Energy Act 2023: System Operation and Energy Code Governance

In the seventh in our series of briefings following the passing of the Energy Act 2023 (the Act) on 26 October 2023, our team at Norton Rose Fulbright look at the framework adopted under the Act to build an efficient, flexible, low carbon and low-cost electricity and gas systems and its potential implications.

System Operation

With the energy system becoming more complex, the government published its “Energy White Paper: Powering our net zero future” in December 2020, in which it pledged to ensure that the institutional arrangements governing the energy system are fit for purpose in the long term. The desire was to build on the reforms to the system operator instituted in April 2019 when the electricity system operator – National Grid Electricity System Operator (NGESO) – became a legally separate function within National Grid.

In January 2021, Ofgem published its report on the review of GB energy system operation¹, the aim of which was to consider the current and future challenges facing GB system operation and assess whether the right governance framework was in place to deliver the UK’s net zero emissions targets. Ofgem recommended that the system operator be given additional responsibilities (most notably in the context of network and energy system planning and independent advice) and to make it fully independent from the transmission network owner. It also recommended separating key gas network planning functions from the gas transmission owner and combining these planning functions with the electricity system operator as an independent body.

Taking on board Ofgem’s recommendations, the government published a joint consultation² with Ofgem in July 2021 proposing the creation of a more strategic and independent body – the Future System Operator (FSO), with responsibilities across both the electricity and gas systems to help meet the net zero target whilst maintaining energy security and minimising costs. After broad support, the government confirmed it would proceed with the creation of an FSO and this has now been legislated for in the Act.

The Act establishes the FSO under the auspices of an Independent System Operator and Planner (ISOP) with roles and responsibilities across both the electricity and gas sectors: on the one hand, it is tasked with co-ordinating and directing the flow of electricity onto and over transmission systems – the main existing role and responsibility of NGESO; on the other hand, it will be responsible for long-term strategic planning and forecasting in relation to the conveyance and supply of gas.

The Act requires the ISOP to carry out its functions in a manner that promotes its three core objectives of meeting net zero, ensuring security of supply, and promoting an efficient, co-ordinated, and economical system for the transportation of electricity and gas. When carrying out its functions, the ISOP must also facilitate competition and innovation, take a whole-system approach to gas and electricity, and consider consumer impact.

Whilst the Act sets out the general framework for creating the ISOP and its associated key duties and powers, the details are yet to be seen and will be implemented through secondary legislation, new and updated licences, and amendments to energy codes. It is expected that the ISOP will be founded on the existing capabilities and functions of NGESO and (where appropriate) NGG, and will be implemented through a phased approach, potentially as early as this year.

Energy Code Governance

In July 2019, Ofgem and the government published a joint consultation setting out proposals on reforming the energy industry codes³ – the technical and commercial rules of the electricity and gas systems. One of the desired outcomes was to create an energy code framework that was agile and responsive to change and made it easier for any market participant to identify the rules that apply to them and understand what they mean and innovate to the benefit of energy consumers.

A further consultation⁴ was published in July 2021 on the design and delivery of future governance arrangements of the energy codes. Two potential governance models were proposed – Ofgem acting as a strategic body with separate code managers (option 1) and the FSO acting as an integrated rule making body combining both strategic and code manager functions (option 2). In April 2022⁵ the government confirmed its preference for option 1, giving Ofgem new strategic code functions. The Act therefore expands Ofgem’s functions by requiring it to publish an annual ‘strategic direction statement’ setting out its strategic assessment of government policies and industry developments that may necessitate modification of energy codes. However, the Secretary of State (SoS) may transfer this function to be exercisable by ISOP (instead of Ofgem). However, given the need for the ISOP to mature in its system-wide operation and planning function, it is not expected that the ISOP will take on these strategic direction duties at least in the short term.

The Act also enables Ofgem to modify energy codes in several specific circumstances bypassing the normal code modification procedure. Currently, the industry drives the process of amending industry codes. Proposals for code modification are considered via a Code Panel – a group of members appointed by parties to the relevant code – which is required to consult the industry with regards to code modifications and requires Ofgem’s approval for material code modifications. The Act now allows Ofgem to directly modify industry codes, within certain parameters. Notably, Ofgem can make such modifications where necessary ‘as a matter of urgency’ to avoid adverse effects on consumers or other interested persons, or, in the case of complex modifications, where required for the purpose of implementing a strategic direction statement.

The Act also introduces ‘code managers’ in both the electricity and gas sectors, responsible for the governance of a designated code. Code managers are required to hold a code manager licence and are to be selected by Ofgem.

Whilst the Act also provides for the designation of central systems that support the operation and processing of data necessary in connection with industry documents, the government decided not to license central system delivery bodies for the time being.