23
Examination of witnesses
Eleanor Warburton and Akshay Kaul.
Q88 The Chair: Good morning. This is the Industry and Regulators Committee of the House of Lords. We have an inquiry into grid issues and our witnesses this morning are Eleanor Warburton, who is Director of Energy System Design, and Akshay Kaul, who is Director General of the Infrastructure Group. Good morning and welcome to you both.
Ofgem plays quite a pivotal role in energy across a wide range of issues, but we are concentrating on energy network infrastructure. Perhaps you could start by saying where you think Ofgem’s role is in that specific area rather than your wider role. Who wants to start?
Akshay Kaul: Good morning, Chair, good morning everybody, and thank you for giving us the opportunity to come and give evidence today. As you say, Ofgem is the network regulator for Great Britain, so we set prices and standards of service for all of the monopoly energy networks, transmission as well as distribution, gas as well as electricity, onshore as well as offshore. More recently, we have also become the joint competent authority alongside the Department for Energy and Net Zero (DESNZ) to regulate cybersecurity in the energy industry, so it covers all of the operators of essential services, which is also a lot of the network companies.
The Chair: Do you want to add anything about the condition of the network infrastructure?
Akshay Kaul: We have one of the most reliable electricity networks in the world, and I think we should take some pride in that. That has been achieved through nearly two decades now of incentive regulation, which has given these private monopolies sharp incentives to improve reliability while trying to bring down the costs for consumers over time. As we look ahead to a shift to a more renewables-based power system, that unquestionably creates new challenges for the management of the grid.
In particular, the grid is becoming more congested. We have seen the costs of congestion rise relentlessly over the last 10 years. They have gone from about £150 million in 2010 to nearly £1.5 billion by 2024. Also, the balancing of the system is becoming a greater challenge because there is much more intermittency in the supply and, over time, we also expect there will be more intermittency in the demand because a lot of solar energy, for instance, is going to be connected at the demand level. These two things, the congestion on the networks and the balancing of the grid, I think are going to be the two main challenges that we need to face in the future.
The Chair: Does that concern you? Does that feel like a very significant challenge?
Akshay Kaul: It is a considerable challenge, but it is a challenge that we are fully up for, and I think NESO, the national energy system operator, and the department are fully up for it, and we will have to work in different ways in the future, so it is not just about building more and more infrastructure, although unquestionably we need to significantly expand the capacity of the transmission grid. It is also about how cleverly we use the grid capacity that exists by introducing more incentives for more flexible demand response, for instance, and better use of technology.
The Chair: Eleanor, would you like to add anything?
Eleanor Warburton: No, I think that is a very fair summary. We will come to it later, but at the moment, I think a lot of the focus is on the transmission grid, rightly, but as we move into the 2030s and we start seeing a lot more electrification of transport and of heat in our houses, we see the same need for expansion at the distribution level. One of the key focuses now is to start anticipating that, learn the lessons of what we have seen on transmission, and put that next layer of planning in place so we are ready for that.
The Chair: Well, we will come on in more detail to some of those things.
Q89 Baroness Harding of Winscombe: How confident are you that the clean power target can be met, how tight is the timetable for delivering on it, and how important is the delivery of the energy network infrastructure to meeting this target?
Akshay Kaul: Thank you, Baroness Harding. It is a very considerable challenge to get to this clean power 2030 target. I am confident that we can do everything that we need to do from a regulatory perspective. We can put in place all of the regulatory enablers, and I will just talk about the four main things that we are doing to enable the target. Regulation will not get in the way of achieving this target, but there are things that are not entirely in our control, such as planning reform and the time that it takes projects to get through the planning system, which I think are more likely to be on the critical path to that 2030 target.
To briefly summarise the four main regulatory enablers that we are putting in place: first, we are engaged in reforming the connections queue, and we are confident that that problem can be resolved. Secondly, we are approving the network build that is needed, and you mentioned that in your question. I think that is absolutely vital. There are about 80 projects which are absolutely critical to getting to that 2030 target. We have approved them as a programme, and we have set sharp incentives for the network companies to deliver those projects to time and to budget.
The third area is to introduce a brand new regulatory regime to get private capital into long-duration energy storage. We do not have a lot of it right now. It is only 2.8 gigawatts in the system. We need to significantly expand the capacity of that because the batteries and the interconnectors on their own—as we saw this winter—are not going to be sufficient. We are introducing a brand new regime for long-duration energy storage. The fourth area is consumer flexibility, which I mentioned, getting a demand-side response to play a much, much bigger role. Again, we have a programme of work with the department to put in all the regulatory enablers and incentives, as well as the systems, things like half-hourly settlement and smart meters, which will be necessary to make that work.
In these four areas, we are confident we will do our bit, but there are some things there, particularly on the network infrastructure side, such as the time that it takes these projects to get through planning, that essentially are matters for Government and outside of our control.
Just to orient the timescales for you, 2030 is only five years away. It takes three or four years to physically build the network infrastructure, and that means the majority of the 80 projects have to get through the existing planning system in the next 18 months or so, and that is what we are going to be watching out for.
Baroness Harding of Winscombe: Thank you. I think you hinted at this, but just to be even more explicit, the Electricity Networks Commissioner told us a couple of weeks ago that delay “haunts” him. What are the main potential causes of delay that haunt you, and what should you be doing about that?
Akshay Kaul: Yes, you are right. Nick Winser did a terrific piece of work on the transmission acceleration review, and I think that essentially set out the three main causes of why it takes so long to build transmission infrastructure in this country, about 14 years from start to finish. Nick’s ambition was to try to bring that down to seven years.
There are three main reasons why it takes so long. The first and most important one is planning, the time that projects spend in the planning system to get planning consent. The second is the time that it takes these projects to get through the regulatory approval system, and the third is supply chain constraints. Sometimes there can be delays that are caused by the supply chain capacity not being able to place orders at the right time and book factory slots and things like that because there is global competition for a lot of the supply chain capacity.
