Innovation and the governance of energy industry codes

Dr. Matthew Lockwood (University of Exeter Energy Policy Group)

Energy industry codes are detailed multilateral agreements that define the terms under which participants can access networks and operate in markets. Adherence to codes is embedded in licence conditions. Codes thus effectively determine the detailed working of the gas and electricity systems and for any aspect of energy policy to function well industry codes must be sufficiently aligned with that policy (CMA 2015a). Despite their importance, relatively little attention is paid to codes in academic research.

With the energy system facing a period of rapid and far-reaching technological and institutional change, a key question is whether and how codes can be adapted to facilitate and support such change. Codes are ‘living documents’, and are continually being modified, so the answer to this question lies with the governance arrangements for code modification. The underlying principle for code governance, established at privatisation, has been self-governance by industry (with the regulator holding a final veto power). This is effectively a form of double delegation from the political sphere (Flinders 2008), in which modifications to codes are developed through code panels made up in most cases of industry representatives.

In this paper I review evidence on how far the code governance system does in fact facilitate the reaching of policy objectives, especially competition and decarbonisation, both in light of historical experience and as the energy system moves into a period of rapid innovation and policy change. The analysis draws on qualitative evidence from a range of sources, but especially code governance reviews by Ofgem, the Competition and Market Authority energy markets investigation and code panel websites.

This evidence points to three types of problem: the complexity and fragmentation of codes governance which act as barriers to innovation; a gap between code objectives and policy objectives, and a lack of incentives for reform of the code governance system from within under the self-governance arrangement.

On the basis of this analysis, I argue for a reform of codes governance arrangements that moves away from self-governance towards governance by a dedicated independent body, accountable to government but probably located within an independent system operator. These proposals go further than those tabled by the CMA (CMA 2015b) and the enhanced Significant Code Review powers proposed for Ofgem (Ofgem 2015).

I also relate these proposals to the two rationales underpinning the original self-governance arrangements; certainty for companies and therefore investors, allowing a lower cost of capital, and efficiency under conditions of asymmetric information between regulator and industry. I argue that the proposals provide a better trade-off between the need for both stability and flexibility in regulation (Newbery 1999).

References

Competition and Markets Authority (2015a) Provisional Findings CMA, London

Competition and Markets Authority (2015b) Possible Remedies CMA, London

Flinders, M. (2008) Delegated Governance and the British State: Walking without order Oxford, Oxford University Press

Newbery, D. (1999) Privatization, Restructuring and Regulation of Network Utilities Cambridge MA: MIT Press

Ofgem (2015) Code Governance Review (Phase 3): Initial Proposals

Keywords: governance, innovation, decarbonisation, competition, codes