The Energy Transition | Energy regulation special | UK government and Ofgem issue three joint consultations on changes to the energy market, details of the new Energy Digitalisation Strategy revealed and a further government consultation on a potential Cap & Floor regime for energy storage

Written on 23 Jul 2021

This week's Energy Transition focuses on energy regulation, looking in particular at proposals for a Future System Operator role, energy code reform, the smart systems and flexibility plan 2021, the Energy Digitalisation Strategy and the potential application of a Cap & Floor policy to certain energy storage projects.

Consultation on Future System Operator role released

Ofgem and the Department for Business, Energy & Industrial Strategy (BEIS) are jointly consulting on proposals to establish an expert, impartial Future System Operator (FSO) with oversight across the gas and electricity systems. The FSO is intended to help the UK reach its net zero targets whilst keeping costs low for consumers and safeguarding energy security.

According to BEIS, the FSO would be independent – not only from the operational control of government but also from other commercial energy interests. It would also be accountable to consumers, and resilient to operational risks over the short, medium and long-term.

The consultation proposes that all of the existing National Grid Electricity System Operator (NG ESO) functions should be carried out by the FSO. For gas, the consultation suggests that the FSO should either undertake all gas system operation roles, or only some of those roles such as strategic network planning, long-term forecasting, and market strategy functions (with the latter option being preferred).In addition to absorbing existing electricity and gas functions, the consultation also considers a number of new or enhanced functions which an independent FSO could take on across the energy market, including:

  • An advisory role intended to support the decisions of Ofgem, the government and other organisations through independent advice based on its expertise on the impact of policy decisions on the energy system and its technical knowledge across a range of decarbonisation issues.
  • A greater role in system planning and network development, with increased focus in the energy system as a whole.
  • Driving competition in energy networks. For example, this could include enabling onshore electricity network competition by allowing parties other than the usual network companies to compete for network solution build, ownership and operation.
  • A greater role in market design, including additional duties in relation to the electricity Capacity Market.

In terms of how the FSO will be structured, two alternative options for organisational models are set out in the consultation:

  • A corporate body model classified within the public sector, but with operational independence from the government.
  • A privately owned model independent of energy sector interests.

The consultation suggests a phased implementation of the FSO, based on the current capabilities of NG ESO and if necessary, National Grid Gas.

Ofgem and BEIS are seeking responses to their consultation by 28 September.

BEIS and Ofgem launch joint consultation to overhaul current energy code system

BEIS and Ofgem have launched a joint consultation on reforming the energy code governance system to create a structure that supports the government's net zero targets.

The consultation notes that the current codes were designed for a more predictable energy system, and as they have only seen incremental changes over time, are not suitable to deal with an increasingly decentralised energy system. Consequently, the current code governance framework is increasingly fragmented and lacks incentives to innovate.

Feedback from a consultation in 2019, during which BEIS and Ofgem proposed two potential models for energy code reform, has been used to develop the proposals set out in the new consultation. The first of these potential models would see a strategic function performed by a separate "strategic body" with oversight of code managers, and the second would combine those two roles into an Integrated Rule Making Body. In the latest consultation, Ofgem and BEIS outlined that the first model is their preferred option, and designated Ofgem as the body that would take on the strategic function. If this model is adopted, Ofgem will develop directions for codes and publish them annually, and ensure that they are delivered by code managers, who would be held to account via licence. Additionally, Ofgem would decide whether to approve material code changes and sometimes lead code changes itself. If the first and preferred option is selected, it is anticipated that the delivery of codes consolidation could begin in 2024, or in 2026 if the second model is chosen.

BEIS and Ofgem's goals are to create a forward-looking, accessible and accommodating energy code governance regime in light of the growing number of market participants. To that end, they have identified four broad areas for reform: providing strategic direction; empowered and accountable code management; independent decision-making; and code simplification and consolidation. Due to the overarching nature of these areas, they will necessarily cover all 12 of the current electricity and gas codes.

BEIS and Ofgem are seeking comments on the proposals by 28 September. Alongside the consultation, Ofgem and BEIS are running a workshop on the proposed reforms, called "Energy Code Reform – consultation engagement workshop". The workshop will take place on Thursday 5 August from 9.30am to 12.45pm.

