I OVERVIEW

The gas and electricity markets in the United Kingdom (UK) were among the first in the world to become fully liberalised and privatised. The drive towards liberalisation, which encompassed the privatisation of state-owned energy undertakings and the unbundling of the natural monopolies of transmission and distribution infrastructure from the competitive industries of production and supply, was introduced by the Thatcher government through the Gas Act 1986 (the Gas Act) and the Electricity Act 1989 (the Electricity Act). This fundamentally changed the structure of the electricity and gas market structures, which had been under complete public ownership since the commercialisation of electricity and natural gas in the late nineteenth and early twentieth centuries.

The UK joined the European Union (EU) with effect from 1 January 1973 and its electricity and gas market liberalisation measures have arguably had a material influence on the development of the structure of the EU internal energy market, progressing through the First, Second and Third Energy Packages in 1996 (for electricity) and 1998 (for gas), 2003 and 2009 (both for electricity and gas), respectively.

The UK is currently in a period of transition and the energy markets face significant challenges, driven by the simultaneous objectives of decarbonisation and ensuring security of supply and affordable energy, as well as the challenges resulting from Brexit, such as business continuity and security of supply.

II REGULATION

i The regulators

Gas and Electricity Markets Authority

Great Britain's gas and electricity markets are regulated by the Gas and Electricity Markets Authority (GEMA), which consists of a panel of individuals appointed by the Secretary of State. GEMA is entirely independent from government and has no stakeholder involvement, neither in GEMA's regulatory nor operational decisions. The powers and duties of GEMA are set out in a range of statutes, including the Gas Act, the Electricity Act, the Utilities Act 2000 (the Utilities Act), the Competition Act 1998, the Enterprise Act 2002 (the Enterprise Act) and the Energy Acts of 2004, 2008, 2010 and 2011. The day-to-day administration of GEMA's functions are carried out by the Office of Gas and Electricity Markets (Ofgem), which was formed from the amalgamation of the Office of Gas Regulation and the Office of Electricity Regulation in November 2000. GEMA defines Ofgem's strategy, sets policy priorities and makes decisions on a wide range of regulatory matters, including price control and enforcement.

The objectives of GEMA are set out in Sections 4AA to 4D of the Gas Act and Sections 3A to 3F of the Electricity Act. The principal objective of GEMA is to protect the interests of existing and future customers. This objective includes promoting the lowering of energy prices, the handling of complaints against suppliers and the protection of vulnerable customers, as well as the broader interests of customers, such as the reduction of greenhouse gases, the security of supply of gas and electricity, contributing to the achievement of sustainable development or the improvement of efficiency and quality of services. Furthering the principal objective of protecting customers' interests may, whenever appropriate, also include fostering effective competition. For this reason, GEMA has concurrent authority with the Competition and Markets Authority (CMA), the role and powers of which are discussed in detail below. Further, GEMA's duties also include ensuring that licence holders are capable of financing their activities, a function that is of increasing importance in regulated markets (particularly price-controlled networks and, more recently, supply markets).

The powers and duties of GEMA allow for the regulatory framework to remain responsive to changes in the market. Acting within it statutory remit, GEMA has the ability to modify licence conditions and the various industry codes that contain the detailed operational and technical rules governing the industry; however, this is generally done in a transparent manner and in consultation with market participants. The Secretary of State has the power, by virtue of Section 134 of the Energy Act 2004, to modify licence conditions if it is considered necessary or expedient for the purpose of implementing new trading and transmission arrangements. Under the Gas Act and the Electricity Act, the Secretary of State also has powers to introduce secondary legislation to respond to more structural changes in the market.

Northern Ireland Authority for Utility Regulation

Electricity, gas, water and sewerage industries in Northern Ireland are regulated by the Northern Ireland Authority for Utility Regulation (NIAUR). The NIAUR is an independent non-ministerial government department that carries the obligation to protect short-term and long-term interests of electricity, gas, water and sewerage consumers in respect of pricing and standard of service. Further duties of this authority include the promotion of a robust and efficient water and sewerage industry, the delivery of high-quality services, the promotion of competition, and the promotion of the development and maintenance of an economic and coordinated natural gas industry.

Northern Ireland operates a separate wholesale electricity market to that of Great Britain, known as the single electricity market (SEM), which is integrated with the wholesale electricity market of the Republic of Ireland. To comply with the European Third Energy Package, the SEM was reformed in October 2018, giving rise to a new set of trading arrangements between the governments of the Republic of Ireland and Northern Ireland referred to as the Integrated Single Electricity Market (I-SEM). Under I-SEM, wholesale electricity in the Republic of Ireland and Northern Ireland is traded on an all-island basis, whereby the island of Ireland is treated as one for many regulatory purposes. The market is jointly regulated by the NIAUR and the Commission for Regulation of Utilities in the Republic of Ireland. The decision-making body that governs the market is the SEM Committee.

Competition and Markets Authority

The Competition and Markets Authority (CMA) was established in April 2014 under the Enterprise and Regulatory Reform Act 2013 (ERRA). It regulates the entire United Kingdom and is responsible for strengthening business competition and reducing anticompetitive activities. The CMA is an independent non-ministerial department. In April 2014, it brought together the existing competition and consumer protection functions of the Office of Fair Trading and the responsibilities of the Competition Commission.

