Reforming OFGEM
Steve Wardlaw, February 2024
We are facing increased global energy insecurity, a creaking energy system in the UK, the need to decarbonise and an understanding that we need greater state involvement. The current regulatory regime needs a rapid and material upgrade to prepare it for the largest energy market changes for a generation. The government is not paying attention to this – and it needs to.
When we look at how a reformed energy sector would work in the UK, there is a general agreement on the need for increased state direction in the sector. You can see my comments on Labour’s idea for GB Energy HERE. There is also discussion about small nuclear, again see my thoughts on GB Nuclear HERE. As well, there are several thought streams around alternative energy sources, onshore v offshore generation, and transmission grids.
However, there is one area that has been largely overlooked – regulation.
If you are going to have a more directed state – which now seems a given whichever party is in government – there are two ways to promote that. The much-discussed first one is to have a powerful state player, GB Energy. Oddly, the second string to the bow often gets overlooked – reform of OFGEM and a new role for it as a necessary “regulator on steroids”.
There is much currently to criticise OFGEM for in relation to being behind the curve in market development. However, that criticism is – in part – unfair.
OFGEM is a creature of statute and can only do what it is authorised to do. When it was originally set up (as OFFER and OFGAS before they merged) its mandate was to protect consumers by enhancing competition between the newly-privatised electricity companies, in what was a fairly radical new structure. Thirty years on, and in an era of dramatic change, the question is broader – should OFGEM be reviewing itself, and does it remain fit for purpose?
Bear in mind that when OFGEM was originally set up, it was probably seen as a suitable balance for the dozen or so RECs (regional electricity companies) that were finding their way in a new market having been broken up from a unitary supply company. However, after a bout of (inevitable) consolidation, does OFGEM still have the power it needs, and how can we make sure that it does?
The issue here is that OFGEM’s original remit has been focussed on pricing for consumers, rather then the general robustness of the market, and the need to futureproof its development – this was not something under consideration in the early 90s. For example, the drive to lower consumer prices led OFGEM to simplify supply licences (as one of the few tools it had), but there was little consideration given to market robustness. Hence 29 new suppliers collapsed in 2021/2022 when wholesale energy prices rose and those companies either had not hedged supply prices, and/or had no reserves or capacity to mitigate those market movements.
In general, with the introduction of GB Energy, OFGEM needs to become a partner to a state power company. It needs to be a lot less reactive and to take the lead as the market commits to change. With decarbonisation, the end of globalisation and a realisation that the old model of privatisation is not going to suit going forward, any regulator needs powers to oversee what will be the most radical transformation for a generation.
The problem of OFGEM’s reactivity was again laid bare with the farce of connection delays to the UK power grid – a seemingly technical issue, but one that has the capacity to derail the connection of much of the decarbonising generation. The government looked at the issue of grid connection delays at the end of last year, pointing out that there was a delay of 5 years already on connection capacity. OFGEM produced a paper promising to help with this, by terminating the contracts of stalled project. The elephant in the room? Why was it not doing this proactively before the government asked it to? While OFGEM had warned in May 2023 that these delays would jeopardise our 2035 decarbonisation targets, it should have been watching this on a rolling basis and a crisis could have been averted.
So what are some potential solutions?
New powers
At the moment, OFGEM has oversight over companies in the sector but not the government. This should change. To be clear, this does NOT mean that OFGEM can direct the government, but OFGEM should be able to mark/grade the government against what the government itself has proposed. As an example, if the government says that it will connect 24 new generating assets to the grid within a certain timeframe, OFGEM should have the ability to produce regular updates on whether the government was taking the right steps at the right time in order to meet any target date. The government would not be obliged to follow OFGEM, but OFGEM could publish its findings and others may hold the government to account.
In simple terms, OFGEM would become the Office of Budget Responsibility for energy. The government does not have to follow what OFGEM says but at the moment the government can make headline-grabbing announcements for long-term goals without any accountability for progress or delivery. The transformation of the energy sector is too important to allow this to continue.
These OFGEM progress reviews would also be very useful to the Energy Select Committee in holding the government to account on its timetabling and achievements.
New remit
The above is clearly an expansion of OFGEM’s powers, but there are other non-governmental goals that OFGEM should cover. While pricing is important, especially keeping prices as low as possible, there also needs to be cover for other aims.
Here is the difficulty with the below list of suggestions – often these aims are competing. A balance needs to be struck. While OFGEM’s original remit was simple – price protection for the consumer – OFGEM’s lack of ability to look behind the curtain and review the resilience of the UK consumer power market has caused structural problems with consumer energy supply.
So, what other areas might OFGEM want to consider? While the primary aim must still be consumer protection, it must adapt and broaden. Consumer protection through simple price regulation has not worked. We need to see consumer protection through ensuring market resilience – protection against international energy shocks. As an example, a beefed-up OFGEM may have taken a view on the government allowing the sell off of Rough (a depleted gas field in the North Sea that was used to store gas by pumping it back in). As any economist will tell you, an untrammelled free market may choose to sell of resilience assets such as gas storage fields or pumped storage generation (see below) because they make more short-term profit overall that way.
That is not how the UK energy market should function. And that is not how it was set up initially. Because of the need for resilience, there was an obligation to maintain significant gas storage, and the UK Grid was allowed to retain ownership of the two pumped storage generators[1] (Dinorwig and Festiniog) because their supreme flexibility was deemed important for system security. Over time, the free market drivers pushed for those assets to be sold off (unbundled), increasing system risk for the sake of market principles. We need to row back on that, led by a more muscular OFGEM.
OFGEM should also consider the push for insulation targets, increased penalties for system losses, higher levels of system resilience, grid connection targets, grid expansion generally, planning interface with the local authorities, alternative entry system for new suppliers, to name just a few.
As mentioned above, many of these are admirable, even essential, targets. Do they conflict with the drive to keep prices low? It depends how you look at it – short-term versus medium-term. Prices were arguably kept lower in the short term by selling off assets such as Rough storage, but over the medium term that assets would have softened the shock caused by the increase in global energy prices. Government needs to ask OFGEM (and other regulators – another story) to take a longer term view of stability rather than lower prices in a single electoral cycle.
Closing summary
It’s simple. A more directed state needs a more directed regulator. However, as the regulator will increasingly hold energy companies and the government to account it needs more power. That involves extra resources, not just money but skills – energy companies have serious legal and negotiating skills that the civil services lacks. That has been a problem thoughout government, from energy price negotiations to defence procurement.
As the energy sector pivots for a new age, it is going to need discipline and longer term views. A properly reconstituted OFGEM could be the adult in the room that is needed for that process.
[1] Pumped storage was the phrase used for very flexible generators that generated by dropping water down the inside of a mountain to generate power very quickly for system balancing purposes. They were deemed to be different from usual income-producing generating assets. However, they were sold off to commercial generators in 1995.
February 2024
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