Now putting planning reform to one side, which I think is largely a matter that the Government have in their sight to deal with, we have put in place the regulatory enablers. We have given programmatic approval. Rather than going project by project, we have approved the entire set of projects that are necessary for this clean power 2030 target as a programme called the ASTI (Accelerated Strategic Transmission Investment) programme. We are just about to announce, I think later this week, a decision on an advanced procurement mechanism to help the network companies book early manufacturing slots in factories ahead of project needs being cleared, so that they can get those orders confirmed and the supply chain can be mobilised, rather than waiting and causing delays later on.
Again, I think from a regulatory perspective, we think we are leaning in and getting ahead of this, but the planning reform is still very much on the critical path.
Baroness Harding of Winscombe: One final question, if I may, Chair. Given the UK’s track record at delivering major infrastructure projects, are you worried that the sector is complacent about the scale of the challenge facing it? It has been quite striking in the evidence sessions that we have had so far in this inquiry that people have been telling us, “It’s okay, we like the changes being proposed. It’s all fine”. That hints at a degree of complacency. What is your view?
Akshay Kaul: I think the sector is quite motivated by the clean power 2030 target. I have not seen this kind of energy and enthusiasm come together for a long time. I think that is the principal benefit of having this motivating mission that essentially gets everybody working toward a common objective, so the department knows what it is doing, the regulator knows what it is doing, NESO knows what it is doing, and the industry knows what it is doing.
To your point, I do not think that there is any doubt in anyone’s mind that this is an incredibly challenging target to meet because of the physical amount of work that has to be done in the next five years, and I think the industry is very live to some of these challenges. For instance, they have been working with us on the supply chain side to get more capacity enabled in the supply chain. There is no question that there is definitely a tremendous challenge associated with getting to this target.
The Chair: Thank you. Lord Gilbert, you wanted to follow up?
Lord Gilbert of Panteg: Yes. Just briefly. You identified three potential causes of delay and one of them was procurement and the supply chain. One of the areas where delivery of these projects often fails is the lack of availability of skills, workforce and trained workforce. Who is responsible for ensuring, right across the piece, that skills policy and a skilled workforce are available to deliver?
Akshay Kaul: I think that long-term skills development is mostly a matter for the Government working between the Department for Energy Security and Net Zero and the Department for Education. There is a shortage, for instance, of qualified engineers, and we definitely need to invest in that profession. This is a generational opportunity. I think if you want to attract young people into engineering, this is a fantastic time to do it.
What we can do from a regulatory perspective is ensure that the network companies put in place well-thought-through workforce plans, and we do that with every price review. We ask them to submit their workforce plans, which include things like running training programmes, apprenticeship programmes, and so on, and much more importantly, provide predictability and stability to the supply chain so that people can see a pipeline of work, and that enables the supply chain to invest in the development of capacity itself. That is what we are doing at the moment.
Q90 Lord Best: You need to take account of the Government’s strategy and policy statement, the SPS. In doing so, you have to balance the different priorities that you have: the looking after the consumer with affordability issues, the decarbonisation you were talking about by 2030, and the security of supply. Would it be helpful now that the SPS is getting reviewed—you are going to get a new version—if there was greater clarity in it as to which priority you should go for first and last?
Akshay Kaul: Yes, definitely. One of the things that we struggle with is that sometimes these priorities can be in conflict with one another. There is a question about, as you say, which one should take priority over others. To the extent that Ministers have preferences, it is very helpful to have that stated explicitly in the strategy and policy statement.
Another thing that would be helpful to develop through the SPS evolution is that there can be gaps in the policy framework: not necessarily a conflict between objectives, but just a gap where there needs to be clearer policy to allow us to regulate more confidently and more effectively. A good example of that is just the gap on heat policy, for instance, the policy on heat decarbonisation. If that could be stated more clearly as to where the Government intend to go, and what the timescales are, I think it would give us a lot more confidence as a regulator.
Lord Best: Do you want to add anything, Eleanor?
Eleanor Warburton: At the next level down, the shift to strategic planning is helpful in this context because, as Akshay says, there is the challenge of high-level trade-offs and then there is the next layer of clarity about, okay, the Government have committed to clean power, for example, but what does that look like in terms of things like their ambition for the generation mix on the system? That next level of strategic planning, which we are starting to see come into play, can also be very helpful in giving us that firmer government context to then do things such as network regulation.
Lord Best: Now the Government are giving a very high priority to growth. To what extent are you now needing to take this dimension on board?
Akshay Kaul: We are taking very seriously our growth duty that was added recently to the list of things that we should have regard to. We can see the contribution that regulation can make to growth. For instance, the two iconic problems in the system at the moment are that it takes very long to get a grid connection, and we need to speed that up. There is absolutely no doubt about that. That is a very fundamental problem if you are trying to grow the economy, if factories and data centres and gigafactories cannot get timely grid connections. Perhaps Eleanor will talk a bit more about that effort. We see that as absolutely fundamental.
Similarly, there is an issue with the high price of electricity for businesses at the moment. Again, we want to do what we can from a regulatory perspective to try to bring prices down. Again, we can discuss some of those things if you wish later in the session.
These two things—the time it takes to get grid access and the high price of electricity—are impediments to growth in the wider economy and solving them is essential. Alongside that, I think we see this huge opportunity in the years ahead, the four or five years ahead, of growth being driven within the energy sector, so the investment that is needed within the energy sector to decarbonise the power system and bring in all these new technologies.
There is a big economic opportunity here for the UK, particularly if you can get more of the capacity in the supply chain located within the UK. That is why we are doing all the work we are doing on supply chain development as well, to try to maximise that economic opportunity.
Eleanor Warburton: I am very happy to talk about connection reform and demand now if that would be useful.
As Akshay has set out, there is a very clear challenge with connections at the moment. The dates that connectees are getting are too late. A lot of the focus and discussion of reform has been around the generation and storage side and about how you align what is in the queue to what is both ready but also needed by the system for 2030 and beyond.
However, one of the consequences of that is that demand, which is a relatively small part of the overall connections queue, is all deemed to be needed. So provided it is ready—assuming the NESO’s proposals go ahead—you will see a reduction in what we call the Gate 2 connection queue, the immediate connect queue, and demand will therefore be able to connect more easily. You will see space freed up and so demand should benefit from that.
