Watchdogs live to bare their teeth again

A landmark report by the National Infrastructure Commission into the future of utilities regulation leaves Ofgem and Ofwat off the lead – for now.

Pressure had been mounting over the past year to scrap the existing network of sector watchdogs and replace them with a single “super regulator” covering all of the utilities.

Utility Week reported that backbench MP John Penrose, who led the ultimately successful campaign to cap standard variable tariffs, was arguing the case for a single watchdog to oversee all utility network functions at last year’s Conservative party conference.

Then, former Tory MP Laura Sandys picked up on the idea in the report on energy data that she recently submitted to the Department for Business, Energy and ­Industrial Strategy (BEIS).

But a new Treasury-commissioned report on the future of regulation stops short of recommending that the existing system of regulating utilities, which has been in place since privatisation, should be scrapped.

Retention recommendation

The National Infrastructure Commission (NIC), which published the study ­Strategic Investment and Public Confidence on 11 ­October, recommends that the existing utility regulators should be retained.

Jonathan Marshall, head of analysis at the Energy and Climate Intelligence Unit, believes it makes sense to retain sector-­specific watchdogs given the “huge” differences in the kind of technical issues that each has to grapple with.

“There will be examples where it [a super regulator] could be helpful, but for the vast majority of issues, it’s fine.”

Catherine Mitchell, professor of energy policy at Exeter University, believes this is certainly the case in the field that she studies. “We really need institutions that are energy focused.”

She acknowledges that the market may be capable of delivering a transition to a net zero electricity system over the next 30 to 40 years.

However, in order to ensure the UK is net zero by the current legal target date of 2050, the electricity system will ­effectively have to be decarbonised by the end of the next decade. This will in turn require a much firmer regulatory steer than Ofgem can ­currently provide, Mitchell argues.

“We have to speed it up and make really big decisions about things like gas networks and transport. That is a really different type of regulation where you are really trying to make something happen as opposed to ­keeping competition going.”

Mitchell’s submission to the NIC review mooted a new Energy Transition Commission to advise on meeting the nation’s emerging power needs.

Wider remit

The NIC suggests that it could itself take on such a role as part of its wider remit to advise on infrastructure needs. This recommendation, which a cynic may view as an exercise in empire building, hasn’t gone down well across the board, though.

Stuart Cook, a former senior partner at Ofgem, is “very sceptical” about this recommendation.

“If they are to take that on, they need to be a different organisation to what they are at the moment, they need greater competence and skills to be able to discharge that role effectively,” he says, drawing attention to what he sees as shortcomings in the NIC’s approach to retail energy issues (see box).

But Mitchell believes that giving the job to the NIC is an acceptable compromise.

“It seems the NIC is setting itself up to do that co-ordination. Preferably it would be a standalone body, but in the absence of that I would prefer NIC rather than Ofgem.”

Ofgem is failing to respond swiftly enough to the fast-changing energy landscape, she argues: “I used to think it was a case of two steps forward and one step back, but I’ve recently begun thinking it’s a one step back organisation and that it would be better for them to do nothing because they keep on doing things which don’t keep up at all.

“It makes things worse because they are so far behind where things are going.”

Marshall agrees that Ofgem has been lagging behind in areas such as energy storage and demand-side response.

“A lot of the decisions that need to be made around how the energy system is evolving need to be laid at Ofgem’s door.

“The fact that they have been an economic regulator for so long and have been able to get involved in anything that falls outside of that narrow remit hasn’t been particularly helpful. A lot of decisions have not been in line with policy decisions about how the energy system should evolve.”

The NIC addresses these concerns by recommending that utilities must take greater account of sustainability when making decisions.

The current regulatory model has created a culture of “short-termism” within utility regulation, according to the report, albeit while encouraging investment and better performance.

Model end

The NIC report points towards the end of the classic model of economic regulation under which watchdogs exist primarily to ensure the smooth running of the market.

Dr David Reader, lecturer in competition law at Newcastle University, says: “If we haven’t reached the end [of economic regulation], it would be a nail in the coffin.”

Cook, who is now managing director of his own consultancy, Complete Strategy, defends the existing set-up and questions whether there is a problem, given the rapid growth of renewable technologies that has taken place during recent years on Ofgem’s watch.

“They [the NIC] make the case that things need to change, but it’s never really clear to me what is broken that needs to be fixed.”

But Mitchell is “really pleased” with the NIC’s move to beef up the regulatory ­system’s sustainability remit.

“It puts net zero at the top of the agenda and regulators have to think long term,” she says.

Marshall agrees. “If the regulator’s remit is changed to take into account the net zero transition, these decisions would come under more scrutiny.”

Sustainability focus

And to help implement this greater focus on sustainability, the NIC report says Ofgem and Ofwat should split out “strategic enhancements” to the networks they regulate from the “standard” periodic price control, which should be focused on “maintenance of ­existing networks and marginal” upgrades.

Reader sees the logic of this move, which could make it less likely that potentially costly strategic upgrades end up feeding straight into customers’ bills through the price control process.

“If you set a price control in a silo of minimising bills, it will fail on the wider agenda.

“There is a lot of political pressure on regulators to respond to vulnerable customers in the short term at the cost of taking their eyes off the ball of the long-term environmental situation.”

But the report doesn’t define where these strategic enhancements should start and marginal upgrades end, critics say.

What may look like a marginal upgrade from one perspective may end up compromising the development of a network, says Sharon Darcy, director of Sustainability First.

“You may meet the needs of the people on the private wire but end up emasculating the DNO [distribution network operator] or DSO [distribution system operator] so they are unable to perform the decentralised energy function in the future.”

And piling new duties on to the existing regulatory system, without simplifying and rebalancing those powers already in place, could lead to regulators pointing in several directions at once, Reader argues.

“You could have such a long list of duties that regulators can take any decision they like because they can point to a list of duties,” she says.

“There needs to be some opportunity to stand back and revisit what we want regulators to do. Regulators have a role to play in ­enabling individual sectors to achieve goals for society, but regulators should not be expected to achieve all the goals in a market.

Addressing the functioning of the retail market

While much of the NIC regulation report focuses on infrastructure issues, it also addresses the functioning of the retail market.

However, its recommendations to crack down on what it terms discriminatory pricing ­practices have struck many as wrongheaded.

Echoing work going on elsewhere by the Financial Conduct Authority on insurance premiums, the report recommends that regulators should be able to prevent companies from engaging in price discrimination by requiring them to change their charging structures.

To ease the process of cracking down on discriminatory pricing practices, the report recommends that regulators be able to take action by using administrative powers, hence ­avoiding the need to go through the courts.

In a bid to shed more light on the issue, it says regulators should require companies to report annually on which groups of customers are paying more for the same service.

But Complete Strategy’s Cook doesn’t understand why it is the role of an infrastructure body to comment on the operation of the retail market.

Intervention in pricing policies could contravene competition legislation, he says: “People being charged different amounts is part of the normal functioning of the competitive market. If you can’t offer a new joiner something to tempt them away from a competitor, you won’t have ­competition.

“They are ill advised to comment on things they are not competent on.”