One of the most hotly debated topics in the energy sector right now is the future role of hydrogen, in particular whether hydrogen boilers will be used to warm peoples’ homes.
For the gas distribution networks, this is an almost existential battle for survival. While hydrogen will nevertheless play an important part in decarbonising industry and supporting the power sector, a decision against the widespread use of hydrogen boilers would leave the necessity and viability of large parts of the current gas grid in question.
Little attention has been paid to what might actually happen to these assets if the future of domestic heat is mostly electric. Recent statements by ministers suggest this is far from a remote possibility, with energy secretary Grant Shapps stating that hydrogen is “unlikely” to be a major source of domestic heating.
This scenario is explored in a new paper released this week by the Regulatory Assistance Project (RAP) in an attempt to ignite the kind of public discussion, which the think tank says has so far been “disappointingly limited”.
The paper says a decision against hydrogen heating in homes would raise several key problems that will need to be addressed by the government, regulators and the energy industry.
As customers switch away from gas, network costs would need to be recovered from a smaller pool of customers, who would therefore see their bills rise.
Gas networks would be left with stranded assets, which would not be paid off by the time they are no longer needed. Assuming there is no further capital investment beyond the end of the current price control period in 2026 and based on current rates of asset depreciation, RAP estimates that gas distribution networks would still have an unrecovered regulatory asset value (RAV) of around £4 billion by 2050.
There would be significant costs for the physical decommissioning of these assets. These costs are highly uncertain and no funding has yet been earmarked to cover them.
A range of options
“The combination of stranded asset risk and a lack of consideration of decommissioning costs places a significant financial liability onto UK citizens,” the paper states.
“In light of a dearth of public consideration and discussion around this issue, this briefing attempts to make a first step in unpacking some of the issues around decommissioning and considers policy and regulatory models which could be used to achieve it.”
The paper proposes three potential models for shrinking or shutting down parts of the gas grid that are no longer needed.
The first is “business as usual” but with “accelerated depreciation”. Gas distribution assets currently have regulatory asset lives of 45 years, although depreciation is front-loaded towards the beginning of the period. The paper’s author and senior associate at RAP, Richard Lowes, says the asset lives could, for example, be reduced to 25 years.
Under the current arrangements, annual depreciation costs for gas distribution networks will amount to around £860 million in 2023/24 – roughly a quarter of their overall charges of £3.4 billion for the year. Lowes says cutting asset lives to 25 years would increase depreciation for the year to around £1.5 billion, meaning it would account for around two-fifths of gas distribution charges. A levy could be applied to gas distribution charges to cover the costs of decommissioning, the report suggests.
Under the second model, “regulatory evolution” would be used to transform gas distribution networks into clean heat providers, whereby they would deliver district heating networks in urban areas, while also decommissioning their old assets.
Lowes says this “more collegiate” approach would give companies “room for growth” to offset their losses. Their expertise around pipes, road works, pressure and flow management, and dealing with local authorities, clearly has “some crossover” with those of heat network operators, although whether they would be best placed to fulfil this role is another question.
To prevent future heat network customers being “saddled” with their “legacy debts,” the paper says this model may also require “public underwriting of liabilities for both stranded assets and decommissioning costs”.
The third and final model is “nationalisation and a planned wind-down”. The RAP says the other models may be “too slow and incremental”. This one would allow the government and Ofgem to “properly plan and deliver gas system wind-down in coordination with other parties such as electricity distribution system operators and local authorities.” The government could also absorb some of the cost of stranded assets and decommissioning to limit network charges.
You can read more about the models here.
Lowes says these options are not an exhaustive list but are representative of the “broad spectrum” of possibilities. He says the gas networks are “not willing to talk about decommissioning publicly” but they really should be, as the options he is exploring will enable them to recover their investments and remove the financial risk to them of stranded assets.
A spokesperson for the Energy Networks Association tells Utility Week: “Leading studies, including the Climate Change Committee’s most recent update to parliament, note that the UK’s decarbonisation targets can only be met through a combination of electrification and hydrogen. The sector is currently waiting for political decisions on how the hydrogen rollout will work and the timeframe for it to occur, and when this roadmap is set, network operators are ready to deliver the right infrastructure, in the right places, at the right time, to make it a reality.”
