Energy Bill [HL] 2022-23, parts 4-6: Electricity and gas markets

The Government’s Energy Bill [HL] 2022-23 was introduced to the House of Commons on 25 April 2023, following its Lords stages. Second reading in the Commons is due to begin on 9 May 2023.

This briefing provides background on parts 4 to 6 of the bill. These parts contribute to the second of the bill’s three pillars, on “reforming the UK’s energy system and protecting consumers”. They cover the following measures, as summarised by the bill’s explanatory notes (PDF):

• Establishing an Independent System Operator and Planner (hitherto known as the Future System Operator), an independent and first-of-a-kind body acting as a trusted voice at the heart of the energy sector.
• Reforming the current energy code governance framework including granting Ofgem new functions to provide strategic direction and oversight on codes and creating a new class of more independent code managers to deliver an improved system for consumers and competition.
• Enabling competitive tenders in onshore electricity networks.
• Enabling the Competition and Markets Authority (CMA) to investigate more effectively the impacts of mergers between energy companies.
• Introducing a definition of multi-purpose interconnectors from which a new licensing and economic regime can be developed.
• Clarifying electricity storage as a distinct subset of generation in the 1989 Electricity Act.
• Removing obligation thresholds under the Energy Company Obligation scheme.
• Driving the rollout of smart meters across Great Britain.

The following summarises each measure.

Part 4: Independent System Operator and Planner

The electricity and gas grids in Great Britain (GB) transport energy from where it enters the network (for example power stations which generate electricity) to where it is used. They are owned by a series of transmission and distribution network owners and operators. There is also a system operator for each network that is responsible for ensuring the grids are always ‘balanced’ (ie that supply matches demand).

National Grid plc is a group of businesses which (amongst other roles) act as the transmission owner and the system operator of the electricity transmission network. Previously National Grid plc also held these roles for the gas transmission network, but in 2022 it sold a 60% equity stake in this business to an investor consortium.

In the December 2020 Energy white paper the Government said it would ensure that arrangements for governing the energy system were “fit for purpose for the long term”, including to deliver the Government’s target to reduce UK emissions to ‘net zero’ by 2050. It said that if the system operator were to take on additional roles, there may need to be “greater independence from the current ownership structure”. In January 2021 an Ofgem report concluded that “net zero requires a step-change in whole system coordination and planning”. Ofgem recommended the creation of a new independent energy system operator.

Part 4 of the Bill would create this new public body, the Independent System Operator and Planner (ISOP). The ISOP would be regulated by Ofgem and would be responsible for:

• planning how electricity and gas transmission systems are developed,
• the operation of the electricity transmission system,
• promoting three main objectives: net zero, security of supply, and efficiency and economy; and
• additional net zero focused roles, which could potentially include planning for new systems for hydrogen and carbon capture and storage.

Many of the ISOP’s proposed functions are currently carried out by licensed operators owned by National Grid plc. The bill would provide for the transfer of the whole, or parts of, these operators as part of ISOP’s establishment.

During the Lords stages, opposition Members moved amendments seeking to ensure the independence of the ISOP from Government, but all were withdrawn. At third reading, Labour welcomed the progress that had been made on the ISOP’s independence.

Note that while the bill refers to the new body as the ISOP, the Government’s earlier publications refer to it as the Future System Operator (FSO). For clarity, the ISOP and the FSO are the same thing.

Part 5: Governance of gas and electricity industry codes

The industry codes are detailed legal agreements between participants in the gas and electricity sectors. They set the commercial terms and technical standards that underpin how aspects of the energy market work in practice.

The current code governance regime, has been criticised by the Government, the Competition and Markets Authority (CMA), and various industry stakeholders. It is regarded as unsuited to responding to the emerging challenges facing the energy sector.

The reforms in part 5 of the bill intend to address this. The bill would give Ofgem greater influence over how codes are governed and modified. Ofgem would:

• be required to publish an annual ‘strategic vision’ statement setting out how it expects the industry codes to develop;
• gain powers to directly modify the industry codes in certain circumstances;
• gain powers to regulate the bodies responsible for managing the industry codes by requiring them to hold licences to operate.

The Government’s factsheet on part 5 of the bill says this will make the codes more responsive to policy objectives and changes in the wider energy market.

Part 5 of the bill was not amended during the Lords stages.

Part 6: Market reform and consumer protection Clause 160: Competitive tendering for onshore electricity networks

The GB electricity grid is owned by a series of transmission and distribution network owners and operators, all monopolies of specific geographic areas. Historically these companies have been subject to network price controls, regulated by Ofgem, which cap the maximum revenue that can be collected from customers.

The bill’s explanatory notes (PDF) set out the Government’s view that the price control process is no longer sufficient for onshore networks, as it can limit innovation and does not always deliver maximum benefits to consumers. This is a particular concern since GB electricity infrastructure needs to increase to deliver on the Government’s ‘net zero’ target.

In 2009, the Government introduced legislation that enables Ofgem to hold competitions to identify new licensees for transmission assets that connect offshore generation infrastructure, such as windfarms, to the onshore grid.

