What would an Independent System Operator look like?

Ofgem’s proposals to fully separate the Electricity System Operator from National Grid have received broad support. But there are questions over exactly what role an Independent System Operator should play in co-ordinating the energy transition and whether more fundamental changes are needed. Tom Grimwood speaks to experts across the sector.

“I think the weather’s changed,” says Patrick Erwin, policy and markets director for Northern Powergrid. “Even two or three years ago, we were talking about this in policy terms, and now the front’s come through and we’re talking about this in delivery terms.”

Among the more significant commitments made as part of its energy white paper published towards the tail end of last year, the Department for Business, Energy and Industrial Strategy (BEIS) pledged to spend 2021 consulting on the “institutional arrangements governing the energy system” to ensure they are “fit for purpose”. The department said these would include energy code governance, engineering standards and the functions of system operators at both the transmission and distribution levels.

“We need the operation of national and local energy markets to be managed impartially, without conflict of interest, ensuring they are fully open to competition,” the paper explained.  It said there is also the need for “greater coordination to drive collaboration between different parts of the energy system which are currently too siloed.”

BEIS said this work would include a review of the organisational structure of the Electricity System Operator (ESO), which completed its legal separation from National Grid Electricity Transmission in April 2019.

Ofgem made its thoughts on the matter known last week with the publication of its own review into system operation in Great Britain, revealing proposals to fully separate the ESO from National Grid to create an Independent System Operator (ISO).

The regulator said it wants the ISO to pick up new responsibilities – providing advice to government and taking a more active role in designing and planning the energy system of the future: “This body will proactively run the day-to-day operation of the electricity system and provide strategic direction to support the transition to net zero.”

It continued: “A body responsible for both system planning and real-time balancing would have the skills and capability to ensure the energy system develops efficiently and safely. This is particularly important for the electricity system given the dynamic and real-time nature of electricity system balancing.

“This body would be best placed to anticipate the challenges of new technologies, identify cross-system solutions for operating the system and proactively consider opportunities for developing energy markets and networks to facilitate them.”

But Ofgem said none of this can happen whilst the ESO remains part of National Grid: “We believe that full independence is crucial for the new organisation to make decisions that are impartial and in the consumer interest.” It said the current structure may still result in “real or perceived biases” against decisions that would negatively impact the “significant value” of existing or future assets in which National Grid has a financial interest.

Conflicts of interest

The regulator conceded that: “At this time, we have no evidence of National Grid acting in a way that deliberately exploits any potential conflicts of interest.” At the same time, Ofgem said any mistrust in system operators’ advice could “delay or constrain policy decisions required to achieve net zero at lowest cost to consumers” given their access to “key data, technical expertise and operational experience.”

“Perceptions of bias are damaging regardless of whether there is any explicit evidence,” it warned.

Colm Gibson, the managing director of Berkeley Research Group’s London office, thinks otherwise. He argues that without “hard evidence” of conflicts of interest making a difference to decision-making “there is a risk to changing it”.

He says there are several downsides to separating the operator from the owner, firstly, that it will dilute their knowledge: “It requires a lot of expertise to run an energy grid and if you start splitting things up you start splitting that knowledge. All of the expertise that moves into the ISO is no longer available to National Grid and all of the expertise that remains in National Grid is not available to the ISO.”

Gibson says this problem could be overcome by doubling up, but asks: “What happens if National Grid’s experts say the ISO experts are wrong, and what happens when the ISO experts say National Grid’s experts are wrong? Who do you go with? Who decides which group is right and which group is wrong?”

He says splitting apart operation and ownership also raises similar issues around accountability: “At the moment, responsibility clearly sits with National Grid. It doesn’t matter whether a system operator makes an error or the rest of National Grid makes an error, you know where the responsibility sits.

“If you split the system up, it’s not going to be clear cut who is to be held responsible when something goes wrong. How do you deal with the situation where National Grid blames the ISO and the ISO blames National Grid?”

“It is important that control and responsibility remain aligned,” he adds. “If the ISO or National Grid end up with responsibility for something they don’t control – or control of something they don’t take responsibility for – that is likely to lead to problems in the end.”

Gibson says if an independent body is required to make decisions about system planning, then the regulator should fulfil that role itself: “If it needs an independent body then why isn’t Ofgem sufficiently independent? If independence was the criteria, then surely it would sit with them?”

Richard Nourse, managing partner at Greencoat Capital, shares Gibson’s concerns over the dilution of expertise: “I guess one of questions that would absolutely need to be sorted out is how do you make it possible for people to move in and out of the two bits of the industry, recognising sterile periods and the issues created by moving employers.”

However, he also believes that conflicts of interest are a far greater issue: “We need to be able to have people we can completely trust to fearlessly make the right decisions for us based on the evidence as they see it.”

“I don’t think there is a day-to-day conflict of interest,” he remarks. “I’ve been to meetings where you have National Grid, the asset owner, and National Grid, the system operator, introducing themselves to one another – i.e. they don’t talk to each other the whole time.”

But he says National Grid’s incentives are a “big problem” at the group level: “At the moment people are paying 1.3 to 1.5 times the RAV (Regulatory Asset Value) for an electricity company.”

