Tackling the existential threat of climate change needs big ideas and bold moves, which inevitably bring risk – and potentially rewards. But how does that square in the highly regulated sectors of energy and water where returns are being squeezed and some would argue room for manoeuvre curtailed? In the second pillar in our Utility of the Future campaign we will explore this tension that lies at the heart of the regulatory framework and ask how can the balance be best struck going forward? Do regulators need to widen their scope? What can Ofgem and Ofwat learn from other sectors? What might be the gaps and ­potential solutions? We kick off our series finding out how the regulators themselves see their roles and remit changing and the response they’d like to see from the companies they regulate to reduce emissions and boost water security for future generations.

It was Octopus’s chief executive, Greg Jackson, who aptly contextualised the gear shift needed to tackle climate change when he talked about the huge aircraft carrier built in the second world war now residing on the Hudson River, built by the US at speed alongside dozens more. It’s quite a contrast to the near decade-long process delivering today’s flagship of the UK fleet, The Queen Elizabeth. He was making the point that tinkering at the edges was no longer an option for government and utility companies – very much a common refrain at Utility Week’s 2019 Congress in Birmingham where he was a keynote speaker. Jackson’s beef was that the way companies were being regulated “infantilised” them, creating the polar opposite conditions to bringing about the bold moves and big ideas needed if we are to meet net zero targets.

Jackson is not alone in his sentiments: there is a groundswell of opinion in the sector that regulation is no longer fit for purpose in the predicament we find ourselves in. The greater need for innovation, collaboration, and more resources is leading many in the sector – including the Utility of the Future (UOTF) Editorial Advisory Board that we’ll be hearing from in a couple of weeks’ time – to the view that redesigning regulation needs to happen as a matter of some urgency.

The debate is timely. The National Infrastructure’s report on utility regulation, published after Congress, includes recommendations for new duties for Ofgem and Ofwat, to ensure that their decisions promote the achievement of net zero and improve the resilience of the UK’s infrastructure.

But what do the regulators themselves think? And what are their views on resolving economic regulation with the challenges of the future? At Utility Week Congress on 8-9 October they spoke candidly about plans for the near and mid-term future. We also explore what can be learned from regulation in Northern Ireland

Here we pick out the key messages of their time on stage.

Dermot Nolan on Ofgem

 

Networks and RIIO2: when the going gets tough, the tough get innovative

It was no surprise that Dermot Nolan once again set out the tough stance Ofgem would be taking with networks as they head into the RIIO2 price determinations, which for 60 per cent of networks take place by the end of 2020.

“The board has taken a clear view so far on what the cost of capital should be, and that networks can expect average returns to be lower. But if they want returns of the same magnitude as RIIO1, they will have to up their game and be more innovative than in the past,” he said.

Nolan acknowledged that he expected kickback from networks on price determinations but Ofgem’s stance was based on the fact they were not risky businesses.

A number of conference speakers, including Economic Insight’s director and co-founder Sam Williams, underlined the need for innovation and on a big scale, and questioned how this could come about in a heavily regulated market. He called for a shift to a more longer-term approach to regulation – one of the key thrusts of the NIC report.

There are certainly jitters in the sector about the availability of Ofgem’s innovation fund, which allows networks headroom to invest in new technology and processes. Nolan reassured the networks that the innovation funding pot would remain going forward, but it would need to be shared with third parties. Networks, he said, would have no divine right to it.

Retailers: Some firms may face obliteration, and that’s fine

Any struggling retail firm looking for Nolan for a sympathetic ear would have left the conference severely disappointed. Nolan acknowledged that there had been interventions, and in the retail market this had created a perception of an uneven playing field. “I think us and government will do our best to correct that,” he said.

But he was unapologetic about the impact of the price cap and the effect it was having on retail businesses, including the departure of a giant like SSE. “In any sector you expect to see shakeouts and mergers and exits – and we’ve seen some spectacular levels of exit and entry. I’m agnostic about any particular firm entering and leaving the sector,” he remarked.

“So, I welcome change and the disruptions that have come to the market.”

Nolan said he was conscious that “there are infelicities in the retail market that do have to be addressed and I would say that when it comes to the price cap, the board of Ofgem has a very clear view. We do not want to see a price cap in the long term and we are determined to remove it as effective competition evolves.”

Nolan said he understood concerns about socialisation of costs – the tab others, and therefore consumers, have to pick up when a company fails – but these “have been relatively minor because by and large there is a ready market for firms to take on customers.

“I’m also aware that we’ve set a price cap at a level so that not many firms are making money at the moment and we were clear that would happen.” He said the price cap was always set to encourage firms to become more efficient in the market and when that happens profits will flow.

“But it may also see some firms obliterated from the face of the earth – and that’s fine – that’s the nature of markets.”

One area that Ofgem wants to see change, he said, was in the controversial area around the payment of Renewables Obligation Certificates (Rocs), which have been blamed for sending some firms under.

