National Grid written evidence (ONZ0051)

Executive summary

National Grid sits at the heart of Britain’s energy system, connecting millions of people and businesses to the energy they use every day. We understand our responsibilities to the environment and future generations, so we are working to develop solutions to enable the transition to a clean economy, in which nobody is left behind.

National Grid is supporting the UK’s economic recovery through investing and innovating across strategic infrastructure solutions which support key decarbonisation technologies, such as offshore wind connections, hydrogen, electric vehicles and carbon capture, usage and storage (CCUS). In combination, these solutions will position the UK as a net zero leader globally, whilst delivering clear benefits locally.

We welcome the opportunity to respond to this inquiry into the work of Ofgem. Appropriate independent economic regulation, which is clear, stable and forward-looking will be vital to achieving the UK’s net zero ambition, as well as ensuring that the UK is seen as a positive destination for inward investment. Ofgem has an important role in supporting decarbonisation throughout the energy supply chain, from generation, to transportation (transmission and distribution via networks) through to end use by consumers in homes and businesses. This response focuses on the work of Ofgem with regard to network regulation.

Since privatisation, the network companies have delivered around £100 billion of investment, facilitating market outcomes and direct service improvements. Since 2013, investment has been delivered through the RIIO[1] price control framework; an incentive-based approach to regulating network monopolies, including National Grid’s electricity and gas transmission businesses. As we look to the future, it is crucial that the regulatory framework supports investment at pace, effectively enabling positive outcomes for the economy, environment and consumers.

In summary, our submission to this inquiry sets out that:

• Ofgem has a critical role in supporting net zero, and the regulatory framework has delivered considerable benefits to date. As the economic regulator for gas and electricity markets, Ofgem must play a central role in net zero delivery through developing and applying frameworks that drive economic and efficient investment while protecting current and future consumers. The UK has had considerable success to date. Specifically, the network regulatory regime has been a key facilitator of the significant progress made to decarbonise the power sector, while energy bills have broadly remained competitive with our European neighbours.

• The scale of the challenge to meet net zero requires a different mindset and approach from Government, Ofgem and industry. Significant investment will continue to be required in the UK’s energy infrastructure, but this will take place in a rapidly evolving system which is becoming more decarbonised, decentralised and digitised. This is an exciting transition, which is happening at real pace. Government, Ofgem and industry will need to work closely together, and a future-looking regulatory framework will be essential.

• Ofgem’s role, responsibilities and duties will need to evolve as part of a wider reform of energy governance, with greater clarity and alignment required across different organisations and processes. We believe that strengthening Ofgem’s statutory duties to specifically support the delivery of the UK’s emissions reduction targets would help to ensure net zero receives sufficient focus, and enable Ofgem to better balance its objectives to serve the needs of current and future consumers. Moreover, it is important that roles, responsibilities, accountabilities, and interactions between government, Ofgem and industry parties are clear, that processes for decision-making are aligned (for example the regulatory process and the planning process), and that all decisions are based on robust cost-benefit analysis that takes full account of the environmental and social impacts. We also expect Ofgem’s role to evolve as part of wider energy governance reforms, including the Government’s proposal to establish a Future System Operator.

• While the fundamental principles of the energy network regulatory framework are sound, changes to the regime will be needed to ensure it is fit for the future. The RIIO price control framework has been an important factor in driving efficient investment, taking an incentive-based approach to performance, with a focus on customer outputs and innovation. However, the RIIO-T2 period (2021-2026) marked a departure from some of these principles, resulting in a framework which may not be in the best long-term interest of consumers or net zero. While the principles underpinning RIIO remain sound, an evolution of this regime will be necessary to ensure Ofgem provides timely investment certainty, encourages innovation, enables anticipatory strategic investment and appropriately balances the needs of current and future consumers.

• In the meantime, there’s a need to ensure Ofgem is appropriately resourced to deliver investment certainty at pace. It is important that Ofgem has the capability and capacity to review, analyse and make determinations on investment proposals in a timely way to ensure the energy transition is delivered at pace and that consumer benefits are not delayed.

Responses to inquiry questions

1. What role should Ofgem play in the transition to net zero? What changes, if any, should be made to its remit, responsibilities and resources?

As the economic regulator for gas and electricity markets, Ofgem has an important role to play in the transition to net zero through developing and applying frameworks that drive economic and efficient investment while protecting current and future consumers, thus ensuring a fair and just transition.