The Government has been exploring options to extend competition to onshore networks for the past decade, to deliver the required increase in electricity infrastructure at a lower cost. In December 2020 it confirmed it would bring forward legislation (PDF) “to enable competitive tendering in the building, ownership and operation of the onshore electricity network”. The Department for Business, Energy and Industrial Strategy consulted on the new proposals in 2021, which broadened the range of technological solutions that would be able to apply for competitive tenders. It published its response in August 2022.

The proposed measure in the Energy Bill would extend the existing competitive regime for offshore electricity transmission networks to onshore networks. A DESNZ factsheet explains it would “enable competitions to be run for the build, ownership and operation of onshore electricity networks in Great Britain”.

At the Lords report stage, a Government amendment was agreed which would require that where the tender regulations would provide for the imposition of financial penalties, they would also provide for the right to appeal against these.

Clause 161: Special merger regime for energy network companies

The CMA is the UK’s main competition regulator. It reviews mergers if it believes a merger might lead to “substantial lessening of competition” (SLC) in the market.

The Government’s view is that the SLC test to review mergers can be inappropriate for energy network businesses, because (as regional monopolies) there is no direct competition between players. The bill would therefore introduce a “special mergers regime” for energy networks, similar to that already present in the water industry.

The bill would require the CMA to consider, when investigating energy network mergers, whether the merger would substantially prejudice Ofgem’s ability to benchmark (make comparisons) between energy network companies through its price control process. This would replace the SLC test.

As the measure is sector-specific and was not consulted on in advance, there has been little press or stakeholder comment. The Government says that the special regime “could save energy consumers up to £420 million over 10 years”, but international law firm Freshfields Bruckhaus Deringer said the new regime “may make potential investors think twice about potential network mergers”.

The Lords made no amendments to the single clause on the special merger regime.

Clauses 162 to 167: Multi-purpose interconnectors

GB’s electricity grid interacts with grids on mainland Europe through interconnectors. Conventional ‘point to point’ interconnectors are undersea cables that link GB’s transmission network with that of mainland Europe and the island of Ireland.

In 2022 the Government set a target to achieve 50 GW of offshore wind generation by 2030, including 5 GW of offshore wind. This new generation will also need to be connected to the GB electricity grid through subsea cables, known as offshore electricity transmission networks.

Multi-purpose interconnectors (MPIs) are a new, innovative type of interconnector:

• Like conventional interconnectors, MPIs are subsea electricity cables that can connect the GB electricity grid to the grids of neighbouring countries.
• Unlike conventional interconnectors, MPIs also enable clusters of offshore wind farms to connect to the shore together, rather than each wind farm having to connect to the shore individually.

MPIs are not currently defined in law and the existing regulatory regime treats interconnectors and transmission systems separately. This makes it difficult for the electricity regulator, Ofgem, to license MPIs.

The proposed measure in the bill would introduce MPIs as a new licensable activity under the existing regulatory regime. This would enable MPI developers to obtain MPI-specific licences from Ofgem.

No amendments were made to the two clauses on multi-purpose interconnectors during the Lords stages.

Clause 168: Electricity storage

Electricity storage technologies allow surplus electricity to be stored as another form of energy until it is required, when it can be re-released as electricity.

The Electricity Act 1989 is the main legislation governing electricity in GB, but it contains no specific definition of, or reference to, electricity storage.

Instead, electricity storage is generally treated as a subset of electricity generation in regulation. This means that (unless an exemption applies) storage providers are required to hold a licence to generate electricity, which entails an administrative burden. It also means that other licence-holders, such as energy suppliers and network companies, are restricted from operating electricity storage.

The absence of a regulatory definition for electricity storage has created a barrier to deployment. The measure in the bill would introduce a new legal definition for electricity storage to remedy this.

No amendments were made to the single clause on electricity storage during the Lords stages.

Clause 169: Energy Company Obligation scheme buy-out mechanism

The Energy Company Obligation scheme (ECO) requires energy suppliers that have over 150,000 customer accounts to install energy efficiency and heating measures in GB. It is focused on providing support to low income and vulnerable households. Suppliers meet their obligation either through in-house services or by contracting with a third party. Costs are usually passed onto customer bills.

Smaller energy suppliers are currently exempt from the ECO. The Government wants to remove this “market distortion” whereby smaller suppliers can undercut larger suppliers (who have to pay ECO costs) on prices.

The Energy Bill would enable the removal of this exemption by allowing the Government to introduce a “buy-out mechanism”. Once the ECO thresholds have been removed the mechanism would allow small suppliers to pay into a buy-out ‘pot’ to meet their obligation as an alternative to installing measures under ECO.

No amendments were made to the single clause on the ECO buy-out mechanism during the Lords stages.

Clause 170: Smart metering

The Government and energy industry are partway through a major delivery programme, which began in 2011, to replace traditional analogue gas and electricity meters with smart meters in homes and small businesses across GB.

The BEIS Secretary of State has powers to modify energy licence conditions and industry codes to enable the rollout of smart meters. These powers are currently due to expire on 1 November 2023.

Smart meter installation across GB is not yet complete. In June 2021 the Government published a targets framework which sets an ambition for completion at the end of 2025. The bill provides for these powers to continue for a further five years, until 1 November 2028.

No amendments were made to the single clause on smart metering during the Lords stages.