he says.
“Another example of something has to be done is to move electric vehicle charging to off-peak and lowest price times, often termed smart charging. Smart charging involves the cars, the charging points, car owner apps, and crosses the meter, because it affects the distribution network. And if there are large numbers of cars charging, it also affects the national power system.
“So, the people designing the apps aren’t part of the regulated world, they’re working with charging point manufacturers, who are independent parties, yet both need to know how to integrate their data, their automation and their controls to meet the needs of local and national grids, enabling flexibility and balancing supply and demand. Whose job is it to co-ordinate that? It’s not just the network companies; it’s not just the charging point manufacturers,” says Scott.
Government initiatives
That said, the government would argue that it has acted to protect consumers and the grid against the risk of variable standards and inadequate protection with the introduction of the Automated and Electric Vehicles Act 2018, which it is envisaged will be enacted by a variety of statutory instruments over the coming years.
The act was intended to both facilitate an uptake of EVs and set minimum standards, which will be phased in as required. The general approach of the act is to focus on desired outcomes without prescribing specific technological solutions, so as not to “hinder innovation in this early and rapidly evolving market”.
As Jeff Hardy discusses in the recently published working paper Electricity Storage & Electric Vehicles (https://bit.ly/3332HWZ), the preferred approach outlined in a recent consultation on electric vehicle smart charging is in the first phase to mandate that all new non-public charge points be required to have smart functionality and meet a minimum set of standards. A second phase would see the requirements extended to the operators of the charge points. The consultation seeks views on the proposed regulations for the first phase (which will initially require compliance with British Standards Institute standards currently under development). Government holds the view that there is not yet enough evidence to determine what the long-term requirements of the second phase should be, so the consultation also contains a call for evidence.
Philip New, chief executive of the Energy Systems Catapult, says that the EV Energy Taskforce, which he chairs, is coming up with recommendations about enabling the steps and functions that need to be put in place.
The three big topics are: the importance of making sure smart charging is safe and secure; the importance of enabling interoperable solutions to emerge; and the importance of having a more planned approach, particularly at local level.
“The difficulty here is, as always, getting the balance right: if you over-prescribe things, you can kill innovation, but if you under-prescribe, you get the Wild West. Making sure there’s enough room to innovate is important. For example, the architecture of potential smart charging systems is very complex. Many different actors and system functions can combine in different ways to deliver outcomes, so the emphasis in the EV Energy Taskforce has been to avoid prescribing how outcomes are delivered and instead offer proposals on the conditions necessary to enable market actors to collaborate to best effect.”
The DSO transition
Another key area for an oversight body, according to our board, would be to drive the transition of DNOs to DSOs. Although there have been a number of successful projects in the sector, “I’ve seen nothing at the moment which suggests there is the capability to scale up,” said one board member. “RIIO2 will include a requirement for a digitalisation strategy, but might this stop at the meter? It makes no sense to do so in a whole-system context. A further challenge is that it is not clear how networks will make money in this new DSO and digitalised business model.”
Says Scott: “Ofgem’s current Energy Codes Review is timely for addressing some of these core challenges. The review is an opportunity to implement more agile change processes and, in the context of whole-system thinking, create mechanisms for strategic direction and technical/commercial co-ordination across the multiple parties delivering energy transformation.”
As part of a new systems architecture, there was also support for exploring whether the Electricity System Operator (ESO), a legally separate business within National Grid Group since April 2019, should be separated entirely. The current arrangements focus the ESO’s role on National Grid’s transmission system, but in a whole-systems context might full independence from National Grid create opportunities for undertaking new and wider roles?
Scott says the London blackout in August highlighted another benefit of creating an overarching oversight role: “The systems worked very much as intended, but at the same time there was huge customer inconvenience. You have the parties in effect saying ‘it’s not our fault’. There simply is no co-ordinating party.”
2 Reorganise to protect consumers in the age of the packaged utility
Our experts thought that rather than buying individual utility packages, telecoms, water and energy could be bundled together in the future, especially with the rise of EVs. If the lines are blurred between products and services, then perhaps it no longer makes sense to have siloed regulators.