As mentioned above, GEMA has concurrent powers with the CMA in regard to competition in the energy sector. They work closely together as the ERRA requires any sectoral regulator to consider the impact under competition law before making use of its sector-specific powers. By virtue of Section 5 of the Enterprise Act, the CMA functions by conducting studies of the functions of competition within a given market in the UK as a whole, rather than conducting investigations on specific actions of companies. When the findings of a market study give rise to reasonable grounds for suspecting that a feature – or combination of features – of a market prevents, restricts or distorts competition, the CMA can initiate a targeted investigation. For the CMA to carry out a market-wide investigation in any of the electricity or gas sector markets, Ofgem may refer any of those markets to the CMA or the CMA may instruct Ofgem to transfer a case.

Other relevant regulators

In addition to the aforementioned regulators, a key role in Great Britain's energy market is carried out by the following regulators and government departments.

The Department for Business, Energy and Industrial Strategy (BEIS), although by definition not a regulator, plays a key part in the regulation, organisation and management of the energy market. BEIS is a department of the Government of the United Kingdom that was created in 2016, taking over from the Department of Energy and Climate Change, and is supported by 41 agencies and public bodies. The Secretary of State is responsible for BEIS, which is accountable to Parliament on matters including security of supply and sustainability in Great Britain's energy sector. In light of the integration of the Northern Irish energy sectors into the I-SEM, the department responsible for the energy sector in Northern Ireland is the Department for the Economy.

The Oil and Gas Authority (OGA) was established in April 2015 as an executive agency of BEIS, with the aim to maximise the economic recovery of the oil and gas resources available in the UK. In October 2016 however, the OGA was incorporated as an independent government company, with BEIS being its sole shareholder.

The OGA has the power to regulate the exploration and development of the UK's offshore and England's onshore oil and gas, the UK's carbon and gas storage and offloading activities. The OGA also has a critical role in encouraging investment in the UK, promoting opportunities that transition to a lower carbon economy and influencing a culture of greater collaboration within the energy industry. To fulfil its role, the OGA has been given a range of powers under the Petroleum Act 1998, the Energy Act 2011 and the Energy Act 2016.

The Health and Safety Executive is a national independent regulator responsible for regulation and enforcement of health and safety in the workplace and for producing guidance and carrying out research in relation to occupational risks.

The Office for Nuclear Regulation (ONR), an independent statutory corporation established in April 2014, is the regulator for the UK nuclear industry. The ONR reports to the Department for Work and Pensions; however, it works closely with BEIS. The objective of the ONR is to provide efficient and effective regulation of the nuclear industry, holding it to account on behalf of the public. This includes granting nuclear site licences, regulating the transport of nuclear materials and ensuring compliance with safeguarding obligations for the UK.

The Financial Conduct Authority (FCA) is the UK authority responsible for the regulation of firms offering financial services. By virtue of the broad definition of financial services in the Financial Services and Markets Act 2000, certain energy products are captured and therefore a variety of electricity and gas market participants are subject to their oversight. These market participants must either become authorised with the FCA or seek one of a number of available exemptions, such as for transmission system operators (TSOs) or for the provision of ancillary services. The FCA is additionally responsible for the oversight of the anti-market abuse regime in the energy sector.

Environmental regulation in the UK is a devolved function, with England, Wales, Scotland and Northern Ireland each adopting a different approach. In England (and in Wales until 2013), the Environment Agency (EA) is responsible for the protection and enhancement of the environment. It is a non-departmental public body that is organised into eight directorates. The Department for Environment, Food and Rural Affairs is partly responsible for the funding of the EA and is responsible for the appointment of the chairman and the board. Environmental affairs are the responsibility of Natural Resources Wales in Wales, the Scottish Environment Protection Agency in Scotland, and the Northern Ireland Environment Agency in Northern Ireland.

Finally, a key role in the development of energy infrastructure in the UK is played by the local planning authorities (LPAs). If market participants wish to develop an energy project, consent generally needs to be obtained from the relevant LPA, which is normally the borough, district or unitary council for the area, as required under either the Planning Act 2008 or the Town and Country Planning Act 1990.

ii Regulated activities

The electricity and gas sectors are structured in a similar manner, in that they operate through a hierarchy of statutes, statutory instruments, licences and industry codes under the supervision of Ofgem to ensure the correct functioning of the regulatory framework. Both the Gas Act and the Electricity Act set out a general prohibition of carrying out a licensable activity without a licence. A breach is triable either way at the instruction of the Secretary of State or GEMA, punishable by a fine up to the statutory maximum if tried summarily and an unlimited fine on indictment.

Licences are granted and administered by Ofgem and always correspond to the entity carrying out the activity rather than the specific asset. As such, licences do not attach to an asset or the land on which an asset is situated and therefore they cannot automatically transfer on the sale of the asset or land.

Under certain circumstances, an entity may be granted an exemption from the licence requirement. Exemptions are made by statutory instrument and take the form of either a class exemption, which is available to all provided that certain requirements are met, or a specific exemption, which is personal to a specific licence holder. In line with the principle of unbundling and certification requirements under the European Third Energy Package, a licence holder may not hold a generation or supply licence if he or she already is in possession of a transmission, distribution or interconnection licence.

