A Green Print for economic regulation

Dr. Tony Ballance - Chief Strategy & Regulation Officer explains our Green Print for economic regulation


We have all become very familiar with the regulatory regimes for energy, other utilities and elsewhere in the economy, which have now been with us for over 30 years.  They were at one point the envy of the world in their ability to take important decision-making out of politicians’ hands and drive significant improvements in the newly privatised companies’ performance (efficiency, prices and customer service).  In more recent times many have wondered whether the current regimes can effectively handle today’s, and tomorrow’s, issues. Net zero has brought into sharp focus whether our regulatory framework can cope with huge future uncertainties - after all, RPI-X was, and RIIO remains, largely anchored around a relatively fixed, short-term regulatory settlement. 

Short term incentives for a long-term problem
With this in mind, it’s sensible to take a look at how the current RIIO framework might need to change to deliver Net Zero in 2050. Ofgem recently adapted their regulatory approach to attempt to deal with uncertainty with the introduction of a number of so-called re-openers, but this ‘adaptive’ form of regulation can only take us so far. The Economic Regulation Policy Paper published by the Department for Business Energy and Industrial Strategy in January 2022 stresses the need for economic regulation to evolve to deliver future investment needs and the paper raises questions specifically over whether the regulators’ duties might need to change.

I think we all recognise there is the need to deliver net zero, but in sectors like heating, it is very unclear what the best the pathway is. It is evident that the challenges of the future vastly differ to those that the model of regulation was designed to address over 30 years ago.  Moving to a hydrogen economy for example will require significant transformation and regulation will need to adapt to make this happen.

There can be a reluctance from those involved from all sides to hold the current regulatory model up to the light and consider what changes may be required.  Its relative success is perhaps one of the reasons for this, as well as the fact that many of us have had lengthy careers in this space.  Given the scale of the challenges we face, however, means this is a conversation that needs to be had to address long-term issues.

At Cadent we feel it is important to set out some of our thoughts in this difficult area, to help shape the policy and regulatory framework to deliver the very best outcomes for customers.  We set out our initial thinking in the Our Green Print – Future Heat for Everyone report, which argued strongly for putting customers at the centre of our collective thinking around the energy transition for heating.  We have now considered what the regulatory model may need to look like to deliver net zero, and in our Developing the Green Print for economic regulation – RIIO for 2050 paper we have set out where we can act now to ensure better decisions in the future are made.

What are our priorities now?
We have identified five key priorities for action ahead of upcoming regulatory settlements in the electricity sector. The first two of these set out the overarching context for how we need to approach the problem:

1. Determine robust scenarios across electricity and gas to support consistent whole-systems planning – The precise mix of energy solutions we will require to reach net zero remains very uncertain, particularly for domestic heating. Electricity and gas networks have been encouraged by Ofgem to take a ‘whole-system’ view when forming investment plans.

In practice, however, it has been challenging for networks to do this - exacerbated by separate price review processes – creating the risk of assumptions and decision-making not being effectively joined up.
We need to ensure investments are robust to the different energy pathways that customers may choose, whilst also enabling that choice. Customers will then be protected against paying for any potentially unnecessary investments and supported in adopting optimal solutions.
 

2. Establish the correct roles and responsibilities - Delivering the future scenarios developed by the Climate Change Committee, and National Grid ESO, amongst others, and developing new energy vectors like hydrogen will require significant coordination and systems planning, as well as the establishment of new roles and responsibilities across industry. These will then support customers by ensuring the right solutions are developed to deliver diversity of energy transitions across regions of the UK.

If we get these elements right, we will then be in a much better place to support the following:

3. Creating the right price control framework – Ofgem’s RPI-X framework successfully managed the transition of public utilities to privatised network companies. The current RIIO framework then built in greater incentives to ensure better delivery of outcomes for customers. However, their success relied on a relatively stable operating environment. Today, with the need for a long-term sustained shift in what energy networks need to deliver, it is important to reconsider the focus the framework places on net zero goals and what incentives it drives.

Ensuring the regulatory framework is given sufficient focus on net zero goals, simplifying output delivery where possible, and is geared to incentivise investment will support customers by ensuring net zero is achieved on time and for an efficient cost.
 

4. Ensuring detailed rules and structures to develop hydrogen – In our Hydrogen Ten Point Plan we set out commitments to deliver the UK’s first scaled blended hydrogen facility by 2025 and the development of at least 5GW of hydrogen by 2030 through HyNet. To support the growth of blended and full hydrogen markets, and their integration into the wider energy system it is essential for greater emphasis to be placed on enabling regulatory and industry rules and structures (e.g. codes, charges, and other mechanisms).

Ensuring the right structures are in place to support the development and integration of hydrogen into the energy system will support customers by providing greater diversity of energy supply and ability to adopt different net zero solutions.
 

5. Supporting customer choice and affordability. While benefitting the UK as a whole, the  impact of decarbonising home heating will be felt by consumers in a very personal way. Costs are likely to fall unequally and determining the right solution for each customer will involve weighing up a range of competing factors. At present, this is complicated by some solutions, such as heat pumps, being available to install today and others still being in development.

By placing greater emphasis on supporting optionality as well as affordability in Ofgem’s price controls, and in charging approaches, this will allow customers to make the right decisions for their home heating and pay a fair cost to transition.

We are clear that there will be no silver bullet, and our paper doesn’t seek to provide answers, to very difficult questions which will require a great deal of thought. What it does do, however, is highlight priorities that need to be addressed sooner rather than later as we cannot afford to take too many wrong steps. The penalty for this being, at best, a significant drain on investment, taking away from other important areas, and unhappy customers; and at worst, it will risk us hitting net zero. 

With this in mind, we want to start a discussion well in advance of RIIO-3 and Government decisions on heat policy in 2026, as there are things we can work on now. This will be difficult, but it is something that needs to be done, and ultimately consumers and wider society will reap the benefits from efforts and steps in doing so.

The full Developing the Green Print for economic regulation – RIIO for 2050 paper can be found at: https://cadentgas.com/riio-for-2050