Interview: Dermot Nolan, chief executive, Ofgem

“One of the tests for the next couple of years is seeing whether or not competition can deliver.”

“Can you let us know the top three areas you want to talk about?” asks the Ofgem press office a few days before Utility Week’s interview with the energy regulator’s chief executive, Dermot Nolan. Not really, is the answer, because with a list of topics for discussion that includes – take a deep breath – Ofgem’s new strategy; the smart, flexible, energy systems paper; the potential price cap; the smart meter rollout; the targeted charging review (TCR); and the open letter kicking off work on RIIO2, it’s difficult to choose just three.

And so the full list remains in place as Utility Week heads to Ofgem’s offices on Millbank, where Nolan is in an uncompromising mood. Always affable, there’s little time for chitchat today as he outlines a vision of energy transition that will see innovation disrupt the market, companies change shape and throughout it all, consumers protected by the regulator. Nolan isn’t shying away from the changes ahead, and drops tantalising hints that they could be even bigger than currently envisaged, if time runs out for the retail market to prove itself capable of competition, and the evolving role of distribution system operators forces system operator-style business separation. He’s ready to do battle – in the courts if necessary – and determined that as UK energy undergoes a once-in-a-generation transformation, the regulator will be leading the way.

Nolan has been in post for nearly four years and is well respected throughout the industry. Thoughtful and engaging, he has kept a lower profile than his predecessor, Alistair Buchanan, but when he does choose to speak out, he speaks his mind. His messages today are clear and, before the questions start, he takes a moment to set out his overview of the market: “The sense of transition in the energy sector is very, very considerable – perhaps greater than it’s been for many years. At the risk of using a cliché, there will be challenges and opportunities, but by and large one of the key functions of the regulator over the next few years will be to try and make sure that those innovations that take place really benefit consumers.”

“The scale of change is such,” he says intently, “that if we get it right we will have an energy system that will be lower cost, secure, and will protect us all.” But, he warns, “the scope for getting things wrong is huge”.

With those words still ringing, it’s on to the first order of business: the vexed energy retail market, and the possible price cap. Nolan has made clear his belief that a market-wide price cap is a matter for ministers – and with MP John Penrose leading the campaign, it seems increasingly likely they will act. In the meantime, Ofgem is expected to consult later this month on a more limited measure, an extension of the current price cap for prepayment customers to all vulnerable customers.

Can Nolan reconcile such an intervention with a belief (his own, presumably, and Ofgem’s) in competitive markets? “I think it’s perfectly reconcilable,” he says, suggesting that a number of regulators, like Ofgem, “try and bring competition where possible and regulate where that is not the case”.

He reiterates that the energy retail market is not working as well as anyone would like, and says: “The reason we’re thinking about a vulnerability price cap… is, one, the evidence has suggested to us that such customers are getting particularly bad experiences in the market in terms of their ability to engage with it. Second, we have statutory duties which specifically require us to protect such customers.”

If competition is desirable only where it can work effectively, and it is not working effectively in the energy retail market, that begs the questions: is it the right solution for that market? “I think broadly yes,” says Nolan. “But I think it has to prove itself, and one of the tests for the next couple of years is seeing whether or not competition can deliver.”

How will that be seen? Nolan cites switching figures, ease of switching, cost differentials between the cheapest and most expensive tariffs on the market, and envisages a situation a few years hence where consumers could switch energy suppliers to save, say, £80 a year, at the touch of a few buttons on a mobile phone.

If that doesn’t come about, he warns rather ominously that “other measures would be necessary”. He won’t go into the detail, but says that if engagement doesn’t improve “then I think we would very much need to be open to other ideas”. Energy suppliers will be anxious to hear, in due course, what those “other ideas” might be.

For the moment, though, there’s plenty of immediate challenges to keep them occupied – not least the smart meter rollout – and a 2020 deadline many think unachievable.

Does Nolan see a problem? “I don’t think so… all I can say is that we will take enforcement seriously and enforce in a way that we think best serves consumers’ interest.” He refuses to be drawn on what form this enforcement action may take, saying only that it will be “reasonable”.

Will we meet the deadline? “Broadly yes, I certainly hope so.” He’s not committing – “I’m not a prophet” – but has this to say to suppliers: “In the next 12 months it is crucial that you get on with delivery.” It’s a point he repeats several times: “The next 12 months are key.”

So much for the retail market. On, then, to distribution, where the energy networks have recently joined their retail peers in the spotlight, coming under criticism from bodies including Citizens Advice and the Energy and Climate Intelligence Unit for making “excessive” profits. Yet the regulatory indicators suggest that, under the RIIO framework, they are performing well. Are the networks making too much money?

“The returns in the first round of RIIO, particularly the first price control involving gas distribution and both gas and electricity transmission, have been higher than expected, higher than when we talked about returns in RIIO we thought would occur. We are conscious of this.

