The UK Government has laid draft regulations in Parliament which, when approved by both Houses after their summer recess, will make legislative changes necessary to fully transpose the requirements of the EU's Third Energy Package into national law.

The regulations fundamentally change key aspects of the regulatory regime for large and small market players and include new licence modification powers and enforcement powers over unlicensed network operators and suppliers, as well as codifying the Third Energy Package unbundling requirements for gas and electricity transmission operators (including the controversial third country provisions), the unbundling requirements for gas and LNG storage facilities and the extension of the third party access regime to offshore LNG facilities.

For the first time, the national regulator is explicitly required to comply with decisions of the new pan-European regulatory agency (ACER) and the European Commission decreasing the scope for matters to remain purely a matter for domestic regulation.  

The draft Regulations, entitled the Electricity and Gas (Internal Markets) Regulations 2011 were laid following the conclusion of three separate consultations by the Department of Energy and Climate Change (DECC). The Government's response to these consultations, published in January 2011, summarised the legislative changes that will be made by the draft Regulations and through modifications to electricity and gas licences.

The changes can be split into five distinct areas:

  • consumer protection;
  • the role of Ofgem as the National Regulatory Authority (NRA) for Great Britain;
  • transmission and distribution networks;
  • gas infrastructure; and
  • licence exempt undertakings and private networks.

Consumer protection

The Third Energy Package contains measures which are intended to protect consumers and reinforce energy retail market competition which has been slow to take off in a number of jurisdictions (Herbert Smith's European Energy Handbook 2011 contains a detailed discussion of the package and is available here). While the UK has had open competition down to the domestic level for over 10 years, the new requirements will necessitate changes to existing practices so that consumers can switch energy suppliers within three weeks of agreeing a contract with a new supplier. In Great Britain there is currently no statutory minimum timeframe for switching supplier, although there are other consumer protection measures such as cooling-off periods to allow consumers to reconsider decisions to change supplier.

To fully implement the requirements of the Third Energy Package the Government has, for licensed suppliers:

  • introduced a licence requirement to include a three week (ie, 21 days, including bank holidays and weekends) switching right in supply contracts. The licence condition will state that customers should be able to switch supplier within three weeks unless there is a failure on their part to provide the supplier with information needed to complete the transfer, or if the customer has outstanding debt. The three week period starts when the customer enters into a new contract, unless a cooling-off period applies;
  • introduced a licence requirement for suppliers to take reasonable steps to improve their systems and processes to increase the speed with which customers can change supplier;
  • obliged incumbent suppliers to co-operate with prospective suppliers to enable customers to switch suppliers.

Other changes relate to the provision of consumer information and dispute resolution. Licensed suppliers will have to:

  • send consumers a concise version of an "energy consumer checklist" annually, and have both concise and full versions of the checklist on their websites. Customer Focus will compile the checklists;
  • provide updated bills or statements when customers (both non-domestic and domestic) provide their own meter readings;
  • retain data on transactions relating to electricity and gas supply contracts and gas derivatives with wholesale customers, transmission system operators (TSOs), operators of LNG and gas storage facilities, or any person who provides the supplier with gas or electricity for five years;
  • provide domestic customers with a final bill 6 weeks after they have switched supplier; and
  • include all relevant information in contracts with domestic customers including the identity and address of the licensee, services provided, the source of tariff information, renewal conditions, compensation and refund arrangements and information on dispute resolution.

Similar requirements are imposed directly on unlicensed suppliers via new schedules to the Gas and Electricity Acts.

Ofgem's role as the National Regulatory Authority for Great Britain

The Government will designate Ofgem as the National Regulatory Authority (NRA) for Great Britain. The Northern Ireland Authority for Utility Regulation (NIAUR) will be designated as the NRA for Northern Ireland. Ofgem will be required to work closely with NIAUR for the purposes of representing the UK's interests in dealings with the Agency for the Co-operation of Energy Regulators (ACER).

To implement the independence requirements a new duty will be imposed providing that Ofgem's staff and members of its board cannot engage in activities or have financial or other interests that may compromise their independence (such as holding shares in energy companies or sitting on the board of an energy company).

In its role as NRA, Ofgem will be given formal duties to monitor:

  • the investment plans of TSOs;
  • contractual arrangements between suppliers and large non-domestic customers to ensure they do not restrict competition;
  • the speed with which TSOs and distribution system operators (DSOs) make connections and repairs;
  • the implementation of rules relating to the roles and responsibilities of TSOs, DSOs, suppliers and customers and other market participants;
  • generation capacity levels (which will tie in with the capacity mechanism proposals forming part of the Electricity Market Reform measures, see our briefing dated 21 July 2011 for more information);
  • technical co-operation between EU countries and TSOs from non-EU countries;
  • the implementation of safeguard measures in the event of an incident affecting the energy markets; and
  • arrangements in respect of Independent System Operators (ISOs) and Independent Transmission Operators (ITOs).