Licences in both the gas and electricity sectors are subject to standard licence conditions (Section 8 of the Gas Act and Section 8A of the Electricity Act). These conditions apply to all licence holders, although some licences may be granted subject to special conditions, or have certain standard conditions disapplied or amended. The breach of a licence condition entitles Ofgem to revoke the relevant licence.

Electricity

Section 6(1) of the Electricity Act states that a licence is required by an entity that wishes to carry out the following activities:

  1. the generation of electricity;
  2. participation in the transmission of electricity;
  3. distribution of electricity;
  4. supply of electricity to premises;
  5. participation in the operation of an electricity interconnector; and
  6. provision of a smart meter communication service.

Licences may be limited in geographical area and supply licences may differentiate between the supply to domestic and non-domestic (i.e., industrial and commercial) premises. In practice, Ofgem grants fewer licences for supply to domestic premises as these licences include strict conditions relating to the provision of particular services to customers.

As provided above, one of the two ways in which an entity may be exempt from the requirement to hold a licence is by falling within a specific class that need not obtain a licence. These are set out in the Electricity (Class Exemptions from Requirement for a Licence) Order 2001. By way of example, two commonly used class exemptions are those for generating stations with capacity of less than 50MW, and on-site supply to premises, which is available to embedded generators supplying directly to the site where the generating station is situated.

Gas

Sections 5 and 7 to 7B of the Gas Act require a licence to be held to carry out the following activities:

  1. the transportation of gas (i.e., the conveyance of gas through pipes to premises or to a pipeline system operated by another gas transporter);
  2. the operation of a gas interconnector;
  3. the shipping of gas (i.e., the making of arrangements with a gas transporter for gas to be put into, conveyed through or taken out of that gas transporter's pipeline system);
  4. the supply of gas; and
  5. the provision of a smart meter communication service.

As with electricity licences, gas licences may be limited in geographical area and supply licences differentiate between domestic and non-domestic customers. The rules applying to exemptions from the requirement to hold a licence when carrying out a licensable activity are the same as under the electricity regime: class exemptions are set out in the Gas (Exemptions) Order 2011 and specific exemptions may be issued via statutory instrument by Ofgem or the Secretary of State.

Storage and development

In respect of the storage of gas and electricity, the provisions in the relevant statutes differ. Gas storage, while being subject to regulation, is not separately licensed. The provisions on electricity storage are currently in development, with Ofgem working with industry stakeholders.

A licence under the Gas Act or the Electricity Act authorises the licence holder to carry out the specified activity; however, it does not convey any other rights. As such, a licence does not entitle the entity to construct infrastructure. When developing a power station, gas pipeline or electricity network, for instance, separate licences and consents need to be obtained from relevant authorities with respect to, inter alia, land and access rights, planning permission and decommissioning.

Codes

The standard licence conditions require holders to be a party to one or more industry codes that set out technical rules and procedures for specific areas key to the operation of Great Britain's energy industry. All industry codes have a similar legal structure, in that they take the form of a standard document or contract and new parties accede to these through an accession agreement. These industry codes have initially been prepared by the Secretary of State; however, these documents are maintained by dedicated entities, which are responsible for any modifications through industry consultation and consent by Ofgem.

There are nine industry codes that apply to the electricity sector, of which the following four are of greatest relevance:

  1. The Balancing and Settlement Code (BSC), to which all generation and supply licence holders must be a party and which is administered by Elexon, contains rules for wholesale trading and settlement of electricity. Non-physical traders who are not licensed also need to accede to the BSC.
  2. The Connection and Use of System Code (CUSC) sets out the main rights and obligations of connection to, and use of, the national transmission system, and additional provisions on ancillary services and balancing services. The code administrator of the CUSC is National Grid Electricity System Operator Limited (NGESO) as TSO.
  3. The Grid Code sets out technical rules for matters such as connection conditions, scheduling, dispatch, operational liaison and safety coordination, and all material technical aspects of connections to, and the operation and use of, the transmission system. All licensed generators and transmission operators are required to sign both the CUSC and the Grid Code. The Grid Code is administered by NGESO.
  4. The Distribution Connection and Use of System Agreement (DCUSA) is a multi-party contract between licensed electricity generators, suppliers and distributors, and regulates the connection to and use of the electricity distribution networks. The code administrator of the DCUSA is Electralink.

In addition to the national industry codes, a number of EU network codes for electricity exist under the remit of Regulation (EC) No. 714/2009 (recast as Regulation (EU) 2019/943), the aim of which is the harmonisation of technical, operational and market rules governing the European electricity grids. These set out the rules for matters such as system operation, balancing activities, demand connection, grid connection for generators, and capacity allocation and congestion management. As EU Regulations, these network codes currently have direct applicability to the UK, prior to its complete withdrawal from the EU, and therefore exist in parallel with the national industry codes outlined above. Under the European Union (Withdrawal) Act 2018, these network codes have been transposed into national law and shall remain in effect post-Brexit.