Recovering the RAV
Speaking to Utility Week ahead of the paper’s release, former Ofgem partner and Grid Edge Policy director Maxine Frerk says it’s not clear whether gas networks are necessarily entitled to recover their full regulatory asset value if their assets become stranded: “I think the answer is nobody knows. We’ve never had to deal with this.”
She continues: “The RAV model works on the assumption that they are guaranteed their money back and that’s how you get such a low cost of capital; because all investors trust that the money will be repaid over time.”
Frerk says the gas distribution networks have previously used the risk of asset stranding to argue for a higher cost of capital as part of their RIIO appeals to the Competition and Markets Authority (CMA). The CMA dismissed this argument, saying the gas networks should instead seek a faster rate of depreciation if they are really concerned.
“It’s quite funny because they’d never normally admit that,” adds Frerk. “None of the business plans ever talked about that but suddenly when they’re trying to argue with the CMA for a higher cost of capital, they get out the violins.”
Vlad Parail, a director at Baringa, says the UK’s regulatory regime is based around the principle that “efficiently incurred costs will always be paid back to investors.” He says it is “inconceivable” that this principle, which has “held up for decades” would be broken by politicians or regulators.
Any short-term savings from failing to pay back investors would be more than offset by the long-term costs of the increased risk premia demanded by the wider investment community in future across the energy sector as a whole: “Governments are usually falling over themselves to decrease their perception of risk in order to ensure that we get cheaper capital and consumers reap the benefits of that.”
A senior figure at one of the gas networks tells Utility Week that its investors are certainly working on the assumption that they will be able to recover their regulatory asset value.
However, the source says it’s not hard to imagine in a situation in which politicians leave investors to absorb the cost of stranded assets on the basis that they should have foreseen this eventuality and acted accordingly, particularly within the context of a cost-of-living crisis in which customers have been struggling with record high energy bills.
The fact that a lot of gas networks’ recent investment has been made on the grounds of public safety could easily get lost in the debate. The source says they don’t actually expect this to happen due to the impact on wider investor confidence but their company is nevertheless exploring this possibility just in case.
Stranded assets
This of course raises the question of how much investment is at risk of being stranded. The RAP report only concerns gas distribution networks but says a decision against hydrogen boilers in homes would mean “large parts, and likely the vast majority” of these networks would no longer be needed.
However, Parail says even in scenarios where it is not used for domestic heating, hydrogen will still have other roles in the energy system, for example, storing or providing energy for periods when renewable output is low.
He says converting gas networks to run on hydrogen, while requiring some investment, would not be “exorbitant”. In this context, it may be more economic to convert some gas networks to hydrogen rather than decommissioning, even if they are only being used for “limited periods” and “volumes aren’t high”.
Parail says the extent to which this is worthwhile will depend on the level of dislocation between supply and demand for hydrogen: “Let’s say you are ultimately using hydrogen to generate electricity in periods when renewable energy is very scarce, you might still want to do that locally rather than centrally because you might have difficulty expanding the electricity grid to certain areas.
“It might be more feasible for you to have a hydrogen turbine which generates electricity in the local area as opposed to having a central location which you generate electricity and then having lots of wires going into that location.”
The source at one of the gas networks additionally emphasises the importance of hydrogen for industrial decarbonisation.
They point out that much of Britain’s industry is located away from the planned zero-carbon industrial clusters but may also need access to hydrogen. Converting parts of the gas grid to hydrogen to serve the needs of these customers may be worthwhile, especially when decommissioning may not be cheap. “You never see decommissioning as a line item in the cost of electrification,” they add.
Further investment
For the time being, the potential cost of stranded assets is continuing to grow. Gas distribution networks are roughly two-thirds of the way through a 30-year programme to replace old iron mains with plastic pipes at a cost of billions of pounds.
The Iron Mains Risk Reduction programme is intended to reduce the risk of gas explosions and the new plastic pipes would also facilitate the conversion of the gas grid to hydrogen. But if that does not happen, then further replacement would mean investing a lot of money in pipes that will be used for a relatively short period of time.
Rachel Fletcher, another former Ofgem partner and now director of regulation and economics at Octopus Energy, says this creates a “tricky problem” as “clearly, we don’t want the network to be under-maintained and pose a higher risk to customers.
“But I think there’s a conversation for Ofgem to have with the Health and Safety Executive about what an appropriate approach to mains replacement means.” She says if newly replaced assets only have an expected lifetime of five or ten years, then “I’d have thought that changes the calculation hugely.”