Another thing, again as we start to look ahead, and I think you mentioned the Government’s ambitions in this area, is that there is a discussion of things such as AI zones and the country’s investment strategy overall. The clearer direction we can have on that—spatial AI zones, for example, a very helpful concept, I think—the more we can then factor that into how we ask the networks to plan, how we ask them to make sure that they have readiness for what is coming, because obviously there is what is in the queue now and then there is what may come forward in the near future.
The Chair: I think that ties in very nicely with Viscount Thurso’s question.
Q91 Viscount Thurso: Thank you, yes. Following up on that around the connections queue and connections queue reform, everybody seems to be in favour of it in principle, and yet everybody also in their particular way has a criticism of the detail. Nothing new in that, is there?
Are you content that NESO has struck the right balance to provide a manageable queue without holding back valuable projects? This is the evidence that we have heard from some people, that the way NESO is doing it is going to make some projects unable to get a connection. Are you content with the way that NESO is doing it and what levers do you have if you are not content?
Eleanor Warburton: As you say, we are clear, we agree with the problem statement and, as you also say, I think that there is a pretty strong consensus in the industry around that. We essentially have to make a decision on the NESO’s proposed reform. We have not taken that final decision yet, but we have put out what we call a “minded-to” position. That went out about a month ago, explicitly for consultation.
The question you raise is going to be at the heart of that final decision, but our initial view, which we set out in the minded-to decision, is that we think that NESO has struck a decent balance in the proposals it has put forward, prioritising for Gate 2 projects that, first, are ready, so it can show that it has access to land, for example. It is worth being clear that a lot of what is in the queue does not necessarily even have any access to land. Technically, I believe it would be possible to get into the connections queue to put a solar farm on Buckingham Palace. It is a low barrier to entry. They must also have what is needed by the system.
NESO also proposed a number of specific protections, which essentially say, “If you have planning permission or any kind of contract from the Government, such as a CfD, you are deemed to move through into this Gate 2”.
Another thing worth saying is that nobody is removed from the queue under NESO’s proposed reforms. Gate 2 is the projects that are most urgent and ready to connect: the ones where you would expect your networks to be building your bays and your substations and doing that very immediate work. The rest go into what is being called Gate 1. That is still in the queue and there will be regular opportunities to move forward, but they are the less ready and potentially the less high priority for the immediate future. They are still in there. They absolutely can still progress, providing they align with the criteria of readiness and need.
Viscount Thurso: Can I check that I have this right? The queue reform is not about saying, “Sorry, you are out of the queue; go away”. It is about saying that you are ready, have a connection and therefore you are to go to the front of the queue.
Eleanor Warburton: Essentially that is exactly correct. The key differential, and this is partly where it matters, both for speed of connection and also for consumer interest, is that if you are in Gate 2, we expect—and there is also work we do on the expectations of the networks—that the network you need, which can be quite bespoke, and we are talking about very locationally-specific things here, will be actively being planned and built. So, quite serious money is being committed, and effort and all of those scarce resources we have just talked about. In Gate 1, you are still there, you can move forward, but you are less ready or have less priority at the front so your bespoke bay, for example, is not being built and reserved as you sit there.
Viscount Thurso: You are pretty confident that nobody is going to be held back as a result of these changes. What you are saying is that they may just get in at a different point in the queue. Do I have that right?
Eleanor Warburton: Yes. I was just thinking about exactly what “held back” means.
Viscount Thurso: Can I give you an example? Supposing you were planning to do a wind farm, but as of today, the probability is that you would not be on stream till post-2030. Because by 2030, there are quite a lot of changes that are going on, it could mean that your investors say, “Well, this has now become too uncertain, so we are pulling out”. Or it could be that the landowner says, “Well, this has changed everything”. It could be that the consenting unit, which is what we have in Scotland, changes its criteria; whatever. There is a huge amount of uncertainty that has gone into that. From a regulatory point of view, are you happy that this is not causing problems to the queue going forward?
Eleanor Warburton: Subject to a final decision, I am happy that this is a sensible trade-off that we need to make. What NESO is proposing recognises the uncertainty that exists for those projects. Can it get land? Can it get planning? Can it get final investment? Historically, we know that there is a significant dropout of projects in the queue. A very long way from everything that applies to connect ever connects, and most of that is at the project side.
What I think NESO is proposing recognises that and tries to provide a sensible way to handle it so that you can prioritise and drive the network build you need to get quicker connections for the projects that you do need. If we try to run them all at the same pace, I think there is a fairly strong consensus that you cannot simply connect through that entire queue, and you will spend a lot of money doing that.
Viscount Thurso: One last very quick question, if I may. If, as the regulator, you decided that this is not actually working the way it was intended, what levers do you have to pull to do anything about it? Can you do anything about it or is it the case that once it is off, that is it and other people are doing it all?
Eleanor Warburton: Once we take a decision, the baton will be handed back to NESO and the DNOs (distribution network operator) to work through the queue and deliver. However, one of the key process aspects of this reform is that it moves a number of the key rules into what we are calling methodologies. Those are easier to change; they are quicker to change. NESO can trigger a change, we can trigger a change, so there is much more space to say, “Actually, no, this is not quite right. We need to look at this again”. Bluntly, we would absolutely expect NESO and the DNOs to work collaboratively on that.
As you will have also seen, the final backstop in all of this is that the Government have also brought forward statutory powers so that, if something more fundamental that goes beyond that is needed, they are creating the lever to do that as well.
Viscount Thurso: Thank you.
Viscount Chandos: When you say that there is a high dropout rate, it prompts the question: how much does this part of the process cause the dropout rate, or merely, as it were, have to respond to it?
Eleanor Warburton: I am basing the comment on high dropout rates on historic queue data and also bits of third-party reporting from various industry bodies, all of which tend to reinforce the view that, over the last few years, absent any of this reform, you do not see anything like 100% of projects that start the process finish the process. Again, it is something that is part of our consultation and we will be interested to see industry responses.
