Ofgem publish their response to Consultation on SO Separation along with a working paper on the future regulatory framework

We reported in February 2017 on Ofgem's consultation on how to effect the separation of the electricity system operator role from the rest of National Grid; see our article Separation of National Grid's System Operator Role. Ofgem have now published their response, along with a working paper on the future regulatory framework.

Proposed separation arrangements

As part of the consultation process, National Grid submitted a set of proposals for how to separate the electricity system operator (ESO) function from the rest of National Grid, which Ofgem considered and accepted.  In summary the key elements are:

  • Governance – A separate ESO board consisting of 7 members (3 National Grid Directors, 3 Independent Directors and 1 Chair who will be the Director of the ESO), with a compliance sub-committee chaired by one of the independent directors. The ESO directors will not be able to sit on the boards of National Grid plc or other National Grid electricity companies.
  • Employee Separation, Incentivisation and Transfer – In principle all ESO staff will be employed by the ESO. Managers and executives will be incentivised on ESO metrics, with the exception of a small number of ‘dual fuel’ staff who will work across the electricity SO and the gas SO and be incentivised on gas and electricity SO performance only. This includes some senior managers in the ESO, including the ESO Director. All moves between ESO and NGET will be treated as "sensitive moves" and reviewed by the Compliance Officer.
  • Physical separation – The ESO will be physically separated from other parts of National Grid’s business. National Grid’s Wokingham office will remain ESO only. The ESO headquarters will be located within a newly developed, physically separate part of the existing National Grid headquarters in Warwick, accessible via a separate site entrance to the rest of the NG building and with completely separate staff facilities.
  • Shared services – Ofgem acknowledges that there would be significant costs in duplicating services to the ESO and that there needs to be a balance between the risks of shared services versus the cost to consumers. Transactional services (HR, procurement, Tax & Treasury, Investor Relations and Audit) will be shared on the same basis as they are provided to all National Grid Group entities. Strategic services (Finance, Corporate Affairs) will be shared under a business partner arrangement. There will be a separate ESO regulatory capability.
  • Culture and branding – The need for a separate ESO culture came through strongly from stakeholder feedback. National Grid will develop a distinct and explicit visual identity of the new “National Grid ESO”, so that it will be obvious when stakeholders are dealing with the ESO rather than National Grid plc or other businesses in the group.

NGET suggested that the separation would incur £54.8m in one-off costs and £8.5m p.a. thereafter.  However, Ofgem believes £49.3m of one-off costs and £9.1m p.a. ongoing costs are appropriate.

Effecting the separation

Ofgem thinks that it can implement most of these changes without major amendments to existing licence obligations.

National Grid plc will make a voluntary application under Section 7A of the Electricity Act 1989 (Transfer of Licences) to transfer the ESO functions in its existing licence to a separate legal entity within the National Grid group. This will include the proposed licence changes needed to facilitate the transfer. If Ofgem consents to this, it can then modify the licence (following consultation) and impose appropriate conditions on the transfer – which will include what costs National Grid can incur.

National Grid's RIIO-T1 price control settlement will be split between the ESO and Transmission Owner (TO) companies, but the overall settlement amount will not increase.

Regulatory framework

Ofgem published a Working Paper on the Future Regulatory Framework on 11 July, before the consultation response. It is part of the process to redesign the ESO's incentives and regulatory framework and sets out Ofgem's latest thinking. There is broad agreement that the SO should fulfil four roles, as set out in the January consultation.

These are backed up by seven principles, against which Ofgem will measure the ESO's performance, underpinned by the recently-modified C16 (Standard Licence Condition 16) licence provisions. The roles and relevant principles are:

Role 1: Acting as the residual balancer

Principle 1: Support market participants to make informed decisions by providing user-friendly, comprehensive and accurate information.

Principle 2: Drive overall efficiency and transparency in balancing taking into account impacts of its actions across time horizons.

Role 2: Facilitating competitive markets

Principle 3: Ensure the rules and processes for procuring balancing services maximise competition where possible and are simple, fair and transparent.

Principle 4: Promote competition in wholesale and capacity markets.

Role 3: Facilitating a whole system view

Principle 5: Coordinate across system boundaries to deliver efficient network planning and development.

Principle 6: Coordinate effectively to ensure efficient whole system operation and optimal use of resources.

Role 4: Supporting competition in networks

Facilitate timely, efficient and competitive network investments.

Next steps

Ofgem is now developing options for the detailed design of the new ESO incentives scheme later this summer and will undertake more formal stakeholder engagement in the autumn. The new ESO incentives scheme should be in place by April 2018 (a year earlier than the ESO separation which will take place in April 2019).

The legal separation will formally start later this year when National Grid makes an application for approval of a transfer of the ESO functions to a new entity, under Section 7A of the Electricity Act 1989. Ofgem will consult on this and decide whether to accept or reject it.

Once the separation is made, the final changes will be confirmed through changes to the ESO and NGET licences, using the standard licence change route.

Key Contacts

Richard Goodfellow

Richard Goodfellow

Head of IPE and Co-head of Energy and Utilities
United Kingdom

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Paul Dight

Paul Dight

Partner, Energy and Utilities
United Kingdom

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