Helm Energy Review

The cost of energy is too high, and higher than necessary to meet the Climate Change Act (CCA) target and the carbon budgets. Households and businesses have not fully benefited from the falling costs of gas and coal, the rapidly falling costs of renewables, or from the efficiency gains to network and supply costs which come from smart technologies. Prices should be falling, and they should go on falling into the medium and longer terms.

For the networks, going forward, there should be no more periodic reviews in the current RIIO framework. Technical change is so fast that predicting costs eight–ten years hence is impractical.

The government should establish an independent national system operator (NSO) and regional system operators (RSOs) in the public sector, with relevant duties to supply, and take on some of the obligations in the relevant licences from the regulated transmission and distribution companies. The NSO and the RSOs should, where practical, open up the various functions and enhancements to the networks to competitive auctions and, at the local level, invite bids for network enhancements, generation and storage, and demand-side response (DSR) from energy service companies.

The separate generation, supply and distribution licences, at least at the local level, should be replaced by a simpler, single licence.

As a result of the above changes, the role of Ofgem in network regulation should be significantly diminished.

There should be a default tariff to replace the Standard Variable Tariff (SVT), based on the index of wholesale costs, the fixed cost pass-throughs, levies and taxes, and a published supply margin.

Capping the margin would be the best way to meet the objectives of the new draft legislation. By focusing on the margin within the default tariff structure, competition would be enhanced, thereby encouraging new entrants.

The government should issue an annual statement to Parliament, setting out the required capacity margins and providing guidance to the NSO and RSOs.

Households and businesses have not benefited as much as they should because of legacy costs, policies and regulation, and the continued exercise of market power.

The scale of the multiple interventions in the electricity market is now so great that few if any could even list them all, and their interactions are poorly understood. Complexity is itself a major cause of rising costs, and tinkering with policies and regulations is unlikely to reduce costs. Indeed, each successive intervention layers on new costs and unintended consequences. It should be a central aim of government to radically simplify the interventions, and to get government back out of many of its current detailed roles. This review explains how to do this.

The legacy costs from the Renewables Obligation Certificates (ROCs), the feed-in tariffs (FiTs) and low-carbon contracts for difference (CfDs) are a major contributor to rising final prices, and should be separated out, ring-fenced, and placed in a 'legacy bank'. They should be charged separately and explicitly on customer bills. Industrial customers should be exempt. Once taken out of the market, the underlying prices should then be falling.

The most efficient way to meet the CCA target and the carbon budget is to set a universal carbon price on a common basis across the whole economy, harmonising the multiple carbon taxes and prices currently in place. This price should vary so as to meet the carbon targets. It would be significantly lower than the cost of the current multiple interventions.

There should be a border carbon price to address the consequences of the UK adopting a unilateral carbon production target.

The FiTs and other low-carbon CfDs should be gradually phased out, and merged into a unified equivalent firm power (EFP) capacity auction. The costs of intermittency will then rest with those who cause them, and there will be a major incentive for the intermittent generators to contract with and invest in the demand side, storage and back-up plants. The balancing and flexibility of markets should be significantly encouraged.

After all existing commitments in respect of FiTs and low-carbon CfDs have been fully honoured, and in the transition to a proper, uniform carbon price and an EFP auction, they should be split into three parts: the construction and project-development phase; the operation of the plant; and decommissioning. The first should have a higher cost of capital, reflecting the equity risks; the second should be more akin to a regulatory asset base (RAB) in the utilities and closer to the cost of debt; and the third should be a charge to operating costs. The customers should benefit from the refinancing when the project comes into operation.

The current RIIO (Revenue = Incentives + Innovation + Outputs) periodic review price caps for the transmission and distribution companies are already being significantly outperformed – in part because of mistakes in the assumptions – and have resulted in higher prices than need to be charged for the efficient delivery of their functions. Ofgem should consider what actions should be taken now.