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Ofgem calls for independent system operator as it cites 'potential National Grid conflicts of interest'

Image: National Grid.

Image: National Grid.

Pointing to what it described as “potential” conflicts of interest within National Grid, Ofgem has issued a recommendation for a fully independent system operator (ISO).

In its review of GB’s energy system operation report, the energy regulator stated that to enable an integrated, flexible energy system - as needed for net zero - a system operator (SO) that is both fully independent from the transmission network owner - National Grid - and has enhanced functions, will be required.

It said that despite the legal separation of National Grid Electricity Transmission and National Grid ESO in April 2019, potential asset ownership conflicts of interest could act as a barrier to the electricity and gas SOs performing their net zero roles efficiently.

These conflicts of interest could resulting in “real or perceived bias” in the SOs’ decision-making against outcomes that would negatively impact the value of existing assets such as interconnectors and transmission assets.

It said that interview evidence – with Ofgem conducting over 30 interviews with industry experts and stakeholders for the report – suggests that although the legal separation has gone “some way” to mitigating perceptions of conflicts of interest, it hasn’t created sufficient confidence to enable the ESO to take on and perform potential net zero system roles effectively.

Ofgem added that while it has “no evidence of National Grid acting in a way that deliberately exploits any potential conflicts of interest”, the perception of bias is “damaging regardless of whether there is any explicit evidence”.

Going into more detail, the regulator presented potential biases that included advice from the SOs to government, Ofgem and other stakeholders being – or being perceived to be – in National Grid’s interest rather than the interest of consumers. It gave the example of the SOs potentially having inherent interests against market designs that reduce the need for transmission assets.

It also suggested there is possible bias in transmission network development, with the SOs potentially acting – or once again being perceived to act – to increase the size of affiliated companies’ transmission asset bases and therefore increasing the commercial return of those businesses.

Lastly, it said there is possible bias in facilitating competition, with the SOs being – or being perceived to be – biased towards affiliated companies in the design, facilitation or operation of competitive markets or processes where those affiliated companies can participate directly or where the markets provide investment signals for less transmission.

Separating the SOs from the transmission operators therefore has the potential to save consumers between £0.4 and £4.8 billion between 2022 and 2050, according to theoretical analysis from FTI Consulting as part of the report.

The benefits to consumers of fully unbundling the SOs consist of preventing potential over-investment on the transmission networks through SO recommendations on the evolution of National Grid's transmission networks and cost savings that wouldn't be achieved through the ESO facilitating competitive procurement of new electricity transmission network assets due to the perception of potential competitors that there is an "incumbency advantage" for National Grid Electricity Transmission.

Alongside potential cost savings, an independent system operator would also have enhanced capabilities to help manage the increasingly complex energy system whilst bearing down on network investment costs, with these responsibilities including:

  • Taking a more proactive role in the balancing of supply and demand across both local and national electricity networks, which could include creating new opportunities to reward consumers and generators for being flexible in the way they use electricity
  • Coordinating the planning of the GB electricity network
  • Making recommendations on the future capability requirements of existing assets
  • Facilitating an integrating approach to the development of networks across the energy system and with other areas including heat and transport
  • Providing trusted policy advice on the costs and trade-offs of different low carbon pathways to government

A key part of this would be enhancing the SOs’ roles to include greater responsibility for strategically planning and coordinating the development of the electricity and gas networks, including onshore, offshore, interconnectors and distribution networks where relevant.

This could also enable greater strategic alignment across electricity and gas network planning and between energy, heat and transport networks, Ofgem said.

As part of the report, FTI Consulting produced a range of alternative SO models, which vary to the degree of separation from National Grid. The first option – Status Quo – represents the current arrangements, with no additional separation. The second option – Enhanced Legal Separation – represents additional obligations on the ESO that aim to further mitigate any conflicts of interest. The final option – Strategic Planning Body – sees a range of current and net zero system roles unbundled from National Grid and handed to a strategic planning body, with control centre operation performed by National Grid Electricity Transmission or National Grid Gas Transmission.

Jonathan Brearley, chief executive of Ofgem, said that an independent body would help deliver the “fundamental changes in how we use energy”, with the energy system needing to undergo the “biggest transformation in over a century” to meet net zero.

Moving forward, Ofgem is therefore to work with the government on its forthcoming review of the energy system governance, stating that there is "a strong case for considering changes to the ownership, governance and commercial model of the current SOs, and for considering combined responsibilities for electricity and gas net zero system roles".

In response to the report, National Grid said that to deliver the clean energy transition in a timely, fair and affordable way, "an aligned view on the activities required from a future energy system, a clear set of principles by which they are governed, and the frameworks to support them" is required, with a potential divestment of the ESO being an "important part of that discussion".

"An industry structure that enables long-term thinking and allows the SO to take on new roles as part of the energy transition is an important step in the market and regulatory reform necessary to deliver net zero. Significant further work is needed to determine the detail of that structure."

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