Lowes says expenditure on the programme is the result of negotiation between Ofgem, gas networks and the Health and Safety Executive (HSE). He says HSE does have a goal to support decarbonisation and so “naturally they should also be thinking about this.”
For the same reason, Fletcher says Ofgem should also be “highly sceptical” of any proposals for new gas network extensions or connections: “We should be saying that’s not we’re not going to make the matter worse by adding even more money onto the regulatory asset base.”
Finding a new purpose
There is also the question of whether some of the value of gas network assets can be clawed back by repurposing them for something other than hydrogen.
The industry figures Utility Week spoke to posed a number of possibilities, including telecommunications, district heating, water/wastewater and carbon dioxide.
Lowes is doubtful about a number of these suggestions. He says the pipes are generally too narrow to transport water and certainly couldn’t be used for drinking water as they have been contaminated by natural gas. They lack the insulation needed for district heating, which also requires two-way flows.
He says they could theoretically be used for fibre optic cables but most places where this would be an option, they have already been installed anyway and can also be easily run along overhead lines.
This question was also briefly explored as part of unpublished research on decommissioning produced for the gas networks and seen by Utility Week. It says although most homes already have broadband internet, faster and more reliable full fibre services are still being rolled out. It says the reuse of gas pipes for this purpose could be seen as an “attractive” option in urban areas where the installation of ducting is difficult.
Like Lowes, the report says the pipes themselves would not be suitable for district heating, although the trenches they are dug into could potentially be reused.
Parail says the physical properties of carbon dioxide are in some ways more similar to natural gas than is hydrogen. He says the pipes could therefore be used to transport carbon dioxide emissions, although the viability of this option will depend on the level of dislocation between production and storage sites: “I think it’s fair to say that dislocation is likely to exist just because the places where we can store carbon dioxide are very limited.”
The costs of decommissioning
Assets that are no longer needed but cannot be repurposed will need to be decommissioned in some form. But how much will this actually cost?
The previously mentioned research seen by Utility Week explores three possible scenarios for decommissioning the gas grid, including both transmission and distribution.
In the first, assets would be left in situ and purged with an inert gas, probably nitrogen. Full decommissioning would only take place where necessary. This scenario would have low capital expenditure but high ongoing maintenance costs.
In the second, full decommissioning would likewise only take place where necessary but the other assets would be left in a permanently inert state by filling them with concrete. This would prevent pipes from collapsing, while avoiding the need keep them safely filled with nitrogen. It would also increase capital expenditure but reduce ongoing maintenance costs.
In the third scenario, all assets would be fully decommissioned. They would be vented, excavated and removed before the land is reinstated. This would initially cost a lot more money, but would mean ongoing maintenance costs are kept at or near zero.
Based on these scenarios, the research estimated the physical costs of decommissioning the gas grid at between £21 billion and £132 billion over a period of 25 years, with a central estimate of £76 billion.
Utility Week understands that the gas networks have concerns over flaws in the assumptions and methodology underpinning these figures and they are not confident they will stand up to scrutiny. They have restarted work on this issue but for now the true cost of decommissioning is effectively unknown.
Lowes says: “There’s naturally an incentive for the networks to make decommissioning costs appear as high as possible, because it makes doing anything, other than use gas, look more expensive. This demonstrates why government needs to properly understand what these costs are.”
One of the recommended actions of the research is identifying the size of a minimum viable gas network at a national, regional and local level.
Frerk says: “You can’t leave people without heating so there’s a customer engagement side of it: How do you actually get the last person to get off the gas network?”
She says past experiences suggest this would not be easy: “I lived through the process of trying to change the form of the prepayment top-up mechanism, where we got rid of the old tokens. While you had one or two people still using tokens you still had to had provide that facility to top up. How do you get the last person to recognise that they need to change?”
The elephant in the room
If there’s one clear message from both the RAP report and the industry experts Utility Week spoke to, it’s the urgent need for preparations to begin for the possible shrinking, if not shutting down, of gas networks.
Frerk says this issue is “a big elephant in the room,” adding: “This is a really big question and we need get on with talking about it and thinking about it.”
Even if the government does opt to pursue hydrogen heating in homes when it makes its strategic decision in 2026, millions of households will still install electric heat pumps, raising issues over the distributional impacts of a reduced customer base for gas networks.