Ofgem release Smart Systems and Flexibility Plan 2021

Ofgem has jointly published with the government its Smart Systems and Flexibility Plan, which sets out its vision, analysis and work programme for delivering a smart and flexible energy system. The Plan is split into five chapters, each exploring a different aspect of the UK's energy system that Ofgem will aim to reform in order to reach the UK's net zero target. These are:

  • Facilitating flexibility from consumers, which will explore the ways in which Ofgem can encourage users to provide flexibility to the system and reduce their energy bills.
  • Removing barriers to flexibility: electricity storage and connection. This will set out how Ofgem will address some of the main policy and regulatory barriers facing electricity storage.
  • Reforming markets to reward flexibility, whichwill explore reforms that will improve market signals to unlock the full benefits of flexibility, including national and local flexibility markets.
  • Digitalising the system, which will highlight the importance of using smart data and digitalisation more effectively to create a flexible energy system.
  • Delivering this plan, which will focus on how Ofgem will track its progress in delivering a smart and flexible energy system.

Ofgem estimates that the transition will reduce the cost of the electricity system by up to £10 billion a year by 2050 through reducing the amount of generation and network capacity needed to meet peak demand. Additionally, Ofgem anticipates that the plan will create 24,000 new jobs.

Government publishes Energy Digitalisation Strategy

The government has published the UK's first Energy Digitalisation Strategy, developed alongside Ofgem and Innovate UK, and in collaboration with the energy sector.

Digitalisation and data are highlighted in the strategy as being a key driver in optimising low carbon assets – including solar PV, electric vehicles, battery storage and heat pumps – across the energy system. By sharing data across the network, assets will be integrated at lower costs for consumers and the system will operate more flexibly. The strategy emphasises that a more efficient 'whole system approach' must be created by digitalising all aspects of the energy system, including demand, supply, markets and networks, which will be necessary to achieve the targets set for the sixth Carbon Budget (2033 to 2037). Doing this is estimated to reduce system costs by £30-70 billion from now to 2050.

During the mid-2020s, the government is seeking to establish standards and regulatory frameworks to ensure energy data application and collection meets best practice and is accessible whilst also retaining sufficient privacy protection. From 2030 onwards, energy assets will be visible to system operators so that forecasting and operations can be more efficient in terms of time and cost. Improved access to data will also support new market entrants who can tailor their energy services by using digital platforms.

A list of actions has been included in the strategy, focusing on:

  • Providing leadership and coordination - leading by example and improving the energy practices within their own organisations, coordinating change and building momentum by creating an Energy Digitalisation Taskforce.
  • Incentivising change by implementing an agile regulatory environment, enabling market participants and stakeholders to make the most of digitalisation opportunities and streamlining processes to simplify data collection.
  • Developing digital solutions, which enable sector-wide accessibility of data, stimulate the market and deliver a long-term solution to transforming asset visibility.

Consultation on large-scale and long-duration energy storage projects considers potential application of Cap & Floor

A consultation on facilitating the deployment of large-scale and long-duration electricity storage (LLES) has been announced by BEIS. The consultation aims to improve understanding around the barriers to LLES within the current market, how they could be addressed, and the potential risks attached to deployment.

LLES is defined as a technology that can store and discharge energy for over four hours and has a  capacity of at least 100MW. The consultation notes that electricity storage is essential to providing the necessary range of services to facilitate a low carbon system. According to BEIS, deploying LLES alongside other smart and flexible technologies like interconnection and heat pumps in buildings is estimated to provide £10 billion of savings per year by 2050.

The consultation also suggests that, at present, LLES storage technologies, like pumped hydro and hydrogen, are not being built at the required scale to support the move to a lower carbon energy system. This is due to the barriers faced by such technology, such as attracting investment (which is fuelled by the lack of track record of the technology being used on a large scale), the high upfront capital costs and long lead times.

To help address these issues, the consultation suggests that a Cap & Floor mechanism, like the one currently in place for electricity interconnectors, could also be effective for use in LLES projects. Ofgem developed the Cap & Floor regime to encourage investment in electricity interconnectors. The scheme has been successful in helping developers to secure financing as it provides a minimum revenue allowance. When operator revenues fall below this minimum floor, they are topped up by consumers. Conversely, when revenues breach a revenue cap, excess returns are passed on to consumers.

It remains uncertain whether the Cap & Floor regime would be suitable for hydrogen as there is currently not a market to which it could apply, but the consultation highlights that it could be useful in the long term, dependent on how the hydrogen value chain develops.