He says the company therefore has a strong motivation to increase its RAV, mainly by building more wires: “Every pound they can put in the ground is worth £1.3 to £1.5 to their shareholders, the minute it happens.”

Nourse says this is particularly problematic when it comes to the future of gas networks and their potential conversion to hydrogen: “These guys are in an intense rear-guard action, basically to be relevant when the methane stops flowing. They need to worry about maintaining the RAV to have a business”.

Whole system operation

Whilst refraining from taking a firm position, Ofgem said the ISO could potentially absorb some or all of the functions of the system operator for gas, which is currently part of National Grid Gas Transmission: “An ISO with enhanced electricity and gas functions would create a new overarching strategic energy body. This body would be uniquely positioned to develop and apply whole system insight, make better, more coordinated decisions and enable effective optimisation across the energy system.”

Catherine Mitchell, professor of energy policy at the University of Exeter, thinks the creation of a fully independent system operator is long overdue, describing Ofgem’s prior decision to legally separate the ESO from National Grid Electricity Transmission as a “total fudge”.

“I think it’s absolutely vital that there is this Independent System Operator because we really have to move to a whole-system approach and an awful lot of this is going to happen at the distribution level,” she tells Utility Week.

Mitchell says the ESO would be perceived to be making decisions in the interest of transmission if it remained part of National Grid, meaning they would lack “any real credibility from the perspective of the distribution companies”.

For the same reason, she also thinks the new body should combine the system operators for both gas and electricity to create an “integrated Independent System Operator”. She says if the system operators for gas and electricity are not merged now, Ofgem will find itself doing so in several years’ time as has happened with the separation of the ESO from National Grid Electricity Transmission: “They’ve just got to bite the bullet and do it”.

But whilst she supports Ofgem’s proposals to give the ISO an expanded role in the transition to net zero emissions, Mitchell says this will not be enough to ensure the target is met by 2050: “We’re not going to get to net zero with slow incremental change.”

The University of Exeter’s Energy Policy Group has previously called for the creation of an Energy Transformation Commission to coordinate the effort.

Under its proposed arrangements, the Climate Change Committee would provide scientific advice to a cross-departmental Cabinet Committee on Climate Change, which would issue policy directions to the Energy Transformation Commission.

On the basis of these directions, the Energy Transformation Commission would consult with all relevant stakeholders, including taking technical advice from the ISO, to develop and implement a strategy for decarbonisation. The Commission would then issue instructions to both the ISO and Ofgem to deliver the strategy, with the latter acting purely as an economic regulator.

In the energy white paper, BEIS said it would set out its “vision for energy as a guide to Ofgem” by consulting on a strategy and policy statement for the regulator. However, even with this new guidance, Mitchell says she does not believe a changed Ofgem and a new ISO will be able to fulfil the coordinating role she envisions as “they won’t have oversight of local authorities and planning and all the other important institutions and actions which need to work together.”

Muddled roles

She is not alone in this belief. Laura Sandys, chief executive of Challenging Ideas, says there is currently an “implementation gap” that needs to be filled: “There is a real problem in the definitions between BEIS, Ofgem and the ESO: who’s responsible for what?

“We’ve got what I would call muddled roles. I think the Ofgem paper was trying to clarify those roles and I think it needs to be a bit more fundamental.”

She says: “There needs to be some kind of delivery body that drives net zero through the system; that owns the strategic planning and owns the whole-system costs as a strategic body. And Ofgem are putting that into the ESO in terms of electricity but I think that this actually needs a smaller delivery body that fits between the policy and those that implement.”

“I’m not sure the ESO should be responsible for the policy trade-offs that are needed around current consumers and future consumers and how the system needs to blend, let’s say, heat and electricity,” she adds.

Ofgem’s review of system operation noted the possibility of the ISO taking on new roles related to energy code governance and electricity engineering and data standards.

The regulator has previously suggested the ESO could become the strategic oversight body proposed in 2019 as part of its joint review of energy code governance with BEIS. An independent review of electricity engineering standards published before Christmas also called for a party to coordinate an overhaul of the standards and – highlighting the overlap with code governance – said this function could possibly be fulfilled by the same strategic body.

Ofgem said it would consider these options and also noted a link between code governance and data standards, given that energy codes “currently provide some of the industry frameworks for collecting and sharing data”.

Whilst she agrees with the regulator’s “overarching” proposals in this regard, Sandys says as the chair of the government and Ofgem’s Energy Data Taskforce she is not on board with the last part. She says the governance of data and digitalisation should not sit with an ISO: “I absolutely believe that is an Ofgem responsibility, not an active players’ responsibility.

“There is very little understand yet of the governance needs around algorithms and consumer outcomes and all of those things.”

Keith Maclean, managing director of Providence Policy and chair of the advisory board for the UK Energy Research Centre, agrees with Mitchell that ownership and operation should have been broken up “a long, long time ago”. He is pleased that Ofgem finally wants to complete the split after “dipping their toes in the water with the legal separation within National Grid.”