The UK government has set a target of increasing annual heat pump installations to 600,000 per year by 2028, whilst the Scottish government is considering a target of installing 1 million heat pumps by 2030 as part of its latest energy strategy.
Responding to the Scottish government’s consultation on the strategy, the Customer and Stakeholder Engagement Group for SGN, of which Frerk is the chair, said the proposed 2030 target would “approximately halve the number of customers connected to the gas network in Scotland. However, it is unlikely to significantly reduce the costs of owning and operating the network.”
In a statement to Utility Week, Scottish energy minister Gillian Martin said: “We urge the UK government to accelerate its timetable for providing clarity on the implications for the gas network from mass adoption of low and zero carbon heat sources.”
Fletcher says the wait for Westminster’s decision in 2026 has the left UK in the position of being “half pregnant.”
“I think this is another reminder of the price you pay for policy uncertainties,” she adds.
“Even if there is no clarity from government, there needs to be somebody rolling their sleeves up and thinking: How would we do it?”
Fletcher says this issue once again demonstrates the need for a proper mechanism to provide bill support to customers as they deal with both a cost-of-living crisis and the energy transition: “If we can figure out the segment of the population that struggles with bills and find a way of giving them bill support, it makes these adjustments a hell of a lot easier as well.
“You’ve already got a mechanism for smoothing and dealing with some of the distributional aspects of your energy policy. This for me is a big gap in in the overall policy landscape.”
Fudging the issue
In a recent open letter on the future of gas network price controls, Ofgem revealed it would not implement a set of shorter interim two-year price controls following the end of the current set in 2026. The regulator had previously proposed this as a possibility to deal with the uncertainty over the future of heat.
Ofgem said there would instead be a set of medium-term ex ante price controls. The regulator said it would also consult later this year on shortening gas network asset lives and accelerating their depreciation.
“The stranded asset thing is a big risk that needs to be managed so it’s good that they’re starting to think about it, but it’s just one part of the overall heat piece,” comments Lowes.
He lacks optimism that the government will address this issue head on in the way he would like as “fudges are what we tend to deliver in the UK. We end up tinkering around the edges and so I expect there will be some accelerated depreciation. I expect the government will take on the decommissioning risks. It’s how these things come together.”
Jeff Hardy, formerly a senior research fellow at Imperial College London and now director of Sustainable Energy Futures, takes a similar view: “Business as usual depreciation is where we’re at right now and feels a lot like kicking the can down the road and not really providing anyone with any certainty. It doesn’t mean it won’t happen, but it’s far from ideal.”
Hardy says he “can see the rationale for nationalisation” but adds: “I don’t see that we’ve got the politics at the moment to even start that conversation.” He says another alternative would be to tender out the decommissioning of gas networks and then compensate companies in advance for their residual regulatory asset value: “I think that would have to come from general taxation rather than energy bills.”
Making decisions
However, in the absence of wider changes, Hardy says Ofgem’s “only tool” to deal with the issue is accelerated depreciation.
He says the regulator should be using it’s “powers of influence” to push the government to act.
“But equally true is government know all of this,” he adds. “Are they thinking about intergenerational equity sufficiently to be putting some plans in place? I think the answer is no given the lack of detail in the Heat and Buildings Strategy and the lack of any appetite to take a decision in this space.
“It feels like everyone knows it’s a problem that’s coming but there’s not any resulting momentum.”
In general, Hardy says politicians are “really reticent to take decisions that affect peoples’ lives directly. This is why we haven’t had a good decision on heat yet. Because it involves telling people what they can and cannot do in their own homes. That’s the main issue as I see it. It keeps getting kicked down the road because no politician wants to grab the bull by the horns.”
Hardy says one idea to solve this problem is creating a strategic decommissioning authority that could decide which gas networks would be repurposed or decommissioned in each area. This authority could take the proverbial heat for the decisions ministers appear nervous about making themselves.
These decisions could be informed by the local area plans developed by councils: “That’s the missing element. I think it’s partly why Ofgem is spending a little bit of time on local area energy governance at the moment. They’ve decided that you need something like a regional system planner in place who delivers that.”
The regulator has proposed that the soon-to-be Future System Operator should fulfil this role but Hardy questions whether it is suitable. He says a politically accountable body is needed to make these decisions and we don’t have one at the moment.
“If anyone, it’s probably the government who should be taking these decisions but they’re not touching it with a barge pole,” he laments.