From just informal contact—as you would expect, we meet a lot of generators very regularly—that is also reinforced by things we are told there, that this is a function of, as you would expect, I will start multiple projects, develop them to a certain point, and I will start funnelling down to the most effective, most viable ones that I want to progress to full final investment and actual build.
Q92 Lord Gilbert of Panteg: You were beginning to get into my question in your response to Viscount Thurso on the issue of legal challenge. There clearly is a risk of legal challenge from people in the existing queue if they are deprioritised. You have been careful not to use the word “deprioritised”, but they would see it as being deprioritised. How substantial is that risk and are you satisfied with the Government’s underpinning in the Planning and Infrastructure Bill to deal with that risk?
Eleanor Warburton: You are right. If you want to deliver any change that has an impact, it tends to create winners and losers. We do see broad support for this, and I think that there is some recognition in industry that there will have to be some trade-offs if they can get the scale of impact they want. However, you are absolutely right. I would never rule out legal challenge. We have been challenged on a number of things in the past, so it is not unfamiliar territory for us.
We are obviously thinking very carefully about that and trying to make sure we take absolutely the most robust evidence-based decisions that we can. The current consultation is part of that. We are not waiting for legislation to do that because we think the problem is pressing and we think we have the powers to act now. However, what the legislation does, I think, is provide valuable clarity and, in a sense, reassurance to the industry—which has been very clear that uncertainty is the biggest risk. It is bigger than any specific change. The Government are willing to legislate on this, have a very clear direction of travel on connections and are using this to give parties that certainty. If they have to use the legislation, they will, but our intention is to go ahead with that because we do not want the energy system to have to wait.
Lord Gilbert of Panteg: We talked earlier about the risk of delays. The legal gold-plating of every bit of the process and building in endless legal procedures and protocols and consultations has the potential to create delay, does it not? Is there a balance between that—between putting in all those legal safeguards—and expediting the process? Is there a trade-off?
Eleanor Warburton: As you say, there is a golden balance. There are things you can just do to work more quickly or intelligently. My team will not thank me for some of them, but, yes, there is an absolute backstop to all of this where I think we are very conscious that while there may be risks in proceeding, there may be bigger risks to the country in delay. Therefore, we have to balance the consequences of inaction or slower action.
Lord Gilbert of Panteg: Looking at all of these reforms to the queue together and the need to provide connection offers in a speedy way, do you have any sense of the timescale and the dates by which all of this needs to be implemented to meet the clean energy 2030 target? Does it need to be done by the end of this year?
Eleanor Warburton: There is a good deal in the queue that is not relevant for 2030. It is going beyond that or, as we have discussed, it is demand.
What is going to matter—and I think, again, the reforms are striking a reasonably good balance on this—is for those projects that you need to be building now for 2030, so large infrastructure with long lead times, to have sufficient certainty over this year, certainly by the end of this year, that they are going to be in Gate 2, they are going to get the sort of offer they need and they can, therefore, build at the pace they need to.
There is good information available on the technologies, the protections, all of those things, that even in advance of offers being issued should enable those projects to have a very realistic sense of where they are going to be in that. We want to see all offers come out as quickly as possible and, very importantly, to start moving new projects into the queue and forward. However, for the purposes of 2030, it is that tranche that is most critical.
Akshay Kaul: The other thing that the queue reform does is send a clear signal to the networks of what they have to build. Once they know what the queue is, they know exactly what they have to build. Because it takes a certain amount of time to build network assets, it is important to get the queue reform done and get the connection offers out by the end of the year.
Lord Gilbert of Panteg: Presumably there is a constant dialogue in that regard. You are not waiting for a point of finality before you talk to the networks, you constantly engage with them and give them a sense of where you think that it could land?
Eleanor Warburton: Absolutely, and the networks will be central to delivering the next stage. Once a decision is there, which should be very soon, it is over to them to say that they will work through the queue, do the engineering assessments and understand exactly what it means for the network build. It is all a parallel process over the coming months.
Q93 Viscount Trenchard: Good morning. I would like to ask you about how NESO is doing in providing greater strategic planning of the energy system. There are various plans that it has been charged with producing: the Strategic Spatial Energy Plan (SSEP), the Centralised Strategic Network Plan (CSNP) and the Regional Energy Strategic Plans (RESPs). There are three different plans, which sounds rather complicated to me. How do you expect to integrate these plans into regulatory approvals so that the projects required to meet them are not subsequently challenged?
Eleanor Warburton: Essentially the plans set out the needs cases for the system. The first one that you mentioned, the SSEP, sets out the energy need for the system overall—things like the generation picture. The CSNP sets out the consequent network need from that, and the regional plans look at the local regional level and the bottom-up picture. We have spent some time working very carefully with NESO about how it makes sure it looks across both of those and progresses them forward.
It should give us the need. It is then for Ofgem to approve the actual build that implies in the network, so making sure that it is cost efficient, that the right incentives are in place and that delivery is tracked. We get that handed over to us and we then have to make sure that the price controls add up. We have done that once already—we need better plan names—with the holistic network design, the HND. That set the needs case and that handed over into the ASTI regime that Akshay mentioned for us to approve the funding and the delivery incentives. We have a model there that has worked, and we now need to build on that to keep that progressing.
Viscount Trenchard: Thank you. Specifically looking at the RESPs, what do they need to deliver to be a success? To what extent is it possible to strategically plan the distribution network, given its greater complexity, and can RESPs provide a clear needs case for strategic investment at the distribution level?
Eleanor Warburton: That clear case for investment is exactly their purpose. Historically, we have tended to assume that distribution is quite static and passive. We have separate planning in each network, which for somewhere like London is potentially a challenge because you have two different power networks and a gas network. They are all planning on their own assumptions for London and it is not necessarily joined up.
What RESPs will do is take coherent geographical areas, such as London or Wales, and set out a blueprint for the energy requirements of that area which takes account of trajectories on things like heat decarbonisation, transport and the ambitions of the relevant local democracies for that area. Do they have particular economic plans for the area, for example, do they have housing plans?
