There are many current issues facing the energy system which are challenging enough without confusing political challenges with regulatory ones. Too many political challenges are being given to regulators to sort out, which is grossly complicating matters for all parties. This document considers how to separate them, and applies to all regulated utilities.
Purpose of Regulation
The primary purpose of regulation is to ensure an affordable, reliable and resilient system.
In order to achieve that, it has a number of secondary purposes, such as:
- Ensuring fair competition for all (the “level playing-field”);
- Opening up market access and contracts to enough parties to ensure sufficient competition to maximise the outcomes, i.e. the purpose;
- Ensuring that no consumers are excluded other than for compelling reasons, e.g. non-payment of bills; one consequence of this is to ensure timely and affordable grid connections where reasonably feasible;
- Setting and enforcing standards of reliability and protection against events and occurrences within the system;
- Compelling and testing resilience to, and recovery from, external shocks and changing conditions.
Regulation Over What Term?
Most grid-connected assets, from domestic grid connections to major plants, are long-lived infrastructure with operational lifespans of 30+ years, often much longer: there are some water pipes and reservoirs still operating from the Middle Ages; parts of the electricity grid are approaching their centenary; and parts of the gas grid are well over 50 years old.
Moreover, the lead times of planning and installing new plant and infrastructure is long in all regulated utilities, typically 5-15 years. Its planning needs to allow for expected future changes in temporal pattern, quantity and location of both supply and demand. Even short lead time actions (such as grid connections for all utilities, which usually take months) have expected lifespans of decades and knock-on effects on the network, by changing demand patterns and quantities.
Therefore the nature of regulation must focus on the medium (10-30 years) and long (30+ years) terms. Anything shorter-term than that is a political issue.
Set against that, there is also a limited role for regulation in the short term, particularly in parts of each sector where there is little or no competition, such as network operation, in order to maximise efficiency and minimise costs. Thus it will ensure that processes are efficient, short-term network utilisation provides maximum access to new connections, supplier/customer/stakeholder interactions are optimised etc.
Politicians are responsible not only for the long-term health and safety of the country, but also its short-term. This is brought into sharp focus by the current energy price spikes which are causing genuine hardship to many.
Being political challenges, these must have political solutions, not regulatory ones. This is because solving them through regulators will create many harmful consequences, such as (but not limited to):
- Confusing the regulatory signals;
- Diverting, diluting and undermining medium- and long-term incentives;
- Forcing both regulatory and private bodies to undertake socio-political actions to which they are poorly suited, have little accountability and will incur unnecessary costs;
- Driving small/new players from the market because they don’t have the resources to cope well;
- Politicising regulation, which should be technocratic and apolitical, thereby making regulation subject to electoral cycles and shorter-term events;
- Greatly increasing the costs of the system as participants must hedge against increased regulatory risk, leading more to pull out and the rest to put up prices.
An Example from the Electricity System
By way of example, consider the electricity price increases of late 2021 to early 2022 due to the rocketing gas prices. These threaten to double electricity bills and drive millions into “fuel poverty”, as well as causing suffering to those already in such poverty. The situation is expected to be temporary, but the duration is unknown and there is a political imperative to help those in need.
One proposed solution is to cut or cap the carbon price, or other mechanisms that are designed to encourage the energy transition. But to do so would greatly mute the incentive to make the changes that the country needs in order to play its part in halting global warming. Moreover, such changes will affect all users regardless of ability to pay, and so be wasteful: spreading benefits more thinly so those in real need receive less of them.
A second proposal is to provide discounts rebates to the poorest, in their energy bills. But that would require electricity providers to gather customer information that they don’t (and, for privacy reasons, shouldn’t) have, and to spend lots of effort and money processing it. Moreover, some manner of appeals system will need to be implemented, in both company and regulator (and/or regulated body) to cope with those who feel unjustly excluded or reduced. Companies will be compelled to make value judgements between customers, which is not in their natural role. All this is likely to blow up later in a huge political scandal.
Much better would be to keep all industry and decarbonisation incentives intact, and to provide the support through taxation, tax credits and/or benefits:
- As energy prices rocket, so the incentives to invest in sensible things like insulation, economy measures, distributed generation (solar panels etc.) and suchlike would be magnified, benefiting the system and country alike.
- The government, which has (by rights) all the requisite information on people’s financial situation, and which already undertakes similar analyses calculations and decisions, would merely expand its remit marginally to take decisions relating to such assistance – and even these could be eliminated by (for example) providing the assistance by a time-limited (or condition-dependent) increase to benefits, tax credits and/or allowances.
- Regulators and companies are enabled to focus on their core purposes, while the government focuses on its.
- The country’s efforts to achieve its 2050 energy transition goals are enhanced.
The Bigger Picture
All this fits into a bigger picture of mistakes that have been made consistently over the last 40-50 years which have led to the non-commodity costs of running all our utilities to rise exponentially, a problem that shows no sign of stopping. See: Where Grid Regulation Went Wrong, and Review of Increasing Grid Balancing Costs.
The regulatory system in all industries is very short-termist and getting more so: it needs to focus on the 10-30 and 30+ year time horizons not only in its rules but also in the markets and contracts that it regulates. See: Issues with Ever-Shortening Contract Durations.
Re-setting the regulatory period every 5 years has never worked in the world and is most reminiscent of the North Korean economy. Private industry needs a longer-term horizon than a short, fixed window that means (for example) no visibility beyond 2 years’ time for decisions that have to be made in year 3 of the window. There is no commercial sense to it whatsoever that stands up to scrutiny. See Ofgem RIIO2 Consultation – Storelectric Response.
Each industry is a complex inter-weaving of different needs and capabilities. They only work if these needs and capabilities are all addressed and none missed. Otherwise the result is unaffordable, unreliable and fragile. See Saving Billions on Grid Upgrades, and Revenue Stacking and Salami Slicing.
And no self-respecting major country can depend, for its essential utilities, on another country sacrificing its own needs for their benefit. It won’t happen – yet this is what is increasingly implemented in the electricity industry: see Interconnectors and Imports.