There has been discussion in the industry about reorganising regulators into consumer issues and infrastructure issues. The heads of both Ofwat and Ofgem have said they do not think it is necessary – as did the NIC. The latter’s report said: “The commission does not believe wholesale change would deliver better outcomes than strengthening the existing model. The whole system does not need to be redesigned. But it needs to be updated to achieve a well-regulated market economy that can respond to the coming challenges.”
Our advisory board, however, thought that more generally in future it would make sense to have the functions split between economic regulation and consumer protection – which happens to a certain degree in water anyway.
3. Adopt less prescriptive more agile regulation to cope with unknowns
What we’ve heard consistently is the need for innovation, innovation, innovation – if zero carbon targets are to be met. One key debate is whether the current regulatory system provides enough flexibility and agility for new ideas and new services to come into the market. An example is that it would be difficult for an energy supplier to also replace a customer’s gas boiler with a low-carbon heat pump, which the consumer might pay back over ten years. This is difficult because customers could be locked in to a bad service provider for a decade or might switch, as they are currently entitled to do, leaving issues over who picks up the cost of the heat pump. This is a major challenge for decarbonising heat, because around 23 million gas boilers will need to be replaced if the 2050 net zero greenhouse gas emissions target is to be met. Business models that enable customers to install expensive new kit without the upfront costs will be required.
As well as innovation, flexibility and agility will also be prerequisites of energy regulators in the view of our board. Laura Sandys and Jeff Hardy, authors of Redesigning Regulation, picked up on ideas they proposed in their December 2018 report to cultivate a less prescriptive approach. A central principle is “perimeter regulation”, which sets boundaries for things that suppliers can do, but does not set out how companies should run their businesses.
As Jeff Hardy, a senior research fellow at the Grantham Institute at Imperial College London, pointed out: “This would mean regulators would need to be comfortable with not knowing what’s going on in businesses – they shouldn’t need to know about every transaction. What they will need to be good at is spotting trends and signals of bad behaviour in the market and coming down on that very hard. Thus, regulators will need to be as good, if not better, than the industry at accessing and interpreting energy and wider data.”
Laura Sandys, director of Challenging Ideas, says the current system was designed 30 years ago for an era in which there were only 500 key players – now there are 20,000.
“Regulation has been all about command and control – now it has to be about identifying key risk, which would be calibrated by insurance.”
Philip New says that getting the market design right is crucial if we are to tackle the most difficult challenge – decarbonising heat.
“There are about 25 million households that need to be decarbonised. If we’re going to do that by 2050, from 2025 onwards we’ll be needing to hit a run rate of a million houses a year. That is 50 times more than we’re managing to do in a year today.
“In other words, if we’re going to hit that target, we need to be decarbonising as many houses in a week as the country is doing in a year right now. Once again it’s a question of market design, innovation, and planning within a framework that’s been set by regulation.”
The NIC report made it clear that regulation needs to be embedded in a clearer strategic framework for the long-term investment needs of the country. It said the government should set out a long-term strategic vision for each of the regulated sectors, through strategic policy statements, within the first year of each parliament.
It also called for a greater leadership role for the UK Regulators Network, which brings together 11 regulators from sectors that include transport, finance and utilities. The board felt the current arrangement was not driving change and opportunity sufficiently.
What the NIC is calling for
The NIC was asked by the government in October 2018 to review the regulation of the energy, telecoms and water industries to ensure they received the necessary levels of investment and innovation, while ensuring these critical services are kept affordable for everyone. Its report, published a year later, said the system must be strengthened and updated, and public and political confidence in it must be improved.
Overall the NIC report said all the regulators should have duties to enable them to more consistently consider vital, long-term factors such as resilience and environmental impact – which cannot be left completely to the market – alongside price and quality.
Recommendations made by the NIC to achieve this include:
• Regulators Ofcom, Ofgem and Ofwat should have new duties to promote the achievement of net zero carbon emissions by 2050 and improve resilience;
• The government should set out a long-term strategic vision for each of the regulated sectors, through strategic policy statements within the first year of each parliament, to support lasting plans and stable funding;
• Most major strategic investments should be removed from the price control processes and opened to competition to support innovation;
• Regulators should be able to prevent companies from engaging in price discrimination that does not provide an overall benefit to consumers;
• The UK Regulators Network should be given a stronger leadership role through the appointment of an independent chair to promote collaboration and co-ordination, and ensure markets continue to deliver for consumers.