With respect to the gas sector, there are five industry codes, the most central of which is the Uniform Network Code (UNC). The UNC is a contractual framework that forms the basis of arrangements between the owners and operators of the gas transportation systems in Great Britain and the users of these systems. It is administered by the Joint Office of Gas Transporters.

Similarly to the electricity sector, EU network codes for gas were introduced by Regulation (EC) No. 715/2009. These network codes facilitate cross-border network access and market integration and, as EU Regulations, directly apply in the UK. As with the electricity network codes, the gas network codes have been transposed into national law under the European Union (Withdrawal) Act 2018.

In addition to connection agreements that accede the relevant parties to the UK national industry codes, a number of agreements regulate entry to and exit from the network, including network exit agreements and turndown agreements.

iii Ownership and market access restrictions

Although there are no specific restrictions concerning the foreign ownership of electricity companies or assets in the UK, an additional certification process requires the assessment of whether foreign ownership or control (i.e., a licence holder from a country that is not a Member State of the European Economic Area (EEA)) poses a security of supply risk, in the UK or any other EEA Member State.2 This assessment is to be carried out by Ofgem in consultation with the European Commission and BEIS.

Depending on the outcome of Brexit, this assessment regime is likely to be extended to investors from outside the UK.

iv Transfers of control and assignments

All licences contain a provision permitting assignment; however, the assignment requires the prior written consent of Ofgem. Obtaining this consent would involve the assignee of the licence satisfying the Secretary of State that it can meet the licence obligations, which, in practice, involves an almost identical procedure to that required when applying for a new licence. There are no specific restrictions on change of control in any of the licences; however, transmission, distribution and interconnection licences do contain provisions that create a regulatory ring fence around the regulated asset. This provides an additional layer of control for Ofgem.

III TRANSMISSION/TRANSPORTATION AND DISTRIBUTION SERVICES

i Vertical integration and unbundling

As mentioned in Section I of this chapter, Great Britain was a pioneer in the legal separation of electricity generation and supply from transmission and distribution. Having been one of the first to be fully privatised and unbundled, the model served as an example for many other markets and jurisdictions.

The unbundling requirement was introduced under the Utilities Act 2000 and was part of the restructuring of the market following the privatisation and restructuring of the individual business units of British Gas in the 1990s. With the entry into force of the European Third Energy Package in September 2009 and the requirement for TSOs to be certified as complying with ownership unbundling, the concept of unbundling became an EU-wide concept.

Although the Gas Act and the Electricity Act both prohibit licensed gas transportation, electricity transmission, and gas and electricity distribution and interconnector assets from holding any other licence, this requirement does have material differences under the respective acts. Under the Gas Act, gas transmission and distribution activities are both dealt with by provisions relating to gas transportation, and there is no distinction between them. However, the requirement to keep generation and supply separate from transmission and distribution exists identically under the Gas Act and the Electricity Act.

ii Transmission/transportation and distribution access

Electricity sector

Transmission and distribution

With the implementation of the British Electricity Trading and Transmission Arrangement in 2005, the operation of three transmission networks in Great Britain was taken over by the National Grid group. This introduced a single electricity transmission system for the whole of Great Britain (the national electricity transmission system (NETS)) and divided the transmission role between the TSO, currently NGESO, and the existing transmission system owners.

National Grid Electricity Transmission plc (NGET) holds the transmission licence as owner of the transmission system in England and Wales, and the networks in northern Scotland and southern Scotland are owned by Scottish Hydro Electric Transmission plc and Scottish Power Transmission Limited respectively. In Northern Ireland, the TSO is SONI Limited and the licensee as owner of the transmission system is Northern Ireland Electricity Networks Limited.

The activities of both the TSO and the transmission system owner are licensable, whereby a TSO must additionally be certified. Transmission owners are obliged to make their transmission systems available to the TSO, which in turn is responsible for their operation, including the balancing of supply and demand and the dispatch of generation. Under the Electricity Act, transmission licence holders are obliged to develop and maintain an efficient, coordinated and economical system of electricity transmission, and to facilitate competition in the supply and generation of electricity. This primary obligation is supplemented by detailed provisions in the respective transmission licences. Furthermore, as discussed in Section II.ii, the activities of transmission and distribution are to a large extent regulated through the industry codes.

The TSO licence granted to NGESO provides not only detailed obligations for the licence holder but also regulates third-party access to the NETS, in that NGESO may not discriminate between any persons or class of persons in the provision of use of the system or in the carrying out of works to the system.

Ofgem has also established a competitive offshore transmission owner (OFTO) regulatory regime, whereby licences are granted – through a competitive tender process – to the owners of offshore transmission assets that connect offshore wind farms to the NETS. The aim of the offshore transmission regime is to support the government's renewable energy targets, and the use of a competitive tender process ensures that generators are linked to efficient and competitive transmission services. The tender process has therefore resulted in lower costs and higher standards of service for generators and consumers.

Ofgem plans to introduce greater competition to onshore electricity transmission with new, separable and high-value onshore transmission assets to be tendered based on a similar mechanism to the offshore transmission regime. There is currently no clear indication as to when this competitively appointed transmission owner (CATO) regime is to be introduced.