But he too is concerned that the regulator is repeating the same mistake in other respects: “I think they make the case quite strongly for having an organisation with an overview of the energy system, but then the actual proposals don’t ask for that and potentially create a halfway house that could be counterproductive, because if it is only the Electricity System Operator, then that’s all it’s going to look like, and one of the problems at the moment is that there needs to be much more joined up thinking about everything.

“A change to the body only for electricity, formalises something which is incapable of looking at the energy system because it won’t have the remit to do that. One of the problems with National Grid all along is it tends to take a view of the world that is dominated by wires. If your main tool is a hammer, every problem looks like a nail.”

“I feel going part of the way isn’t actually going to help and could possibly actually hinder finding whole-systems solutions to net zero,” he cautions.

“There’s obviously the policy work upfront,” he adds. “The government needs to say what needs to happen. In my view, you then need somebody to design that, you then need someone to deliver that, and you then need someone to operate it.

“There’s a muddle between what’s being designed and operated in the Ofgem proposals. And there isn’t a clear proposal on delivery; delivery for a programme that will be going on for decades and will have such an enormous impact and will need to be well coordinated at national, regional, local and household levels.

“There needs to be a body that is competent to do that.”

New institutions

Maclean believes the best option would be to split National Grid into three parts: the transmission owner, the system operator and a system architect, with the latter fulfilling the design function. Meanwhile, the delivery role could be undertaken by a new “Olympic-type authority”.

Ofgem did acknowledge in its review the calls for some kind of energy agency or system architect but argued that system operators (SOs) would be “better positioned” to take on this role “given the importance of real-time system balancing experience for effective system planning.”

The regulator said: “There are important synergies between the SOs’ current control room operation, market development and network planning functions. The ‘feedback loop’ between these functions enables the sharing of information, technical knowledge and expertise vital for performing these functions effectively.”

It said: “Separating system balancing and system planning functions could also lead to security of supply risks over time by making it more challenging to give unequivocal clarity on responsibility for system security between the SOs and an energy agency.

“The SOs would retain responsibility for securely operating the system in the short-term but the energy agency would be responsible for creating and developing many of the tools the SOs would need to perform this function. The closest possible feedback loop is required between those operating the system and those creating the tools for them to do so, with minimal barriers to the flow of information.”

However, Maclean says the feedback loop described by Ofgem does not require the architect and operator to “sit in the same room at the same time. The timescales are so different.”

He says the operator is looking from days and weeks ahead down to “sub-second” timescales, “whereas the system architect is looking at the design of the system over decades, because that’s what the lifetimes of the assets are.”

“There’s a much stronger argument to be made for having a whole-system architect than have the architect to be in permanent contact with the operator,” he states.

Patrick Erwin does not believe divorce between the ESO and National Grid is “absolutely necessary” but says “the politics have taken it there”.

“I think National Grid sowed the seeds of this separation a long time ago by being less transparent than it could be,” he explains.

That said, Erwin also sees advantages to separation: “There’s quite a lot of administrative complexity at the moment – there’s quite a lot of government bodies – so I think there’s an opportunity, if you are going to carve it out of National Grid, to see what things it can pick up to simplify the landscape, because there are a hell of a lot of interfaces already in the energy system.”

He says the energy system is undergoing two major transformations at the same time – decarbonisation and digitalisation: “Having a system that is not too complicated makes all of that easier because it’s easier to understand, it’s easier for people who aren’t in the market to enter it and it keeps the accountabilities clear.”

He says it should be possible for “a reasonably intelligent person” to get a basic grasp of the energy system: “Once you’ve made a decision to completely separate the system operator, I think makes sense to say can we do some administrative tidying up.”

Erwin is less concerned about the exact arrangements. What really matters is that there are clear roles, responsibilities and accountabilities and that those to which they are assigned have the resources and powers to discharge them: “And then you can worry about the institutions.”

For instance, the National Energy Agency proposed by Simon Virley, a partner at KPMG and its head of energy and natural resources, of which he said the ISO should be a part, would just be “a manifestation of government, one way or another. It could just be BEIS doing this or it could be BEIS creating a new agency.”

Erwin continues: “The engagement I’ve been doing with local authorities has really shown the fact to me that we need to at the simplest level get much better at integrating spatial planning and network planning, and there’s a bit of a gap between national policy and local delivery. There’s a lack of capacity in local authorities, which government really needs to solve, but even a lack of capacity in central government.

“Part of the argument for institutional reform is actually a cypher for saying we need more resources in the centre”.

He says achieving net zero emissions is “not quite a moon-shot but it’s in that spectrum. It’s about one per cent of GDP between now and 2050. That’s a lot of money. But that’s the kind of scale of the programme we need to do this, if we’re actually going to do it.”

Erwin says BEIS’ announcement of a review of energy system institutions and governance shows that “the penny is dropping”.  He says the government and Ofgem are now “getting their heads around the enormity of this challenge and working out how they’re actually going to deliver it.”

“I think the weather’s changed,” he adds. “Even two or three years ago, we were talking about this in policy terms, and now the front’s come through and we’re talking about this in delivery terms.

“That’s subtle but a really important change. And it’s going to mean organisations like us and local authorities and government are going to have to really think about the roles they play.”