He said Ofgem had written to the Department for Business, Energy and Industrial Strategy to ask if these could be made payable every month – or perhaps once a quarter – because paying them on a yearly basis had not been helpful.

The challenge of net zero – Ofgem to act

One difficulty being highlighted is the fact that Ofgem has no legal duty to drive net zero carbon and when it comes to choosing between costs of bills and acting on climate change, it was bound to choose the former. Again, the NIC report is calling for new duties to promote net zero.

Nolan believes that it is already within Ofgem’s power. “Net zero is an enormous challenge for the energy sector and the board decided over the summer to be more proactive in this regard,” he told the audience. “We will consult in more detail what we think that means for regulation, before Christmas and I expect to have clarified our views early in the new year.”

Nolan said that because it was Ofgem’s duty to protect current and future energy customers, that in itself had given the regulator a mandate on driving zero emissions for the future. But he said “it would not be unhelpful to have further clarification of our statutory duties”, again picking up on industry calls for a more formal change in Ofgem’s remit.

There was the expected sting in the tail of course: decarbonisation yes, but there will no blank cheque.

In another break out from Ofgem’s perceived comfort zone, Nolan said that going forward the regulator also sees as part of its role provoking public debate about energy use and climate change and who will pay for the transition.

“Whether we will be effective in stimulating public debate I don’t know, but we are going to try, and we’re also going to try and push the sector we regulate to increase consciousness too.”

Nolan said that Ofgem may also need to be “interventionist” if it is to stimulate mass public behavioural change around decarbonisation.

He said this was particularly true when it came to electric vehicles and how to manage the demands on the networks resulting from charging.

“Things we are thinking about at the moment include whether to put in some sort of mandate where the default charging rate at peak times is frankly very high. Now, that might evolve very naturally through market conditions and incentives but it might not. We might have to make an active intervention into people’s lives. They in turn may not like that. There may be outrage. So, we have to justify that level of intervention.”

Regrets – he has a few

Reflecting on his six years at the helm, Nolan said his main regret was that he had not reacted more quickly to the CMA super-complaint and made moves to temper public concern around pricing.

However, he said he was comfortable with the position the market now finds itself in, admitting the price cap would cause some pain but that this was helping to drive a necessary transition.

“I look back over my time and think there are many things I regret about the retail market and things I or we should have done differently or at different times, but I don’t regret the current situation. The level of change and innovation that is taking place is quite spectacular and when I joined Ofgem in 2014 the phrase ‘the big six’ was enshrined as a constant. Now, there isn’t a big six – or at least not in the same way – and vertical integration is no longer really an issue. And by and large that is positive.”

Rachel Fletcher on Ofwat

We’ve heard the talk, it’s time for action

Rachel Fletcher’s participation in the debate came at a juncture of peak tension as water companies do battle over final PR19 determinations and on the day it published its vision for improvement and social value.

The vision has three key goals, as Fletcher explained: “Firstly, to transform the performance of the industry. It’s fair to say that water companies are not consistently meeting customers’ expectations. In some areas performance is stagnating. In some companies, performance is going backwards and particularly the challenges of variance in weather and increase in population is beginning to take its toll.

“The second plank is ensuring much greater collaboration across the industry as a whole in ensuring reliable, affordable supplies for future generations while improving the environment.

“Finally, recognising water companies have an opportunity to do much more for society and the environment. The goal should be to become public value providers not just a provider of a transactional service.”

Fletcher said water companies’ recent public interest commitments were a good step forward. These make water the first industry to pledge to achieve net zero emissions by 2030, as well as making far-reaching commitments around plastics, leakage, water poverty and social inclusion.

However, she made it clear that talk was one thing, action another: “We have got a massive amount of ambition, and companies recognising they are about more than just giving a good service at a decent price and making a good return for their shareholders. What we need to do over the next few years is get from good words into some really impressive action.”

Fletcher stressed that getting consumers to value water was vital – but unless companies got their own house in order it would be difficult to bring the public onside.

“One of the things that stops customers using water wisely and listening to the advice is that they don’t believe their provider is doing a particularly good job of using water. They see a leak at the end of their road and they think: what does it matter if I water my rose bush, then? There is an absolute necessity for companies to step up their performance.”

She added: “I would really like to see a national campaign on water use. I don’t think in my whole life that I have thought about my water consumption for more than half an hour. It just has not registered on my consciousness. We take water that has been taken from the environment, cleaned to food standard safety – a very energy-intensive process – and we use it to clean our mountain bikes. These things have to stop but we need to do more of these things by education because most of us just haven’t had the time to consider the impact we have on the environment through our water use.”

Resilience means efficiency

Ofwat’s chief batted off criticisms that in rejecting capex figures in some of the water companies’ business plans Ofwat’s stance on investment to boost resilience was unworkable and contradictory.

“Ofwat signalled two years ago that we would set stretching performance targets, that we expected companies to increase their efficiencies and that they needed to look at their balance sheets and make sure that it was shored up for a tougher determination,” she said.