“I do think by and large the companies have delivered on what was expected of them… The whole principle of the RIIO price control is that a company that really delivers for consumers is entitled to earn a good return, and in that sense, I think much of RIIO has been a success.”

Will returns come down in RIIO2 – as has been indicated by the open letter that kicked off the planning process this summer? Nolan confirms Ofgem will “learn the lessons” of the last round of RIIO, and more publications can be expected in the next few months. He also mentions, uninvited, Cadent’s recent decision to return £54 million to customers following delays to its planned iron mains replacement programme in central London, calling it with classic regulatory understatement a “positive development”. Would he like other companies to do the same? “That’s a matter for them, but it’s something that perhaps we would welcome.” A gentle hint, but a hint nonetheless.

Putting the eternal question of what constitutes a fair profit to one side, the big issue for distribution networks is their evolution to become distribution system operators, or DSOs. While it has become the received wisdom that this transition will occur, a consensus on its exact shape has yet to emerge. Does Ofgem seek a uniform model and if so, how will it be developed?

“We are not sure yet precisely what DSO models will look like. We are in the process of thinking carefully about that.”

Nolan himself raises the contentious issue of storage. Networks are keen to play an active role in the emerging storage market, but Ofgem and the Department for Business, Energy and Industrial Strategy (BEIS), in a joint paper this summer, ruled out direct ownership. Nolan says he is “aware there are other jurisdictions which have permitted a degree of ownership”, and says “Ofgem is looking at those models.”

Nolan hints at more drastic change ahead, suggesting that if DNOs evolve as planned into DSOs with local balancing responsibilities, that raises issues for a level playing field and “further separation within distribution companies might be needed to deal with that”. He doesn’t go into detail, but one imagines the proposed legal separation of the system operator role from National Grid’s other activities isn’t far from his mind.

For Nolan, this all comes back to the energy transition and the question of fairness. This is at the heart of the current targeted charging review, which is seeking to realign the way network costs are apportioned to users. Nolan sees more active energy consumers going off-grid and setting up community energy companies, and says this is happening quicker than he would have imagined possible. “Trying to deal with [that] in a manner that is efficient, in some sense fair, a level playing field… that will be a particular priority for us in the next 12-18 months, and will indicate in one sense the way in which we think the charging system may evolve, which of course will have impacts for DNOs as well.”

Finally, the conversation turns to generation. Had this interview been happening two or three years ago, near the beginning of Nolan’s tenure, the inevitable question would have been, “will the lights go out?” These days, with the capacity market up and running, we don’t hear so much about the capacity crunch. Is it over? “Ceaseless vigilance is the phrase I would use here,” Nolan says, though he acknowledges “we are in a more positive place than we were two years ago”, and says with a rare glimmer of smile: “I do feel very positive about capacity going forward.”

On to distributed generation (DG), where there seems an apparent conflict between the push for more DG on the one hand, and the very controversial decision earlier this year to drastically cut embedded benefits to distributed generators on the other, coupled with the separate decision by BEIS to tighten the rules on battery derating. The only time in the whole conversation that Nolan becomes a little snippy is when Utility Week makes the mistake of suggesting that, triad payments aside, Ofgem is “pushing” for DG. In fact, Nolan emphasises with steel, Ofgem is technology-neutral and its role is to ensure a level playing field. There are no regrets here about cutting the triad payments or about the howls of protest that doing so caused: “I would say very clearly to any new entrants, we welcome new entrants, we want as much innovation as possible, smaller distributed generators are very much part of that, but no new entrants should come into the energy system on the basis of saying we think there’s a significant distortion there, we’re building our business plan on that.”

Will the decision face judicial review? “I don’t know, I really can’t comment on it, if we do face judicial review all I can say is we will defend it rigorously.”

A judicial review over triad payments is not Nolan’s only potential day in court. Change is coming, and Nolan is getting ready for a fight: “Many of the issues I think we will see in energy transition, particularly in electricity but perhaps in the future in gas, are likely to be contentious. I’m not dodging that. We want to make it less contentious as [far as] possible but ultimately, we will make decisions, potentially difficult decisions, that we think are in consumers’ interests, and that could lead to litigation… we will defend any decisions we make vigorously.”

Ofgem has taken more than its fair share of flak over the past few years as the whole energy value chain, from security of supply to retail prices, has been hauled through the public wringer. With Dieter Helm’s cost of energy review set to report next month, the scrutiny is not over yet. Nolan is clearly determined that, in the next few years which are so crucial to the energy transition, the regulator leads the debate. He acknowledges that the question of public trust in the energy system keeps him up at night, as does “the sense that, if we don’t make good decisions, we’ll muck it up”.

The stakes are high, and Nolan’s ready.