It will not plan that down to network line level, you are right. For distribution, that is hundreds of thousands of very small lines. However, it will set out the need for investment, “In this area you expect to have a massive new housing infrastructure with these requirements and this profile. You need a network that is capable of dealing with this need”. They will then go over to the networks, and it will be for the network to say that it will fulfil that need by a mixture of probably building lines, reinforcing these pieces, using other flexibility tools or data tools to use the network better in this area. Then the plans come to us for cost assessment and incentives to make sure that the consumer is getting value for what is being delivered.
Q94 Lord Udny-Lister: Good morning. With the introduction of the Accelerated Strategic Transmission Investment framework, are you content that your price controls for energy networks provide a strong, early signal to the need for strategic network investments? Will you be expanding this approach to a greater portion of your price controls for energy networks?
Akshay Kaul: The short answer is yes.
The Chair: It is unusual to get such a short answer.
Lord Udny-Lister: Is there a need for all network price controls to move towards providing early certainty of the need for projects at the start of each price control period, with fewer projects brought forward through uncertainty mechanisms?
Akshay Kaul: The way to think about this is that the four sectors that we regulate are slightly different in their dynamics. For transmission, it is true that we need to give early certainty and we are doing that at the moment with the needs case assessment, not to do it project by project but to do it programmatically around the various net-zero targets that need to be met and then to provide the procurement certainty for the networks so that they can book manufacturing slots and place factory orders.
Broadly, the same dynamic applies at the electricity distribution level. However, as Eleanor said, instead of having a small number of very large projects, as you have in transmission, it is the other way around in distribution. You have a very large number of very small projects.
What we will work through with the industry, building on the recommendations of the National Infrastructure Commission, is what form that early certainty and assessment of need takes in the distribution sector. It could be that we just go with a load forecast, a demand forecast, that properly tries to anticipate the demand and embed a generation on the distribution grids, and the networks can respond to that. However, it may not necessarily be an ASTI-like mechanism, if that makes sense, because it does not relate to a programme of big projects, it is more to do with funding the network programmes at the distribution grid level. That is on the electricity side.
On the gas side there is less need to do this, because they are not networks that are in a state of expansion, so the problems are quite distinct on the gas transmission and the gas distribution network side. However, on electricity what you say is perfectly correct.
Q95 Baroness Valentine: Good morning. We have heard concerns at the varying levels of service that major connections customers receive. What are the main aims of Ofgem’s end-to-end review of the regulatory framework for connections? Do you expect to put in place a strengthened framework, including more consistent application processes, clearer deadlines for each stage of the connections process and sanctions if they are not met?
Akshay Kaul: Again, the short answer is yes. You have beautifully set out the three main things that we want to do with the end-to-end connections review. First is the data. Having clearer data out in the industry about where there is grid capacity and where there is not will help people to plan their own connection applications and connection requests. This is work that is already under way, but we will make a big push for the networks to get fully digital and put out a map of grid capacity in different parts of the country so that the industry can plan and sort out their own positions in the queue.
The second thing is the quality of the service that they get from the networks. It tends to vary from DNO to DNO and we want to standardise the quality of service so that everybody gets timely offers, they can rely on the quotes that they get from the networks and they have some sense, end to end, of how long it will take them to get connected.
The third thing, as you said, is where the networks breach their commitments to customers. We are putting a lot of commitments on the customers in the queue reform to be ready, to have land rights, to have planning permissions and things like that. We want to see an equal and opposite commitment on the part of the networks. If they do not deliver what they are supposed to, there should be an automatic redress for the connecting customers.
There is one other issue, which is slightly more complicated, but we want to tackle it somehow through this end-to-end review. That is the way in which costs are distributed between the connecting customer and all consumers. We hear that different distribution network operators apply the rules in different ways as to what gets socialised and what gets charged to the connecting customer. This creates an unnecessary amount of uncertainty in the market. Therefore, we would like to try to standardise how those rules are applied.
Baroness Valentine: Distribution networks emphasised the need to avoid the creation of perverse incentives through the review, such as connecting customers before they are ready, in order to meet new deadlines. Is this a major challenge, and could it be managed by not penalising networks for missing deadlines, provided that the customer sanctions that?
Akshay Kaul: Could you repeat the question?
Baroness Valentine: There are a lot of double negatives, sorry.
Eleanor Warburton: You are saying that distribution networks are worried that they will get an incentive to connect a project before it is ready to use the system. I agree that you always want to avoid perverse incentives in regulation, but probably the one that I am more conscious of is that we create a perverse incentive to offer rather cautious connection dates initially so that networks are very, very confident that they can meet them. I agree in principle, but the specific one that you raise is probably not my highest concern and it is perfectly possible, as you say, to find sensible, transparent ways to understand who is asking for a connection date change. If that is genuinely the connecting customer and they are genuinely still getting the date that they want, that seems on the face of it perfectly reasonable.
The Chair: Can I clarify? You mentioned that a map of grid capacity is something that is needed. Are you saying that that does not exist at the moment?
Akshay Kaul: It is in development. NESO has set up a connections portal, for instance, where it is providing a lot more digital information to the market at the transmission level. Each of the DNOs has been doing its own version of this at the distribution level, so it is definitely in progress now. We want to keep improving it so that it gives people accurate and timely information of where grid capacities exist, which is helpful for people to work out where the best place is to make a connection.
The Chair: Why has it not existed in that detail in the past?
Eleanor Warburton: One thing to weave in is what potential connectees are looking for. It is not just the physical grid connection. Bluntly, what they want to know is who else is trying to connect in that area and therefore where they might be. As Akshay says, some of that is available and we want to make it better, but there is also a genuine dialogue about the level of transparency on individual projects and the quality of the information being provided, because what your connecting party wants is a forward-looking map that tells it where it will be in a couple of years’ time.
The Chair: There is an issue of commercial confidentiality, presumably, if you want to know what other people might be doing.
Eleanor Warburton: I do not think that it is insuperable but, yes, it is about commercial confidentiality, level of detail and timely accuracy that is kept up to date.
Q96 Viscount Chandos: You have both talked about different aspects of demand and supply connections. Has the right focus and the right balance been applied to the two ends of the network?