The scale of investment needed in the underlying network infrastructure to support net zero in the coming decade and beyond is significant; indeed, National Grid Electricity Transmission and National Grid Gas Transmission plan to invest around £10bn in the next five years to transform our network for the future. This investment will be delivered through the RIIO price control framework set by Ofgem, giving it a critical role in ensuring delivery at pace, both in this price control period, RIIO-T2 (2021-2026), and in future periods.

To ensure net zero is given sufficient weight in Ofgem’s decision-making, we think there is merit in reviewing its duties to reflect the UK’s current decarbonisation targets, which is considered in question 7. More broadly, Ofgem’s role in delivering net zero will need to be considered in the wider context of an evolving institutional governance landscape for the energy system, which is looked at in question 6.

From a resourcing perspective, it is important that Ofgem has the capability and capacity to review, analyse and make determinations on investment proposals in a timely way to ensure the energy transition is delivered at pace and that consumer benefits are not delayed. As part of RIIO-T2, Ofgem has established a flexible package of Uncertainty Mechanisms, enabling £10bn or more of additional funding (above baseline funding) to allow companies to bring forward strategic network investment during the price control to help meet net zero, such as those needed to support offshore wind connections in line with the Government’s target for 40GW by 2030. Uncertainty Mechanisms will require many projects to be subject to a detailed review by Ofgem before funding is agreed, therefore Ofgem must be appropriately resourced to ensure decisions are made at speed, and the Uncertainty Mechanisms process is not a barrier to the timely delivery of infrastructure. Transparency on the timeliness of decision making could be improved through appropriate monitoring and reporting.

2. How well does Ofgem balance environmental objectives against its responsibilities in relation to affordability for consumers?
3. How well does Ofgem fulfil its obligations to consumers? Does Ofgem take consumer views into account sufficiently, particularly those of vulnerable consumers?

We recognise that Ofgem has a difficult balancing act, considering the needs of current and future energy consumers in terms of costs, security of supply and sustainability. Ofgem’s focus has traditionally been on lowest cost outputs and solutions for current consumers. Whilst this was appropriate for mature and stable networks, the focus now on delivery of a fair and just energy transition requires prioritisation of inter-generational affordability, security of supply and decarbonisation considerations.

We welcome open engagement with Ofgem and other stakeholders on how to best to balance affordability with the investment required to facilitate the energy transition. In addition, HM Treasury’s review into funding the transition to a net zero greenhouse gas economy (‘cost of net zero review’) is an opportunity to ensure costs are allocated appropriately and proportionally.

We think there is merit in reviewing Ofgem’s duties to ensure net zero is given sufficient weight alongside affordability in its decision-making, which is considered in our response to question 7. In addition, potential changes to the RIIO regime outlined in our response to question 5 should be considered to ensure minimisation of net costs and therefore appropriate protection of consumers (and maximisation of consumer benefits) throughout delivery of the energy transition.

It is important that Ofgem evidences how they have considered the views of consumers in their decisions. Customer and stakeholder engagement was a major focus area for the RIIO-T2 business plan formulation. However, the determination process felt detached from the engagement undertaken by networks as part of their business plan submissions. This could be improved with greater transparency and clarity on Ofgem’s consumer and vulnerability objectives. We look forward to continuing to work with Ofgem and BEIS as we build and strengthen the RIIO stakeholder engagement approach.

4. What implications will the transition to net zero have for the security of the UK’s energy supply? How does Ofgem currently manage issues relating to security of supply?

Security of supply will increasingly be a whole system challenge and should be considered in this context. It is important that Ofgem enables timely investment in network connections and asset health to ensure continued security of supply throughout the transition.

5. Is Ofgem’s current system of price controls appropriate? Does it provide sufficient incentives to invest in the context of the transition to net zero?

Overall, the network regulatory regime has, to date, been a key facilitator of the significant progress made to decarbonise the power sector while energy bills have broadly remained competitive with our European neighbours.[2] The RIIO price control framework has been an important factor in driving efficient investment since its inception in 2013, taking a long-term, incentive-based approach, with a focus on customer outputs and innovation. However, the RIIO-T2 period, which started this year, marked a departure from some of these principles which, notwithstanding the improvements made between Ofgem’s draft and final determinations, has resulted in a framework which may not be in the best long-term interest of consumers or net zero.