Distribution network operators

The distribution network in the UK carries electricity from the high-voltage NETS to industrial, commercial and domestic users along lower voltage lines. The individual networks are organised along geographical lines with various regional monopolies. Historically these lines follow the boundaries of the former publicly owned electricity boards. There are 12 licensed distribution network operators (DNOs) in England and Wales and two in Scotland, which are owned by six different corporate groups, namely Electricity North West Limited, Northern Powergrid, SSE, SP Energy Networks, UK Power Networks and Western Power Distribution. There is one further DNO in Northern Ireland. In addition to these, Ofgem also grants licences to a number of smaller networks owned and operated by independent network operators, which are commonly granted for business and commercial parks.

To distribute electricity through the network, each DNO must hold an electricity distribution licence. Each DNO also owns and operates the local electricity network.

In respect of the obligations of DNOs, the Electricity Act states that they must develop and maintain efficient, coordinated and economical systems of electricity distribution and facilitate competition in the supply and generation of electricity. The distribution licences subject DNOs to specific obligations in their licence conditions, and they also must comply with the relevant industry codes. Furthermore, DNOs must offer a connection between their distribution system and any premises when requested to do so by the owner of the premises and they are prohibited from discrimination.

Gas sector

Transportation

The owner and operator of the gas transmission network, a national transmission system (NTS), is National Grid Gas plc (NGG). The NGG licence covers the entire transmission system in Great Britain, in a similar manner as for the electricity sector, whereby the licence restricts ownership of the gas networks to NGG.

In contrast to the electricity sector, there is no separate licensable activity for the distribution of gas. A transportation licence covers both the high-pressure NTS and the lower-pressure gas distribution networks (GDNs). The transportation of gas requires a transporter licence, the obligations of which include the requirement to develop and maintain an efficient and economical pipeline system, to provide a connection to that system and to convey gas to third parties. The Gas Act also imposes a general duty to facilitate competition in the supply of gas and to avoid discrimination of system users. The individual licences held by gas transporters provide supplemental detailed and technical provisions to those contained in the Gas Act.

Distribution

The gas distribution system is organised in a similar manner to the electricity distribution system, with eight GDNs, each covering a separate geographical region of Great Britain. These eight networks are owned and managed by four companies, namely Cadent Gas Limited (which owns four GDNs), Northern Gas Networks Limited (which owns one GDN), Wales & West Utilities Limited (which owns one GDN) and SGN (which owns two GDNs). In addition to these companies, and similarly to the electricity distribution system, there are several smaller networks owned and operated by independent gas transporters, located within the areas covered by GDNs.

iii Rates

Network assets are subject to price control, regulated by Ofgem, which is implemented by licence conditions in each respective licence. The current price control model is referred to as the RIIO model, which stands for 'revenue set to deliver stronger incentives, innovation and outputs'. The RIIO price control sets out the revenue network companies may recover and what they are expected to deliver within eight-year price control periods (from 2015 to 2023 for electricity distribution and from 2013 to 2021 for transmission and gas distribution). The process of RIIO price control includes network companies presenting a business plan detailing how they intend to meet the objectives, followed by an evaluation and (if successful) approval by Ofgem. The outputs are set out in the licence, to provide transparency of costs to consumers and reflect enhanced engagement with stakeholders.

In respect of charging in the electricity sector, system users are subject to three types of transmission charges:

  1. connection charges: to recover the cost of installing and maintaining connection assets used by the party connecting to the transmission system. It takes into account the asset value, asset age and maintenance costs;
  2. transmission network use of system (TNUoS) charges: to recover the revenue for the transmission system owners, which is either NGET, the Scottish transmission owners, OFTOs, and in future any owners under the CATO regime;
  3. distribution network use of system charges: to recover revenue for the distribution system owner; and
  4. balancing services use of system charges: to recover the cost of balancing the transmission system.

Each type of charge is payable to NGET for connection and use of the transmission system. For the distribution system, similar charges arise. They are referred to as distribution use of system charges.

iv Security and technology restrictions

While some jurisdictions have legislative acts in place to bolster their national grid against threats, including terrorist or cyberattacks, there is no regime specific to energy infrastructure in the UK. Legislative measures, however, ensure security of supply, such as in the case of a cybersecurity threat affecting an energy utility company's operational capability. The Secretary of State for BEIS has powers to take control of fuel and electricity supplies by an order under Sections 1 and 2 of the Energy Act 1976.

The main government authority in the area of security and technology is the Centre for Protection of National Infrastructure, which has the role of identifying and mitigating vulnerabilities in the national infrastructure that could be exploited, including energy infrastructure.

IV ENERGY MARKETS

i Development of energy market

Electricity

The UK electricity market has been fully privatised and liberalised since the early 1990s. With state control giving way to market competition, the government began to focus on strategic choices, including generation capacity planning, and choice of fuels and sites. Today, electricity market participants have the freedom to choose the terms on which they trade and the price at which they trade. The market operates on the basis of bilateral contracts, which may be executed over the counter or over an exchange.

Electricity is traded between generators, suppliers and trading entities via the NETS. Although any entity granted a licence will need to become a party to the BSC, entities that are not licence holders may also accede. These include, in particular, non-physical traders (i.e., those that do not take physical delivery of electricity), such as banks or trading houses. Most trades of electricity are made under the industry standard Grid Trade Master Agreement (GTMA), under the ISDA Master Agreement (published by the International Swaps and Derivatives Association) with the GTMA annex, or under bespoke power purchase agreements.

