How can energy regulator, Ofgem, support a net zero future

How can energy regulator, Ofgem, support a net zero future

Dr Jeff Hardy, Grantham Institute, Imperial College London

28th June 2021

In Britain, the Office of Gas and Electricity Markets, known as Ofgem, is tasked with regulating the companies that operate our gas and electricity networks and protecting the interests of energy consumers. But what role should it play in helping the UK transition to a net-zero emissions economy? And what changes to its remit and responsibilities are needed? These questions are currently being examined by a House of Lords committee, which recently invited Dr Jeff Hardy, Senior Research Fellow at Imperial College London’s Grantham Institute – Climate Change and the Environment, to give evidence. In this blog, he provides a summary of that evidence, outlining some of the major challenges facing Ofgem in the years to come.

Having spent four years as Head of Sustainable Energy Futures at Ofgem before joining Imperial’s Grantham Institute, the question of the regulator’s role in the energy transition is one that is close to my heart. It is a complex issue that is worthy of detailed discussion so I was delighted to be invited by the House of Lords Industry and Regulators Committee, led by Labour’s Lord Hollick, to give evidence alongside University of Exeter’s Professor Catherine Mitchell. 

For two hours, the Committee asked Catherine and me a series of excellent questions about the current and future role of Ofgem in net-zero, including the interests of energy consumers, energy network price controls, security of energy supply, parliamentary scrutiny, and international comparators. You can watch the session back in full here, but in this blog I want to highlight four challenges that Ofgem faces in the net-zero transition.

Big energy systems changes are afoot

Since Ofgem was founded around 20 years ago, the electricity system has moved from one predominately powered by coal to one that is often predominately powered by renewables, particularly wind, solar and biomass. Our energy system is still reliant on gas for power and industrial and domestic heat but increasingly, that gas is imported rather than produced in the North Sea. 

The next decade will see more of the same renewables for electricity. Alongside this, there will be a rapid increase in the electrification of transport and heating and other changes such as district heating and (in some places) the emergence of zero-carbon hydrogen economies. 

To date, it has been a zero-carbon transition that consumers have been able to ignore. Next up, it is coming to everyone’s home and business. 

Ofgem’s challenge now is to regulate a system in which every user has a role in delivering zero-carbon, with devices and homes providing flexibility when the sun is not shining and the wind is not blowing. It is a transition that could create new benefits or harms for all its users, and one in which people and businesses that cannot or will not engage are at risk of being left behind. An example of this is where those who can afford equipment like batteries, smart heating and electric vehicles can access smart tariffs and benefit from lower bills – those who cannot afford such technologies might end up paying more because they can’t access or benefit from the cheapest smart tariffs. 

It is, in other words, a transition that must work for everyone, or it won’t work at all. 

A subtle change to Ofgem’s objective is needed

Currently, Ofgem has a smorgasbord of duties and issues it must have regard to (i.e., can’t ignore). These duties essentially pit climate against other factors, such as cost, security of supply and vulnerability. This competition between duties makes decision making complex as Ofgem must balance all factors or at least explain why it hasn’t taken particular factors into account. My proposal is simple: promote net-zero into Ofgem’s principal objective. 

Ofgem’s current objective derives from various relevant legislative Acts. It reads:

The Authority’s principal objective is to protect the interests of existing and future consumers in relation to gas conveyed through pipes and electricity conveyed by distribution or transmission systems.  The interests of such consumers are their interests taken as a whole, including their interests in the reduction of greenhouse gases in the security of the supply of gas and electricity.

The change I propose is along the following lines:

The Authority’s principal objective is to protect the interests of existing and future consumers in relation to net-zeroenergy systems

Promoting net-zero in such a way would stop greenhouse gases from competing with everything else and instead enable a discussion on how a net-zero system can best meet other objectives. 

Business model innovation is needed to help customers on their net-zero journeys

At the Committee session, I made the point that the net-zero transition could mean that energy becomes more complex for citizens. For example, in the future, we expect most customers to be on time-of-use tariffs, where the price of electricity is different every half hour reflecting things like how much the wind is blowing and how constrained the grid is. Homes might also need advice and indeed help with the costs of installing new zero-carbon equipment, like electric vehicles, insulation and heat pumps. 

Committee members rightly pointed out that this sounds complicated. I agree and think that this is where businesses (for profit or not) need to innovate and step in to remove the complexity and risk from their customers by, for example, helping their customers with the upfront costs of zero-carbon kit or automating home devices to keep energy bills low. We recently published some thinking on future energy supply business models and whether customers are interested and able to engage in such models

More user-centred energy businesses entail a different relationship with their customers, and such business models do not fit comfortably into the current supply licence regime. An example is a business that sells energy-as-a-service. Such businesses have the potential to install zero-carbon equipment in homes, at no or low upfront costs, and the customers pays for the energy services (like comfort, mobility and illumination) at a fixed price over a long-term contract. The business needs to understand the customer’s needs, values and preferences to ensure it can meet their energy services at a fixed price and make a profit. Currently, the retail market and the supply licence are skewed towards regular switching which makes such long-term symbiotic business models difficult and risky. 

Ofgem needs to accelerate its work on the future retail market and create space for such business model innovation. At the same time, Ofgem needs to learn how to protect customers from harms caused by novel energy business models. These new customer protections are something Laura Sandys and I argued in our Redesigning Regulation report

Can GB learn from elsewhere?

Many countries are undergoing net-zero transitions, and there is always something to learn (and indeed others can learn from GB). During the Committee session, we cited good examples in the USA, such as the Public Utilities Commission-led New York Reforming the Energy Vision, a ten-year programme to reform the state energy and utility industry. We also cited Australia, where there is a very high penetration of rooftop solar and batteries, energy market and network pricing challenges, and their forward-thinking Energy Consumers Australia body, which looks after customers interests. 

There are countries ahead of the UK in their decarbonisation transition, from whom we have an opportunity to learn. We mentioned Denmark (where some days they have 150% of electricity demand met by wind) and New Zealand (where renewables meet 80% of electricity demand). 

I ponder whether we need a global forum for regulators to get together and share knowledge and experience about regulating zero-carbon energy systems. Or perhaps I’ve missed it if such an organisation exists?

Overall, I commend Lord Hollick and his Committee for taking on this important inquiry. We only have a small window to get net-zero right, and Ofgem is a critical piece of the energy governance jigsaw. 

This blog was first posted by the Energy Futures Lab at Imperial College London on 28th June 2021: