Net zero transition – major structural changes ahead

Blog | Energy
Published: 23rd April 2022
Area: Corporate & Commercial

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Recently (April), BEIS and Ofgem announced a decision to create a new ‘future system operator’ (FSO), the culmination of a consultation which began in July 2021. Around the same time they also published a response to a separate consultation on the reform of the energy industry codes.

System operation - the case for change

This is all about the net zero transition – creating an expert and impartial body to coordinate the ever more integrated electricity and gas systems, both onshore and offshore, with an eye to the emerging hydrogen and carbon capture and storage markets.  And crucially, managing the trade-offs and synergies between net zero transition, security of supply and affordability.

The system operator roles for electricity and gas are currently undertaken within National Grid, by respectively National Grid Electricity System Operator (National Grid ESO) and National Grid Gas. As a firm we have a long relationship with both, especially National Grid ESO, for whom we have been supporting on balancing services procurement and contracting all the way back to shortly after industry privatisation in the early 1990s.

Fully supported by National Grid, the changes now announced will see the biggest structural change in electricity system operation since those early days, which is perhaps an indication of the scale of the net zero challenge the country faces.

The new FSO

The new FSO will be a public corporation, sitting within the public sector but outside of central government.  And it will be independent, of both asset ownership and commercial interests but also of government.  It will be founded on the existing roles and capabilities within National Grid, notably the system operator role within National Grid ESO but also the longer term planning, forecasting and market strategy functions of National Grid Gas.  The existing gas system operator role will remain within National Grid Gas.

New regulatory framework

Key features:

  • Two new categories of licence within legislation – an electricity system operator licence and a gas system planner licence, both to be held by the FSO, with regulation by Ofgem

  • A primary statutory duty for the FSO to undertake its functions in a way that best promotes achieving net zero, ensuring security of supply in electricity and gas, and ensuring an efficient, coordinated and economical electricity and gas system

  • An additional duty to have regard to the need to facilitate competition and innovation, the impacts on consumers and consumer behaviour, and whole system impacts

  • A statutory advisory duty for the FSO, building on National Grid’s current responsibilities such as the future energy scenarios programme

  • New statutory powers for the FSO to obtain data from other licence holders (and exemption holders)

Crucially, while operating independently, the FSO will have an additional legislative duty to have regard to government’s energy sector policy and strategic objectives set out in its Strategy and Policy Statement framework (SPS) when undertaking its functions, in much the same way as Ofgem is required to currently.

Implementation

In terms of implementation, in addition to new primary and secondary legislation, it is envisaged that there will be a statutory transfer scheme to ensure that all relevant assets and capabilities are moved to the new body. Modifications will also be required to industry codes and agreements to take account of the new arrangements. It is also planned to consult on the future ownership of Elexon, currently held by National Grid ESO. With all this in mind, the government plans to work to a timetable that will see the FSO established “by, or in, 2024”.

Energy Code Reform

In a related development, again looking to the net zero transition programme, government and Ofgem also published in April its response to a separate consultation in July 2021 on the reform of the energy industry codes. New strategic code functions are to be given to Ofgem, in an expansion of its existing code roles.

Key features:

  • Ofgem will be required to publish an annual strategic direction setting out its vision for how the codes should evolve, taking into account relevant aspects of the SPS, which the code managers will then implement

  • Ofgem will also have direct ability to change codes, albeit in limited circumstances and after consultation (and subject to government veto and appeal to the Competition and Markets Authority)

  • Ofgem will have power to select and licence code managers, including after competitive tender, and these code managers will replace existing code administrators and panels and be regulated by licence

Also within scope are the four central system delivery functions: those underpinning the gas industry undertaken by Xoserve, the electricity balancing and settlement arrangements undertaken by Elexon, the smart metering delivery rules and requirements that sit under the Smart Energy Code, and the functions underpinning the Data Transfer Service that are used in the change of supplier process. In due course, these will be supplemented by the central switching service. These functions are fundamentally important to the operation of the energy industry, including the move to net zero. Ofgem will be given powers to give directions to the relevant bodies, and the code managers will be given an obligation to cooperate with them for the purposes of delivering the strategic direction.

These changes are in some cases quite fundamental, and it is envisaged that transition will take place on a code-by-code basis, with Ofgem being granted powers to modify codes, licences and agreements for seven years and to establish transfer schemes. Further details will be published by Ofgem in an open letter to the industry later this year.

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Andrew is a specialist energy regulatory and contracts lawyer, who works with a range of utility and developer clients and funders to help them manage regulatory and legal risk in a fast moving and complex environment. Andrew is also currently our elected Senior Partner.

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