“I think it is important the industry realises the clarity of the signals we gave. There is a serious conversation that needs to be had about whether there is a glide path on some of the performance targets that we’re setting to 2024; and there are always conversations about costs and whether our models are right.

“But I would take issue with the argument we are pushing back on resilience – and you would expect us to run a slide-rule and determine whether the schemes being put forward are being made efficiently.”

Innovation critical

Like Ofgem, Ofwat has recognised the need for innovation funding on top of the day-to-day business costs and has set out proposals for a new £200 million fund which has gone down well in the sector. “We recognise there is a gap so wide between what is happening and what is needed – the principle that we should take a lead is there,” she explained. “What troubles me most about innovation in the water sector is not the extent of trials and pilots going on, but the slow pace at which new approaches get adopted.

“That said, it’s not immediately obvious to me that the approach that is used in the energy sector will necessary solve that challenge and I’m open to ideas and views on how you deal with that last step in water.”

Reorganising regulators is like rearranging the deckchairs on the Titanic

As discussed on the previous page, an ongoing debate in the sector is about whether it would make more sense to slice and dice the regulators differently. Rather than one devoted to water and one to energy and one to telecoms, there is a school of thought that it would make more sense to combine the different ­disciplines and then split by infrastructure and consumer focuses.

What did our regulators think of such an idea? While Nolan was agnostic and thought it unlikely to happen because of the administration needed, Fletcher thought it the wrong debate to be having. “You can move deckchairs around – spending time and money doing it – but the real question is what outcomes are we aiming for?” she said.

Nolan agreed that regulators needed to be collaborating and providing coherence across the consumer agenda. Fletcher said it was the Environment Agency that Ofwat needed to be joined at the hip with.

Denise Chevin, Intelligence Editor

What we can learn from Northern Ireland

Debate about the future of utilities in the UK is overwhelmingly dominated by the interests and structures of the mainland GB market. But what of Northern Ireland?

As the Utility of the Future campaign turns the spotlight on drivers for regulatory transformation, we examine three ways in which Northern Ireland has diverged from the GB market and the lessons on offer.

Pan-utility regulation. The first is in terms of pan-utility regulation. There has been considerable speculation from some quarters of late about the potential advantages of doing away with Ofgem and Ofwat as separate economic regulators and creating instead a single utility super-regulator spanning the energy and water sectors. NI already has this model in place. Its Utility Regulator is responsible for water, energy retail and energy network regulation.

Also speaking at Utility Week’s recent Congress event, chief executive Jenny Pyper extolled the virtues of the model, claiming it supports joined-up thinking about interdependencies between utility systems – a valuable benefit in light of growing resilience challenges – as well as encouraging the uptake of best practice across utilities in disciplines like cost reporting and asset management. She also said that consolidated regulatory responsibility brought internal resource efficiencies to her organisation, allowing it to develop multi-skilled teams that can be flexed to work key projects as the regulatory cycles for each vertical come and go.

This said, Pyper was not on the campaign trail for a utility super-regulator in GB. She observed that, alongside the efficiencies that a single regulator can grasp, the model also brings challenges in terms of retaining important specialist skills and knowledge for individual utility types. She also admitted that she would predict major difficulties for a pan-utility regulator presiding over the considerably larger scale and more complex GB utilities market.

Pricing. The second difference is price regulation. The supply market in NI is not subject to the standard variable tariff price cap currently creating havoc for GB energy retailers – an intervention Pyper frankly stated she saw few advantages for.

The Utility Regulator, however, is responsible for price regulating part of the NI energy retail market. It sets the tariffs and margin for the dominant supplier – Power NI – on an annual basis. Meanwhile, a relatively small pool of competitive retailers fight for the opportunity to attract customers away from the incumbent with better price offers and service innovations.

Pyper claims the set-up is an effective way to offer consumers choice between an established – and relatively well trusted – brand with regulated prices, and the opportunity to find savings in the more dynamic competitive supplier arena. Interestingly, at Utility Week’s Consumer Vulnerability conference in June, Centrica’s former director of consumer vulnerability Steve Crabb suggested that creating a price-regulated supplier with a primary duty for protecting the interests of vulnerable consumers could be a good solution to key GB market challenges around choice and fairness.

Smart meters. The third area of divergence is over smart metering. While Ofgem continues to grapple with its responsibility to oversee the GB smart meter rollout, Pyper candidly told the audience at Utility Week’s Congress that the Utility Regulator and NI at large had “dodged a bullet” when the devolved government declined to participate in the programme.

While acknowledging the need for greater visibility of consumer demand patterns and activity on the low-voltage power network, Pyper insisted that NI has an opportunity to leapfrog the many technology specification and redundancy issues – not to mention consumer engagement challenges – that have been the experience in GB by using alternative solutions. She expressed real hope for a trial of Bluetooth technology, which she said has great promise to give the same smart capabilities and foundations for decarbonisation that conventional smart metering can offer – at a fraction of the cost and consumer disruption.

Jane Gray, content director