National Grid: The latest in the wave of regulatory separations

An overview of Ofgem’s consultation on the National Grid system operator role. This will be of interest to all generators, suppliers, storage providers, aggregators, and DNOs in the electricity industry. It will also be of relevance to legal or regulatory teams in other industries who work with level playing field issues day-to-day.

16 January 2017

The Department for Business Energy and Industrial Strategy (BEIS), Ofgem, and National Grid have agreed upon common objectives for how the national electricity system should be operated. Noted below, these objectives and Ofgem’s accompanying consultation underline the need for a controlling eye in the middle of the electricity markets and build on the recognised benefits of separation within utility network groups. In the short term all industry participants should expect more engagement and potentially some increase in costs. In the longer term these developments, if successful, will open opportunities and help ensure the networks and markets of the future work well.

The BEIS, Ofgem, and National Grid shared objectives for the electricity system operator are that it “delivers real value to consumers and provides system leadership in: 

  • overseeing a safe, resilient, and cost-effective electricity system; 
  • driving competition and efficiency across all aspects of the system; and 
  • promoting innovation, flexibility and smart/demand-side solutions.”

To achieve those objectives, Ofgem is proposing a new emphasis in key areas of the National Grid System Operator (NGSO) role. Significantly, it is also proposing that the NGSO be separated into a new National Grid group company, with its own licence and revamped ring-fencing obligations. Reflecting a trend across industries throughout the UK, including Ofcom’s recent work on the separation of OpenReach and Ofwat’s on-going work to disaggregate water companies, the revamped ring-fencing obligations are designed to ensure industry confidence in the fairness of competition between the National Grid group and the rest of the industry. 
Re-focused Role for NGSO
Ofgem’s consultation describes ways in which the various SO roles as residual balancer, market facilitator, and central co-ordinator could be improved. These include:

  • Greater transparency in the way in which it procures third party services, more accuracy in system forecasts, and more openness to industry views on how balancing and other services should work; all of which is intended to enable potential providers to anticipate and supply solutions more effectively.
  • More effective co-ordination with Distribution Network Operators (DNOs), allowing smaller scale, embedded, generation, and demand side programmes to be integrated.
  • More active identification of improvements to the industry arrangements and codes, ensuring that regulatory blocks are identified and resolved as quickly as possible.
  • Greater testing of non-traditional solutions to network upgrades and more attention on the non-network impacts of particular approaches. 

Ofgem consider numerous such improvements to be possible without further legal change and National Grid appear to recognise the potential benefits of many of them. Regardless of the outcome of this consultation, industry participants should therefore expect NGSO to start reviewing its current working methods and trialling new approaches. 
A More Independent NGSO
There is a clear view that the objectives and enhanced roles described above will be better met if the SO function is more separate from the rest of the National Grid group. Although the SO functions within National Grid are already ring fenced, Ofgem is proposing various reforms, many of which are similar to the requirements in other sectors, such as banking payment systems. The proposals include:

  • That the SO be put into a new, separate company within the National Grid group. That company should have an independent board with no overlaps to other National Grid companies and potentially with at least three independent members.
  • That the SO will operate under its own licence and be ring-fenced from all National Grid companies, not just the Transmission Owner.
  • That staff will be deployed to either the SO or TO roles, with almost no circumstances where someone will have responsibilities towards both and with their bonuses clearly linked to performance of their home business. 
  • Premises for staff should also be physically separated, and, in a move that will be of particular interest to those in the water industry, Ofgem are consulting on whether that separation has to be on different sites or could be managed through separate entrances and secure corridors within existing buildings.
  • A further new group company to be established to provide shared services such as finance and legal on arms-length terms to all group companies, although there is an open question as to whether both the SO and TO should house their own regulation teams.

A future move to divestment and ownership separation has not been ruled out at this stage, although Ofgem are clear such a decision would be for BEIS and would potentially need new legislation. 

Ofgem recognise that the changes which have been proposed will require the separation of the RIIO price control into SO and TO parts and are initiating work to consider how the revenue and incentives could be split. Whilst they make clear that they do not see the need to increase the overall revenue allowance, they recognise that National Grid should be able to recover efficient costs of separation from its customers. Ofgem also intends to require NGSO to maintain an investment credit rating, in part so as to ensure minimal disruption to all existing contracts where it is the counterparty, e.g. as administrator of the current system charges. It anticipates that the broader NG group will provide it with the financing needed to do that on commercial terms, albeit at no net cost to customers. The devil of these financial changes should be watched closely by finance and regulatory teams throughout the industry.
BEIS and Ofgem are clear that these reforms should help avoid perceptions of conflict of interest as well as actual conflicts themselves. Experience from other industries suggests that they will also be a useful, albeit potentially painful, part of focusing the company on its core role and key customers. National Grid will be aware of the cultural challenge and personnel difficulties which such separations can bring but there are many examples of how it can work successfully with pre-emptive management and careful consultation. 
Next Steps
The common objectives and Ofgem consultation give the clear impression this is a part of a direction of travel towards greater independence and a wider role for the SO. Even if adopted in full, the current proposals therefore seem to be a way marker rather than the end of a journey. Given the trend for separation across utility industries, this is something those within and without the electricity industry should find useful to be aware of.
Ofgem’s consultation is open until 10 March 2017. Its target date for implementation is April 2019, although it would like to see work to re-focus and change the SO culture start sooner. BEIS will be reviewing progress after April 2018.