Akshay Kaul: That is an excellent question. Demand connections are about 42 gigawatts out of that queue of 750 gigawatts, so they are comparatively small in terms of their overall magnitude. However, they are fundamentally important to the growth objective because a lot of these are the data centres and the factories that will drive economic growth. Therefore, it is fundamentally important that we accelerate both the demand and the supply projects.
Our sense is that with the clearing out of the queue it should have that accelerating effect on both demand and supply. In particular, as Eleanor mentioned, for demand we will automatically deem that they are all needed. As long as they meet the readiness criteria, all the demand projects will be deemed as needed and therefore progressed. That should accelerate significantly the existing 42 gigawatts of demand in the queue.
Looking ahead, we see a logic in terms of major sources of demand, like data centres, for instance. If they are going to grow massively—and some of them could be huge in their energy demand—it makes a lot of sense to start to take a strategically spatially planned approach to demand as well as supply.
At the moment we are largely taking that approach to supply, the generation and storage, but as you will have seen with the Government’s AI and growth strategy, the Government are introducing the idea of zoning for data centres. That is a fantastic opportunity to take a spatially planned approach to the infrastructure required to support the data centres in these zones so that communications in energy and transport can all align and support the growth in these zones.
Viscount Chandos: Baroness Drake will come on to zonal issues in a second. There are connections or businesses that can be both a source of demand and a source of supply—the data centres as generators of a lot of heat and so on. Does that get adequately factored into planning?
Eleanor Warburton: It is a good question. It is factored in—and I appreciate that this is an unhelpful answer—but a great deal comes down to the specifics of exactly how these sites work. If they have a small connection because they are netting off a lot behind the meter, for example, from a connections point of view the only thing that matters is the size of the connection. Therefore, it is adequately factored in at present, but with the potential for very significant changes, particularly on the data-centre side, as we have seen in other countries, so it is an area that will merit close, ongoing work to make sure that we understand how it is evolving.
Viscount Chandos: You have touched on information. How good do you think that the information is area by area to assist particularly the sources of demand to make decisions?
Akshay Kaul: It is getting better. There is a much better digital map now. Is that what you mean, the grid capacities across the country?
Viscount Chandos: Yes.
Akshay Kaul: There is a big initiative that NESO is doing with its connections portal on the transmission grid to make that map very visible and very clear to people. We need to do more work at the distribution grid level. The digitalisation of the distribution grid is also fundamentally important here, but it is a bit further behind compared to transmission. That is why the initiative to drive that progress through the end-to-end connections review is so important.
Q97 Baroness Drake: The Government are currently seeking views on options for changes to the electricity market, including the locational pricing issue, which is a hot debate, and its potential to incentivise generation and demand to locate closer together to each other, reducing the amount of grid that needs to be built. In your view, do greater incentives need to be introduced to encourage generation and energy demand to locate closer to one another? If so, should that be done through locational pricing or through reforms to network charging?
Akshay Kaul: Again, that is a good question and, as you say, a live debate in the industry. It is quite a polarised and vicious debate in the industry. I studied locational pricing 25 years ago in power market design and it is a very technical topic in congestion management in the power network. To see it developing into something of a culture war in the industry is very odd. It is striking how polarised the debate has become.
Where we see a role for locational pricing is in the better management of congestion by sending better price signals to batteries and interconnectors. That is the principal benefit that we see from locational pricing, because those signals do not exist at the moment, and you cannot send those signals through transmission charges. That is the unique contribution that we think locational pricing or zonal pricing can make in helping the control room in particular to use the fleet of batteries and interconnectors much better.
Interconnectors I would highlight as a particular issue since the exit from the European Union. Because we do not have access to the European single market, it is very difficult for the control room to operate the interconnector fleet in the way that they would like. Zonal pricing can definitely help with that.
These benefits, what we call dispatch benefits, of using batteries and interconnectors are very real, and they will definitely provide a saving to consumers. The question is whether the reform can be done in such a way that you do that while keeping the investment that is needed flowing smoothly and at a low cost of capital. From an Ofgem perspective, we do not see any reason why that cannot be done, but we recognise that that is essentially a trade-off and a policy decision for the Government to make.
Where transmission charges come in is on the question of location, where you locate objects, rather than when they generate or charge or discharge or import or export. It is a question of where you locate the objects. Something that has happened since the debates began is that we have significantly moved in favour of spatially planning the energy system. As you can see from the connections queue, that is going all the way to using the clean power action plan to reorder the queue so that it contains the things in the location where you need them.
A live question for us is that if you take that spatial planning as given, that that is the way that we will operate the system going forward, what further role is there for incentives sending price signals to people on where to locate? We have not fully answered this question, but we can say that if you did want to send price signals to both demand and supply to locate in line with a spatial plan, transmission charges are a perfectly feasible way of doing that.
Baroness Drake: Your answer triggers a whole series of questions, but I only have a limited time. You referred to the trade-offs and the issue of the cost of capital. Do there need to be trade-offs? Should the Government be prioritising incentives to make the system as efficient as possible, or greater certainty for investors, given the growth aspirations? Should the Government be providing more of a steer on the trade-offs between growth and investment, affordability and decarbonisation?
Akshay Kaul: This goes back to one of the earlier questions about the priority between competing objectives. Definitely, from a growth perspective, everybody would agree that trying to bring down the price of electricity is very important. If this is a way of doing that, it is definitely something that is worth prioritising. However, it has to be done in such a way that it does not imperil the investment that is needed within the energy sector, which itself is a significant driver of growth activity and jobs and manufacturing in the next four or five years.
The question really is how to manage the transition to a power system that has zonal pricing in it. Is it possible to provide adequate certainty to investors in renewable power, in particular through Contracts for Difference and the like, so that they can invest with confidence while the reform goes through, and we introduce these arrangements that will help to bring down the price of electricity in the long term?
Baroness Drake: Is there a timing issue here, with the urgency of the 2030 clean energy target? Does that suggest that locational pricing should come after 2030 rather than move on it prior to 2030, or is it not relevant?
