One-off costs for setting up FSO could climb to £390m

The one-off costs of setting up the Future System Operator could eventually reach up to £390 million, Ofgem has stated.

The regulator revealed the figure in a consultation on the funding arrangements for the first part of the transition.

The government and Ofgem confirmed plans in April last year to establish a Future System Operator (FSO) as an independent, publicly owned corporation by 2024.

The FSO will take on all of the existing roles and responsibilities of the Electricity System Operator (ESO) currently owned by National Grid as well as the long-term forecasting and strategic planning functions of the gas system operator owned by National Gas Transmission.

It will also take on new and enhanced responsibilities, including providing expert advice to the government and Ofgem and becoming a Central Network Planner for the electricity transmission network. In April, Ofgem proposed to create a series of Regional System Planners across the country to coordinate the development of local energy system plans and identified the FSO as the most appropriate candidate to fulfil this role. The regulator also suggested that the FSO should become a neutral facilitator for flexibility markets.

In its latest consultation, Ofgem said the estimates submitted by the ESO, National Grid and the National Gas Transmission suggest the establishment of the FSO is expected to cost £180-210 million (2022/23 prices) by “Day 1” of the transition.

By this point, the FSO will have been established outside of National Grid Group, will be owned by government, will have the majority of the property, rights and liabilities it needs to discharge its statutory functions, but will hold agreements with National Grid for the continued use of key business services.

Broken down by company, the costs are estimated at £60-68 million (2018/19 prices) for the ESO, £111-138 million (2022/23 prices) for National Grid, and £1 million for National Gas Transmission.

The total costs are expected to rise to £300-390 million (2022/23 prices) by Day 2 of the transition, by which point the FSO will have exited its business services agreements with National Grid and will have its own standalone capabilities to perform all its functions. The one-off costs between Day 1 and Day 2 of the transition are estimated at £68-104 million for the ESO (2018/19 prices), £52-62 million (2022/23 prices) for National Grid, and £2 million for National Gas Transmission.

As well as these one-off costs, the ESO expects to incur £4-7 million of additional annual running costs before Day 1, building up to £25-40 million per year once it becomes part of the FSO.

Ofgem has outlined proposals on how to fund both the one-off costs and additional running costs incurred up to Day 1 of the transition. The consultation does not cover subsequent costs.

Among other things, the regulator has proposed to:

• Fund in principle “all economic and efficient separation costs” for National Grid and National Gas Transmission
• Introduce an additional passthrough term in the ESO’s licence for it to recover costs incurred by National Grid. National Grid’s costs would be paid back by the ESO
• Implement a funding method for National Gas Transmission’s costs which is “flexible and reactive” to the current policy uncertainty around gas related FSO activities. This could mean adjusting National Gas Transmission’s RIIO T2 totex allowance or introducing a new passthrough term in its licence
• Apply a cap on values allowed through any passthrough terms to provide a “final backstop” for unforeseen cost increases. The caps would be set at the level of the companies’ high cost estimates but Ofgem would have the ability to adjust the caps if it received strong justifications
• Require the ESO to hold an intragroup contract with National Grid, whereby National Grid would commit to carrying out separation activities and would receive payment from the ESO following the government’s approval of delivery and Ofgem’s approval of the costs
• Introduce a reporting a framework to provide ongoing transparency over the ESO and National Grid’s separation plans and actual spending
• Extend ex-post disallowance power to the ESO’s costs but not those of National Grid or National Gas Transmission

The deadline for feedback on the proposals is 2 August.

In the final submission of its most recent business in September, the ESO estimated that the establishment of the FSO would cost it up to £185 million.