One of the factors determining the direction of development of Great Britain's electricity market are the market coupling measures provided for in EU legislation, particularly those set out in the European Third Energy Package and the new Clean Energy Package (finalised in 2019). To date, the UK has taken significant steps to implement coupling measures; however, with the outcome of Brexit still being uncertain, future developments (or acts to revert coupling measures) are yet to be seen.

Gas

Gas may be traded by gas shippers at entry points to and exit points of the NTS. When gas is traded at entry points, it may be traded under standard terms and conditions, the Beach 20003 terms or under bespoke gas sales agreements. The terms on which the trade takes place are not subject to specific regulatory requirements, but since entry point trade involves a physical transfer of the title to gas – and therefore provisions relating to title, quality and pressure, and those determining the damages payable by the party that fails to fulfil its contractual obligations – in practice, it is more common for parties to use the Beach 2000 terms rather than individually tailored agreements. Only licensed shippers may inject gas into the NTS; however, shippers that only trade gas within the NTS (i.e., do not take gas beyond the entry point or exit point) do not need to hold a shipping licence.

Similarly to the electricity market, developments in the gas market are materially influenced by reforms brought by the EU gas regime. The implementation of Regulation (EC) No. 715/2009 required the European Network of Transmission System Operators for Gas (ENTSOG) to develop EU-wide network codes that seek to remedy cross-border network and market integration issues. ENTSOG is responsible for the development of these network codes and, prior to Brexit, was responsible for the monitoring and analysis of their implementation in Great Britain.

ii Energy market rules and regulation

As described above, the regulation of the energy markets is largely set out in industry codes such as the Grid Code, the CUSC or the BSC for electricity or the UNC for gas. Compliance by individual market participants with the industry codes is governed through the licence conditions, which require the respective licence holder to accede to and comply with the relevant industry codes.

Depending on the nature of the market participant or the transaction, financial market regulation may additionally apply. This was introduced through the Markets in Financial Instruments Directives I and II (MiFID I and MiFID II), implemented in the UK as the Financial Services and Markets Act 2000. There has been an increasing trend towards the regulation of energy trading under financial market regulations, particularly as MiFID II has significantly narrowed the exemptions available to commodity derivatives trading firms.

Another development introduced through EU law is in respect of market manipulation and insider trading. The Regulation on Wholesale Energy Market Integrity and Transparency4 (REMIT) requires market participants in wholesale supply and transportation or transmission of physical gas and electricity to disclose inside information and avoid (actual or attempted) market manipulation and abuse. REMIT substantially increases Ofgem's power in the area of market transparency, making it a criminal offence to breach certain provisions under the REMIT.

iii Contracts for sale of energy

Generators, electricity suppliers, electricity traders and large customers can enter into commercially negotiated contracts to buy and sell electricity and gas. The volumes, but not other commercial details, of the resulting trades are notified to the system and market operators, and any imbalances between the notified supply and demand are priced and settled. Trading takes place on a half-hourly basis with gate closure set one hour ahead of real time, upon which participants notify the system operator of their intended final physical position. After this point, no further contract notification can be made and settlement is based on the gate closure positions.

iv Market developments

In respect of both electricity and gas, the energy supply market is dominated by the six biggest energy companies – known as the Big Six5 – which provide 95 per cent of the energy in Great Britain. Concern has been raised that this market share may be harmful to competition.

In the electricity market, this concern led Ofgem to carry out a retail market review, which resulted in new standards of conduct at the retail consumer level (e.g., transparency to allow consumers to compare tariffs more easily). As problems in the electricity supply market persisted, Ofgem placed additional obligations on large suppliers in respect of their trading strategies. Consequently, there was a rise in the number of new entrants; however, these new players soon failed, as the increased number of failures among smaller independent suppliers proved. Furthermore, as part of the efforts to attain healthy competition, Ofgem launched the implementation of a major project in the electricity market under the UK's Electricity Market Reform (EMR) programme in 2013. The EMR involved, inter alia, a capacity market to ensure security of electricity supply and a feed-in tariff with contracts for difference (FiT CfD) to promote renewable generation development.

In November 2018, the capacity market mechanism was tested in the European Court of Justice (ECJ) case Tempus Energy Ltd and Tempus Energy Technology Ltd v European Commission (T-793/14) of 15 November 2018. The claimant, Tempus Energy, a UK-based demand side response (DSR) provider, claimed that the European Commission did not properly conduct its investigations to ensure that the UK's proposed capacity market scheme was consistent with EU State Aid rules. The claimant further argued that the scheme did not equally treat DSR providers and battery storage operators with generators with respect to providing capacity. Following judgment in favour of the claimant by the General Court, the capacity market was suspended for one year while the Commission repeated its investigation and ultimately deemed the capacity market consistent with State Aid rules. Consequently, the suspension was relieved in late 2019 with a release of withheld payments to capacity market participants.