While the principles underpinning RIIO remain sound, an evolution of this regime will be necessary to ensure it provides timely investment certainty, encourages innovation, supports anticipatory strategic investment and appropriately balances the needs of current and future consumers. With this in mind, we would propose focusing on adjustments in the following areas:

Providing earlier funding certainty which can support strategic network investments: Under the current framework, the initial recommendation for electricity transmission network infrastructure is typically determined through the Network Options Assessment (NOA), performed by the Electricity System Operator[3]. NOA provides an economic signal to progress the delivery of network infrastructure, however it is iterated on an annual basis, resulting in a ‘stop-start’ approach to investments in some cases. For larger infrastructure, this is tested in further detail by Ofgem through the Large Onshore Transmission Investments (LOTI) process[4], however there is a misalignment between this regime and the process to obtain the Development Consent Order planning permission, which creates uncertainty and risks delay to these projects to the detriment of consumers and environmental targets.

Certainty of investment need, and confirmation that the optimal options have been selected, are therefore needed much earlier. We welcome the ongoing development of the onshore Holistic Network Design[5], which should provide a clear ‘blueprint’ for network investment over the longer-term, and it is important that this is endorsed by Government and Ofgem. Furthermore, it is critical to align the planning and regulatory approvals processes, ensuring earlier agreement between Ofgem and Government on the right schemes to deliver net zero.

From a gas network perspective, the future hydrogen network will evolve under diverse regional pathways and timelines and will require an agile and adaptable regulatory framework to enable the right investment at the right time. Anticipatory strategic investment in hydrogen networks, to optimise the repurposing of existing natural gas assets and the development of new infrastructure, is needed ahead of the emergence of mature conditions for production and demand. This will enable the timely development of the hydrogen economy and provide the required integration and interconnectivity of the whole energy system.

Ensuring a clear and consistent approach to determining the cost of capital across sectors and a consistent appeals framework: A vital part of creating a stable regulatory regime which attracts the investment required to deliver critical infrastructure is ensuring that returns appropriately reflect investor risk; however, we do not believe that this is currently the case for RIIO-T2. While it is appropriate that the allowances for cost of capital in this investment period are below those in RIIO-T1, the current levels set by Ofgem do not appropriately reflect the level of risk borne by networks, especially given the role they will play in enabling the required transformation of the energy system to meet our net zero goal. Furthermore, the returns set by Ofgem are lower than those set for the water sector, which is not required to deliver a comparable scale of transformative investment.

It is notable that nine network companies, including National Grid Gas and National Grid Electricity Transmission, are currently appealing Ofgem’s decision on the cost of equity (as well as other issues) to the Competition and Markets Authority (CMA). In their recent Provisional Determinations, the CMA has not found in favour of the appeals regarding cost of equity. Whilst the process is ongoing, it has highlighted the disparity between the sectoral appeal regimes, whereby the CMA has a more limited role in reviewing Ofgem’s decisions on RIIO-T2 than it has in reviewing Ofwat’s decision for the water sector.

In future price controls, the process for establishing the appropriate balance between risk and returns should be improved through greater cross-sector collaboration. We believe that there is some merit in considering whether a single body should have accountability for ensuring that the regulated weighted average cost of capital (WACC) across sectors appropriately balances risk and returns. Consideration should also be given as to how to achieve greater clarity and consistency of processes and decision-making in the appeals regimes across sectors. These changes will help ensure that the UK regulatory environment is consistent and stable, with the framework across different sectors reflecting fundamental economic principles, rather than differences in rules and approaches.

6. Is the current system of governance for the UK energy market appropriate to secure the transition to zero? What improvements could be made and what role should Ofgem play?

The current system of energy governance requires reform, with clear roles, responsibilities and accountabilities for government, Ofgem and industry, to enable the delivery of infrastructure at pace and ensure an efficient and effective transition to net zero. It is important that those accountable for decision-making undertake robust cost benefit analysis that takes full account of the environmental and social impacts and considers the practical considerations of delivering net zero.

Last month, we welcomed BEIS and Ofgem’s consultation on the Energy Future System Operator (FSO). An industry structure that enables long-term, holistic thinking and allows the Electricity System Operator to take on new roles as part of the energy transition is an important step in the market and regulatory reform necessary to deliver the clean energy transition in a timely, fair and affordable way. We will continue to work closely with BEIS and Ofgem on the role of an Energy Future System Operator to ensure appropriate allocation and clarity on roles and responsibilities. For example, we support the recommendation for a new FSO to take on additional roles in system planning and network development, with a focus on the system as a whole, to make recommendations on new infrastructure investment to deliver net zero. Ofgem’s role in this process should then be limited to scrutinising the economic elements of the investment (e.g. the costs of agreed solutions) rather than issues such as need, options selection and technology choice. Conversely, we would expect the FSO’s advice on existing network assets to be limited to where decommissioning or upgraded capacity is considered, with Ofgem assessing the evidence for the need for, and then cost of, maintenance to ensure networks are able to maintain the integrity of the network infrastructure.