Akshay Kaul: It is always a good question to ask about the perfect timing. There is probably no perfect time to introduce a reform like zonal pricing. Some people say that we should have started 15 years ago. Perhaps, but we are where we are. If you look ahead to the next 10 or 15 years, the system will be in a state of investment for all of that time. There will be a huge need to first get to the clean power target and then to put in the investment needed for heat and transport in the next decade. I do not think that there will ever be a perfect time to do it, but you are right that there is a trade-off there between the long-term benefit of this kind of reform and minimising the short-term disruption that it can cause to energy sector investment.
Baroness Drake: Given your response to Viscount Chandos that a spatial view could be delivered by demand side as well as supply side considerations, what complication does that introduce for consideration on pricing going forward, or does it not produce a complication?
Eleanor Warburton: It is an integral part of the picture. First, yes, if you have these different pricing zones you have to look equally at the means for generation and the demand in those areas. We have seen, for example, a lot of the Scandinavian markets do have zones, and you start to see things like data centres looking at those prices and looking at where they might locate because of them.
Equally, as Akshay suggested, increasingly we will have quite a lot of assets that are both demand and supply, anything that has storage, interconnection, electrolysis, those things. Therefore, again a key question and purpose of any move to zonal is what it is doing to encourage the flows of those in different directions at the right point in time on the system. Your future demand landscape and what you want to achieve there and what you can expect from it are integral in deciding whether to do this and the mitigations that you might need. You want to make sure that it fits with your industrial strategy and so on.
Viscount Thurso: I want to ask about the relationship between Ofgem and NESO, but can I ask a quick follow-up question to Baroness Drake’s? The AI zone criteria that the Government have put out and asked for submissions on have three things that they ask for: one is 500 megawatts of energy; one is land for development; and the third is proximity to nuclear. It just so happens that all three of those things can be found in Caithness. Does that not drive, almost automatically, locational pricing?
Akshay Kaul: Not necessarily. You still have to decide what tool you will use to determine the location of these objects. For instance, if you use a planning power and they can only go in those zones, sending price signals for them to do that may become a bit redundant and unnecessary. Similarly, if you are sending transmission charge signals, you can do that rather than using planning powers. There are alternative ways in which one can take a spatial plan, like AI growth zones, and give it effect in the real world. Some involve sending price signals and some involve using planning powers that the Government have.
Q98 Viscount Thurso: Let me go to my question. Can you tell us about how Ofgem and NESO co-operate in relation to energy networks? To what extent is NESO able to give independent advice on the energy system needs and what is Ofgem’s role within that, given that you regulate it and that gives you a power over them and that is always a power imbalance, automatically. How does that work?
Akshay Kaul: Yes, that is a great question, Viscount Thurso. We were a very early and vocal campaigner for the establishment of NESO as an independent system operator. What we meant by “independent” in that phrase is that it should be independent of commercial interests, of private sector interests, because it used to be part of National Grid, which is a for-profit network entity, and we could see the clear conflict in asking a body like that to plan the energy system and carry out essentially a public policy objective. Therefore, the creation of NESO for us is very important in giving it full independence from any commercial interests that the industry might have.
On the relationship that we have with NESO, which is a two-part relationship, we work as strategic partners in a range of endeavours, for instance on queue reform, on the planning of the system and other changes that might be needed to the rules. We very much act in partnership. The NESO acts as a technical body advising Ofgem, the department holds the energy policy responsibilities, and we hold the economic regulation levers.
At the same time, the Government have quite deliberately set up NESO to be an independently regulated entity. That is the second part of our relationship with them. They could have chosen to do it differently. They could have chosen essentially to regulate NESO through ownership, because the Government are the sole shareholder, but it was seen as quite important to give NESO operational autonomy and day-to-day autonomy and, therefore, for it to be independently regulated by Ofgem. There our role is largely to make sure that NESO is performing well and that the spending of NESO is delivering good value for money for consumers.
Viscount Thurso: Some of our witnesses have suggested that it would be helpful to have more clarity between the roles of you, NESO and the Government. Do you think that that is necessary or are you content with the way that it has been set up?
Akshay Kaul: As you say, there is a live debate at the moment on the number of institutions, not just these three. There are a few institutions that have taken shape in the energy system and how they interrelate with one another. The Government’s review of Ofgem is a good opportunity to try to give greater clarity in these distinct roles.
I can sketch out for you in a relatively simple way what we see as the distinction between at least these three entities: the department, Ofgem and NESO. The department is there to make energy policy because the Secretary of State is accountable for that, and that is rightly the place where energy policy should be made. Ofgem sets prices and sets standards of service for regulated entities. We are the economic regulator. That has always been our job and it continues to be our job. NESO is the system operator and system planner, and it gives technical advice to the Government and Ofgem on the needs case, as Eleanor mentioned, for a lot of the investment.
We see these three roles as very distinct, clear and complementary. However, once you get into the detail of the day-to-day working, we ask ourselves every other week if this could be done better somewhere else. Our collective aim is to make sure that any work that needs doing is done in one place rather than being duplicated. As time goes on, we will be able to evolve those boundaries in a better way. I can give you a quick example of that: the idea of introducing tender as a competition for network infrastructure. We are quite interested in the American model, where the system operator not just prepares the system plan but tenders out the links that need to be competed. That is a good example of something that is currently done in Ofgem that possibly over time could be done in NESO.
Viscount Chandos: It is early days, but have you seen benefits yet from the move from ESO to NESO?
Akshay Kaul: Yes. The Clean Power Action Plan is a very early dividend from that move. It is very difficult to imagine that being a credible, legitimate piece of advice if it was coming out of a for-profit, private sector entity. The NESO team has done a good job in a very short space of time in putting together a spatial plan where the numbers all add up to a clean power target. It gives us a very clear mix of technologies in different locations and has allowed the Government essentially to prepare their Clean Power Action Plan and then provide clarity to the sector. That has already been a singular benefit of having an independent system planner. That is just the downpayment. With the spatial planning coming up, that is where it will really come into its own.