V RENEWABLE ENERGY AND CONSERVATION

i Development of renewable energy

Renewable energy developments and related technologies have benefited from the support of the UK government for three decades. By the early 1990s, the energy market had been fully liberalised, which enabled the progressive entry of independent power producers to the market. Almost simultaneously, the Non-Fossil Fuel Obligation came into effect, which was replaced by the Renewables Obligation (RO) in 2002. The RO has been closed to all new generation as of 31 March 2017. Since then renewables support has been delivered primarily through the FiT CfD mechanism under the EMR programme, which was launched by Ofgem in 2013. Of further relevance at national level are the Climate Change Act 2008, by which the UK has committed to a reduction of greenhouse gas emissions, and the climate change levy (CCL), which was introduced in 2001 and is a levy on UK business collected by energy suppliers.

Renewables obligation

The RO scheme was introduced in England and Wales in 2002 and administered by Ofgem. The RO places an obligation on suppliers to source a minimum percentage of electricity supplied each year from renewable generation. Compliance with this obligation is demonstrated through the purchase of renewable obligation certificates (ROCs), which represent a volume of electricity generated by an accredited generator. ROCs were issued by Ofgem in respect of 1MW of renewable source electricity generated by accredited generators and further sold from generators to either traders or suppliers. If the minimum number of ROCs to be held is not met by the supplier, a buyout price is to be paid as a penalty.

As mentioned above, the RO has been closed to all new generation from 31March 2017.

Feed-in tariffs for contracts for difference

CfDs were introduced as part of the EMR scheme and are currently the main support instrument available for renewable generation in the electricity sector. CfDs are contracts agreed between low-carbon generators and Low Carbon Contracts Company Limited (LCCC), a government-owned private company. CfDs provide a steady income to eligible generators by paying difference payments against a predetermined strike price; if the electricity market price is below the strike price, the generator receives the difference between the strike price and the market price and, consequently, if the market price rises above the strike price, the generator will need to pay the difference to the LCCC. This strike price mechanism reduces the generator's exposure to the volatility of electricity prices and, therefore, provides bankability for the project by lowering the cost of debt and the equity capital required. An eligible generator is, broadly, any renewable or nuclear generator.

Feed-in tariffs

The FiT scheme was introduced in 2010 with the purpose of promoting the deployment and use of small-scale generation (less than 5MW). Suppliers that join the FiT scheme – either voluntarily or compulsorily for those that supply more than 250,000 domestic users – become FiT licensees. The mechanism provides that owners of eligible small-scale renewable generation plants receive a payment from FiT licensees for each unit of electricity provided to that FiT licensee, which in turn passes on costs to consumers. A fixed payment is made for electricity that is generated on-site, which is referred to as the 'generation tariff', and another payment is made for any unused electricity that the generator exports to the grid, namely the 'export tariff'.

The FiT scheme was subject to major reform in late 2015 (including, inter alia, a reduction of tariffs and the introduction of quarterly deployment caps) but was fully closed to new applicants as of 1 April 2019.

EU renewable energy regime

The Renewable Energy Directive (RED)6 is the core EU act for renewable energy promotion and sets the rules to achieve the EU renewables target of 20 per cent by 2020. This has been transposed into UK law through various statutes and statutory instruments, including the Energy Act 2013, the Electricity (Guarantees of Origin of Electricity Produced from Renewable Energy Sources) Regulations 2003 and the Electricity (Guarantees of Origin of Electricity Produced from Renewable Energy Sources) Regulations (Northern Ireland) 2003.

In December 2018, the recast Renewable Energy Directive (RED II)7 entered into force, raising the overall EU target for renewable energy sources consumption by 2030 to 32 per cent. RED II will take effect in June 2021 (which is therefore also the deadline for the UK to transpose RED II into national law), at which point the RED will be repealed. In light of Brexit, the adoption of these new measures by the UK will depend on whether it has, by the end of the Brexit transition period, transposed the new provisions contained within the RED II. If so, since the UK's national renewables target exceeds that prescribed at EU level, the position under RED II in the UK would remain unaffected by what the final position under Brexit turns out to be.

ii Energy efficiency and conservation

As noted above, the CCL, introduced in 2001, is a levy on electricity delivered to non-domestic consumers and has the aim of incentivising businesses to become more energy efficient in how they operate, thus helping to reduce their overall emissions. To be eligible to pay a reduced CCL main rate, a business must be an energy-intensive business and must have entered into a voluntary climate change agreement with the EA. A business with energy-intensive industrial processes (e.g., metallurgical and mineralogical processes) can get a 90 per cent reduction for electricity consumed and a 65 per cent reduction for gas.

The Renewable Heat Incentive (RHI) scheme was introduced by the government to promote energy efficiency through promoting renewable heat usage. The RHI operates in a similar manner to the FiT system with the aim of levelling the cost of renewable heat with that of heating from fossil fuels by providing successful participants with periodic payments calculated in terms of £/kWh of eligible renewable heat or biomethane produced. Although originally introduced only for non-domestic buildings, the RHI was extended to domestic buildings in April 2014. Support is given for 20 years to non-domestic buildings and for seven years to domestic buildings. The RHI is due to end for new applicants on 31 March 2021, with no indication yet from the government on how it will encourage low carbon heating after that date, or the supply chain on which it relies.

iii Technological developments

In light of the UK's commitment to decarbonisation and increasing renewable generation capacity, a key area for development in the UK market is security of supply and system flexibility, in particular the ability of NGESO to respond appropriately to electricity imbalances. This requires increased access to system usage data in timeframes that are as close to real time as possible.