The establishment of an FSO can only resolve some of the issues with current governance, and therefore wider reform is still needed, including consideration of:

• Coordination across government departments and regulators with respect to net zero (e.g., transport, energy, water, heat etc.)
• Coordination between national bodies, regional and local authorities and community energy groups, with respect to regional developments in net zero
• Public engagement e.g. on the transition to low, or zero, carbon domestic heating
• Planning, coordination and management of the skills pipeline
• Planning, coordination and management of the supply chain

We will be responding to both the Energy Future System Operator consultation and the BEIS Committee net zero governance inquiry, with further information in both these areas.

7. Are Ofgem’s duties and powers appropriate and sufficiently clearly defined? Do Ofgem’s objectives conflict and, if so, how should any conflicts be managed?

Ofgem’s principal objective[6] in carrying out its functions is to protect the interests of existing and future gas and electricity consumers. This includes consumers’ interests in the reduction of emissions of targeted greenhouse gases.

To improve alignment between policy outcomes set out by Government, Ofgem’s actions and decisions and the investment required, we support the recommendation by the National Infrastructure Commission[7] for the strengthening of Ofgem’s statutory duties to explicitly support the delivery of legally binding greenhouse gas (GHG) emission reduction targets. This clarification of statutory duties, alongside the proposed Strategy and Policy Statement (SPS), as set out in the Energy White Paper[8] last year, would help ensure that Ofgem has due consideration of the need to serve consumers through supporting efficient, timely delivery of investment to help meet decarbonisation targets through a fair and just transition.

8. Is Ofgem’s relationship to Government and Parliament appropriate? Are there issues related to the split of responsibilities, transparency or accountability?

Having an economic regulator which is independent of Government and accountable to Parliament has delivered considerable value to date (as above) and is still appropriate. As outlined in our response to question 7, we support an amendment to Ofgem’s statutory duties and Government’s proposals for an SPS to help ensure alignment between Ofgem’s actions and decisions and policy outcomes set out by Government.

9. How does Ofgem compare to similar bodies internationally? What lessons can be drawn from the experience of other countries or jurisdictions?

National Grid has experience of both UK and US energy network regulation. Different regimes have strengths in different areas. Under the RIIO-T1 framework the UK benefited from strong performance-based incentives, multi-year plans which allow for investment certainty and support for innovation. As outlined in our response to question 5, whilst we have concerns that the RIIO-T2 framework may not be in the best long-term interest of consumers or net zero, we are confident that the principles underpinning RIIO remain sound and that an evolution of the regime could deliver the investment and innovation required for delivery of net zero. As things stand, risks are currently better managed in the US, with regulatory control more proportionate to the risk and allowed cost of capital that is more appropriate for the scale and pace of investment required and the overall risk borne by investors.

In terms of differences between the UK and our European neighbours, the Uncertainty Mechanisms and associated need to apply for additional funding to deliver key net zero investments in the RIIO-T2 framework, as well as the uncertainty surrounding the development of a competition framework, creates a barrier that is not typically experienced by European Transmission Owners (TOs) relying on the same supply base. For example, our work involving High Voltage Direct Current (HVDC) cable systems, such as those to be used on the Eastern Links projects, suggests that other European TOs are able to avoid market uncertainty without bearing additional cost risk in a way that is not possible under the RIIO-T2 LOTI framework. Ofgem needs to provide earlier investment certainty to enable GB projects to secure timely delivery of the components required.

We consider it important that relationships with EU bodies are maintained post-Brexit so that solutions to joint and common energy transition issues can be shared. We therefore support a constructive and effective relationship between Ofgem and ACER (the EU Agency for the Cooperation of Energy Regulators), with a view to continuing to co- operate on the shared challenges of energy security, affordability and sustainability.

10.                     Are there any other aspects of Ofgem’s work that the Committee should consider?

The Committee might also wish to consider BEIS and Ofgem’s proposals for introducing competition. It will be important to ensure that any changes to the regime will benefit consumers and support, rather than stifle, investment at the scale and pace required to meet decarbonisation targets.

27 August 2021