Eleanor Warburton: I absolutely agree. Bluntly, we all knew for some months before it happened that there would be a move to NESO, the whole sector, and we knew roughly when. Therefore, if we are honest, we started anticipating the benefits of NESO a little. Some of the work that it was already starting, even in that period before it formally was NESO, were not things that would ever have been asked of it if it had been the system operator permanently staying within National Grid. That whole trajectory to strategic planning has only been possible because we knew that change was coming. We can now start banking that and over the next couple of years we will see that pushing forward into the longer-term future in some important ways.
Q99 Lord Udny-Lister: This is a slightly controversial question, but if the Government wanted to reduce regulation, why do they not merge NESO and you together?
Akshay Kaul: That is properly a matter for the Government. You should probably ask them that question.
Lord Udny-Lister: Let me rephrase it. There is a lot of overlap between the two of you. Would it not be better if you were actually one?
Akshay Kaul: There are pros and cons to doing something like that. The current model has a check and balance embedded in it. NESO is spending a lot of consumer money, and ordinarily a public authority spending all that consumer money would be subject to Treasury spending controls, but it is not. It is independently regulated by us so there is a check and balance in that respect. There is also a logic in having a check and balance in people holding one another to account. We can point out, for instance, to the department where there is a gap in the policy, as can NESO. We come to that from different perspectives. We look at it from the perspective of an economic regulator trying to set prices, whereas NESO would look at it as a technical body trying to operate the system day to day. The insight that they generate from that gives a different vantage point but a very valuable perspective on improving policy as well as improving regulation. Therefore, this model does have the benefit of having different perspectives creating an institutional check and balance on one another.
At the same time, in the past there have been ideas of creating energy agencies that bring together all of the levers—regulation as well as planning as well as system operation. The main downside of that is that you lose these checks and balances, and you might well create a behemoth that becomes very unwieldy because it is trying to put too many different things into one place. Having said all that, this is entirely a matter of policy for the Government, and we work with their preferences.
Viscount Trenchard: I want to jump in. You are very enthusiastic about the NESO’s report. I think it was based on the costs that offshore wind can generate power at £44 per megawatt hour at current prices. However, the recent capacity auctions are awarding contracts at much higher prices. How do you explain that?
Akshay Kaul: You are right. The NESO report indicated that, by and large, the total costs of the energy system would be roughly the same in 2030 as they are right now, they will be roughly flat. That included some assumptions about clearing prices in the auction rounds. It is true that the recent auctions, known as “AR6”, have seen an increase in those auction prices.
As the economic regulator—and you probably expect us to say this—we are looking at the costs quite carefully because we think that there are three cost pressures on this path to 2030 that we need to carefully watch from a consumer bill perspective. The first is what happens to the cost of delivering the infrastructure in the auctions and in the capacity market. The second is the co-ordination between generation and transmission infrastructure. If we build a lot of generation but we are not able to build the grid to take the power, we will end up driving up the cost of congestion, which goes on consumer bills. It is very important to time and co-ordinate those things well.
The third thing that we need to watch out for is market power. There will be a gas fleet, about 35 gigawatts, as set out in the NESO report. They will have a degree of market power, and we want to work with the department to make sure that that market power is not abused in any way and prices remain under control. You are right that these are three areas that we need to watch out for.
Eleanor Warburton: The only uncertainty to note in the other direction is that the less we move power on to renewable sources, the more exposed it is to the regional and global gas price. As everyone acknowledges, that is the other big uncertainty going forward. Whether path A will turn out to have been cheaper than path B with the benefit of hindsight in 2030 will depend hugely on what happens with the gas price. Particularly given current events, I am not sure. It is certainly not a bet that I am going to make, but it is the other big uncertainty in the picture.
Q100 The Chair: A final question from me about energy codes. We are, as we all recognise, in a dynamic situation. The pace of change is very rapid. There has been some reform to energy codes. Do you think that they are now flexible enough and fit for purpose and is Ofgem using them to drive change? They are not complete yet. Is there a timeframe, is it difficult to put an end date on this or would that help in any way?
Eleanor Warburton: The code reform that you allude to is a reform primarily of process. At the moment, at the risk of stating the obvious, there are a very large number of codes, they are quite specific, and any change of real strategic value normally cuts across several, so trying to change them all in tandem is slow and difficult and the process is clunky.
For the process reforms, as you say, they are partway through. We have had the primary legislation; we have the Government working through the secondary legislation and the Secretary of State is due to designate the new code licence towards the end of the year. We will then start licensing the code bodies.
We have already put out what we call a strategic direction statement, which clearly tells all the codes that these the things they need to prioritise, this is the direction they need to be moving in. We expect them to be looking at that and thinking about that now. The act of licensing makes it enforceable on them, so it moves it from being something where we say, “You can clearly see the direction we are going in, work with this”, to, “You are now a licensed body and you have obligations in this space”.
That should increase all of our ability, so that when we do have key changes that need to be made—things like the right charging model for the future, or connections reform—it can be done in a quicker, more agile way as we move across the second half of this decade and consolidate some of the codes across a smaller number of codes that are more coherent and more joined up.
We expect it all to be done over the next five years, but it is not a case of not realising changes until the final piece is done, it is more that we should already start to be seeing some speeding up. That will increase and we will work across the codes to embed it. As with all things, it is a bit of a trade-off between keeping the space to make the individual changes you need—this particular rule change—and reforming the code overall. You have to give them enough space to get on with both.
The Chair: Has that approach been accepted by the players? Have they welcomed this approach that you are taking about now?
Eleanor Warburton: In principle. I do not think that you will find anybody in the industry who seriously argues that codes do not need reform. I fully expect us to experience a bit of this as it beds in: as the strategic direction statements start to push complex, challenging areas, that inevitably brings some winners and losers, so you will see industry grappling with the new process as they go through it, perhaps particularly for the first time, and you will see a bit of bedding in there. However, you will see it particularly in terms of how it applies to this reform or that reform that is particularly controversial.
The Chair: Thank you very much indeed for the information that you have given us. That is very helpful, and we will take what you have said on board. Thank you, and I will close this session.