The development of smart meters has been an important part of enabling this transition. Energy suppliers are responsible for replacing gas and electricity meters with smart meters, which provide the consumer with near real-time information on the energy used and thus aids in saving energy. Although the original requirement was that suppliers had until 2020 to provide smart meters to all consumers, this deadline has been extended to 2024.

One area in particular that has seen significant growth in the UK is the electricity storage industry. The UK is considered a market leader in this respect, with corresponding new technological developments emerging. The number of applicants to build battery storage projects is continuing to increase rapidly: the total capacity of battery storage planning applications has soared from nearly 6,900MW in late 2018 to more than 10,500MW in early 2020. Various technologies are being used for the storage of electricity, including hydrogen, ammonia and compressed air.

A further development that is important to improved flexibility was highlighted by the Tempus ECJ case. DSR is a service that focuses on the consumption of electricity rather than its generation, whereby instead of ramping up generation to correct an increase in demand, certain consumers could temporarily reduce their consumption for non-essential purposes and processes. In its judgment, the ECJ held that the Commission's investigation into compliance of the UK capacity market with State Aid rules should have considered whether DSR was treated as an equivalent to generation technology.

VI THE YEAR IN REVIEW

The past year has been dynamic for the UK energy markets. The 11-month Brexit negotiation period and the associated preparations for the full withdrawal of the UK from the EU have been key; however, there have been other important developments, several of which are highlighted below.

As detailed above, the ECJ Tempus case has been a significant development, with the UK capacity market being suspended as the Commission repeated its investigation of the scheme compliance with State Aid rules. Following a positive decision, Ofgem reinstated the capacity market, allowing deferred payments to be made to participants.

In November 2019, Ofgem carried out its Targeted Charging Review, which is expected to replace the current electricity charging system in 2020 or 2021. The details of the proposal remain under consideration; however, these changes generally aim to create equality in the market and reduce the overall costs of electricity market operation. Key proposals include fixed network charges being introduced to create a fair system for more flexible and less flexible users, the removal of embedded benefits for generators and the passing on of TNUoS to consumers, with the aim of reducing generation costs and, therefore, wholesale prices.

On 9 August 2019, Great Britain suffered a major electricity blackout following a lightning strike on a transmission circuit north of London and the simultaneous reduction of supply of two generators totalling 1,378MW. Despite calling on backup power, the scale of the generation loss required NGESO to disconnect approximately 1 millions customer so that the normal frequency range could be reinstated and thereby ensure system stability.8 Although this was an unusual incident, it demonstrated the value of ancillary services to system stability and the need for further investment in security of supply and flexibility services.

VII CONCLUSIONS AND OUTLOOK

During the past four decades, the UK energy markets have generally served as a model for energy market liberalisation. This extends through the privatisation of the electricity and gas sectors in the 1980s, the introduction of modern and liquid electricity and gas markets, the facilitation of subsidy-free renewable energy technologies through the use of corporate PPAs, and the development of flexibility mechanisms such as the capacity markets.

The UK has made ambitious commitments to the continuing threat of climate change, which have been formalised in its nationally determined contributions under the Paris Agreement, as well as the promotion of advanced technology throughout the energy sector.

At the time of writing, future development of the energy markets is uncertain. The UK is currently within the 11-month Brexit transition period, during which the UK and EU aim to agree upon a post-Brexit cooperation agreement. However, because of the covid-19 outbreak in the first half of 2020, the pace of these negotiations appeared to have slowed down.

With the European Union (Withdrawal) Act 2018, the UK has carried across the body of European Union law into national law that seeks to ensure legal continuity post-Brexit. There are various questions, however, that depend on the outcome of the cooperation agreement negotiations, particularly in relation to continued operation of and trade across the electricity and gas interconnectors with the UK's neighbours, as well as continued access to the single market for electricity and gas, and continued participation in the EU Emissions Trading System.

The policies of BEIS and Ofgem suggest that the UK remains committed to further developing low-carbon, stable and competitive energy markets. However, it remains to be seen whether the UK will voluntarily remain in alignment with EU energy policy and market structures, or whether it will elect to develop its own energy policy, and at what speed.

It is likely that indications of the future policy development will only crystallise after the elapse of the Brexit transition period and the full withdrawal of the UK from the EU.


Footnotes

1 Andreas Gunst and Natasha Luther-Jones are partners and Kenneth Wallace-Mueller is a senior associate at DLA Piper International.

2 The European Economic Area includes all 27 EU Member States and also Iceland, Liechtenstein and Norway. It allows them to be part of the EU's single market.

3 Standard Terms and Conditions for the Sale and Purchase of Natural Gas for UK Short Term Deliveries at the Beach 2000.

4 Regulation (EU) No. 1227/2011.

5 The Big Six are SSE, EDF Energy, British Gas, npower, E.ON UK and Scottish Power.

6 Directive 2009/28/EC.

7 Directive (EU) 2018/2001.