Franck Latrémolière says years of experience in commercial matters related to electricity networks have given him an insight into what doesn’t work. That includes some of the conclusions of the Helm review

 

The Helm review contains some radical ideas to reduce the cost of energy networks by relegating the current network companies down to contractor roles. They would compete with each other to provide construction and maintenance services to new independent system operator organisations that would take over the planning of transmission and distribution systems.

At first sight, these suggestions might seem sensible. It does look plausible that allowing competition for all aspects of the construction and maintenance of network infrastructures could lead to large benefits, not least by reducing the economic harm done by price controls (especially those under the RIIO framework).

The most important people have been almost ignored in choosing the route: energy consumers

It is true that facilitating side-by-side comparisons of network investment solutions with generation, storage or data management solutions would be highly desirable. The current system, where radically different ways of remunerating network investment and other investments are applied for substitutable projects, is an unfair and inefficient one.

It is also true that refocusing regulation on procuring system services, rather than on the finances of large infrastructure companies, would allow the absurd complexity of the current licence and exemption categories and conditions to be swept away. These companies could be driven primarily by competition and contracts, not by legal and regulatory manoeuvring.

So from a narrow point of view of cost control, the ideas in the review sound worth exploring.

 

Too narrow?

The narrow focus was intentional. The secretary of state wanted a review of costs in the energy sector and some ideas about what the government could do to cut those costs. But if this is what the minister wanted, is it what the minister needed? Would the review’s suggestions be good policy?

I don’t think so. Limiting the analysis to competition between service providers obscures serious risks that would arise from taking forward the review’s suggestions as they stand.

One risk arises from simple political economy. Helm’s proposals would amount to transferring the power of patronage from Ofgem and government to the system operators acting as auctioneers and co-ordinators. It would not take long until these auctioneers and co-ordinators would be so captured by vested interests that they would start to pick winners, or otherwise behave in crazy ways with customers’ money. There would be nothing to stop them from paying contractual incentives for unnecessary (but shiny) innovation, handing over rewards for apparent efficiency (also known as skilful manipulation of cost models), giving disproportionate rewards for providing information, or taking account of vested-interest-influenced views about the alleged risks of different technologies when choosing between competing bids.

Put these concerns aside, and imagine that some incorruptible superhumans, immune to vested interests, had been found, and that for some unfathomable reason they were in charge of the energy system operators. Would boarding the Helm ship lead somewhere nice?

I doubt it, because the most important people have been almost ignored in choosing the route: energy consumers. An excessive focus on competition between suppliers and on administrative and regulatory processes has ignored them.

In a way, this is understandable: once the supply side and regulation blinkers are on, markets look like merely the mechanisms by which the prices charged are constrained to reflect some reasonable measure of the costs. But it is wrong. A free market in a free country is not just characterised by fair prices controlled by competition between suppliers; it also provides freedom for customers to exert their free will about what they need or what they want.

Ofgem should be a good old-fashioned price regulator

On the Helm ship the system operators would be deciding what you want, buying it and charging you for it. That loss of freedom might be reason enough to resist implementation of the Helm review.

But there also strong mercantile reasons to join the good fight.

Ofgem has put some effort into enabling customers to choose their suppliers in markets where this is not a given, such as the construction and operation of new distribution systems. Not all of it has been crowned with success, and the fundamental error of applying total revenue price controls to infrastructure incumbents has caused untold damage to any markets in which they compete. Despite that, real customer choice has been delivered for many property and industrial sites, with genuine benefits, both financial (lower charges) and strategic (such as faster construction). These forms of competition – real markets supporting real customer choice – have been disregarded by the cost of energy review. On the Helm ship, you’ll regret Ofgem for its defence of economic freedom and customer choice.

The world will change in unforeseen ways because of social changes, migration, new technologies, and so on. Imagine that in the next couple of decades there are technological developments that reduce use of energy significantly, or the need for a continuous power supply to every house, so that a lot of the current infrastructure to provide a secure supply from centralised power generation becomes redundant. Or – a completely different direction but also a possibility – that technological changes increase both energy supply and demand by so much, or change the way energy is packaged so radically, that the existing infrastructure would become irrelevant: little more than museum pieces, in the same way that floppy disks or DVDs have been made irrelevant by modern file sizes and modern ways of transporting data.

Faced with such changes, the system operators would either ignore the changes and provide an energy system increasingly unsuited to customer needs, or try to follow them and incur enormous change-management expenses and long delays under their complicated procurement contracts. Bad either way. You’ll regret Ofgem for its flexibility.

And remember that system operators will actually be organisations staffed by petty bureaucrats in hock to salespeople for whatever is the best-hyped technology of the hour. Their procurement efficiency will be comparable to that of a hospital stuck in a nightmarish PFI contract. You’ll regret Ofgem for its competence.

 

Not the status quo

My criticisms of the review’s solutions do not amount to supporting the status quo. The review is right that Ofgem’s price control regime is failing to protect the interests of customers. It is also right to identify a need for structural separation between providers of network infrastructure, who should be freed to compete, and central administrative bodies such as the system operators.

Where the review has gone wrong is in proposing to give far too much power to these administrative bodies. Central planning will not work for energy networks. What would work? I think that the principle should be that of a good old-fashioned market economy, in which the customers – the people who want to pay for the development of networks – would decide which service provider they want to use and what infrastructure or services they want to buy, like normal customers do.

And Ofgem should be a good old-fashioned price regulator, that ensures that incumbents don’t overcharge too much, instead of attempting to supervise investment, total revenues or the overall financial position of the network companies. Enabling a good old-fashioned market economy to work smoothly on complex and shared infrastructure will entail some changes and challenges. It might mean big cuts to the role, powers and resources of the system operator. Perhaps it should only be facilitating voluntary transactions, instead of ordering everyone around.

It might need to restore to electricity transmission a principle that applies on every sane transportation system: that nobody is entitled to schedule consumption without being able to identify both a matching amount of production and sufficient rights over transport capacity. And it might need to create a way to charge users of reserve or response services for what they use, instead of carelessly putting costs into some residual charge.

 

First published in the December 2017 issue of New Power. Franck Latrémolière is a consultant