Ofgem will be required to:

  • report annually to the European Commission and ACER in respect of its functions as NRA;
  • comply with binding Commission and ACER decisions (including by initiating modifications of industry codes);
  • consult and co-operate with other national authorities and NRAs to integrate national markets, manage networks, promote cross-border trade and the development of cross-border capacity (including interconnection); and
  • take into account the objectives set out in article 36 of the Third Electricity Directive and article 40 of the Third Gas Directive which set general objectives for National Regulatory Authorities.

The Government will also amend dispute resolution procedures to extend the scope of complaints that can be made to Ofgem against TSOs, DSOs, owners of LNG import and gas storage facilties, ISOs (and, where the ITO model is used for gas interconnectors, vertically integrated undertakings).

The Government considered that it was necessary to amend the current electricity and gas licence modification procedure to enable Ofgem to carry out its duties and effectively implement the requirements of the Third Energy Package. Setting aside the protection given to licence holders and their investors on privatisation, under the amended procedure Ofgem will no longer need to seek the support of licensees in order to make a modification. Ofgem will be permitted, after consulting on a modification, to make a decision on whether or not a modification should be introduced. Licensees are left with an ex-post right of appeal against Ofgem's decision, which will be heard by the Competition Commission, on the basis that Ofgem:

  • failed to have regard to its statutory duties;
  • failed to give proper weight to its statutory duties;
  • reached a decision based on a factual error; or
  • reached a decision based on an error in law.

These changes, coupled with the requirement for Ofgem to give effect to binding Commission and ACER decisions, represent a fundamental change to the nature of regulation for the industry, which was established on the basis of an industry-owned contractual structure with statutory protection from unwelcome changes to licence conditions.

Transmission and distribution networks

The Third Energy Package included unbundling requirements for the separation of transmission undertakings from supply, electricity generation or gas production undertakings. To implement these requirements the Government has:

  • appointed Ofgem (NIAUR in Northern Ireland) as the "certification authority" for those transmitting electricity or gas or operating an interconnector;
  • made full unbundling, the ISO model and the unbundling derogation for arrangements providing greater independence than the ITO model available in both the gas and electricity markets (the ITO model is only available for gas interconnectors);
  • provided for Ofgem to certify exempt undertakings; and
  • made certification by Ofgem, and maintenance of certified status, a statutory requirement for transmission and interconnection licensees. New licence conditions will require licensees to notify Ofgem of any relevant changes in circumstances that could affect their certification. DECC has transposed the controversial third country provisions by allowing certification to be refused where a TSO is controlled, or will be controlled, by a person from a non-EU country if Ofgem, following receipt of a report prepared by DECC, considers that granting certification would endanger security of supply for Great Britain or the European Community.

The following exceptions to the unbundling requirements have been allowed:

  • TSOs will be allowed to engage in small-scale generation/supply, for example, to supply tenants, provided those arrangements do not present a risk of discrimination;
  • where a TSO is also involved in generation, production and supply activities in non-EU countries these do not have to be unbundled;
  • arrangements that permit the testing and limited operation of transmission assets pending transfer to a TSO (such as in relation to offshore transmission assets under the OFTO regime); and
  • finance providers (also referred to as "debt investors") may simultaneously hold rights (arising, for example, from financial covenants) in a number of energy undertakings.

Legislative changes introduced by the draft Regulations will prohibit those who control a TSO from exercising rights over licensed supply, electricity generation and gas production undertakings (and vice versa). The existence of such rights will not prevent a TSO from being granted certification by Ofgem, but the exercise of these rights may allow a court to void decisions that could result in discrimination.

The draft Regulations also make legislative changes to ensure the independence of DSOs by prohibiting licensed gas transporters from carrying out gas production activities, and by prohibiting holders of electricity distribution licences from holding generation or supply licences (the current prohibition is limited to supply licences).

Gas infrastructure

The provisions of the Third Gas Directive seek to improve the operation of the gas storage market and LNG facilities. The requirements of the Directive include the legal and operational unbundling of gas storage system operators to ensure their independence. The Directive also strengthens the requirement to grant third party access to storage facilities that are technically and/or economically necessary for providing efficient access to the system.

The draft Regulations will amend the Gas Act 1986 to introduce these new requirements and to enable Ofgem to enforce compliance with new obligations (including obligations relating to transparency and the publication of daily information about gas flows and capacity) imposed directly on operators of gas storage and LNG facilities by the Gas Regulation (also part of the Third Energy Package).

The new legislative requirements for operators of gas storage (including LNG storage) facilities will include:

  • rules requiring the legal and functional separation of gas storage operators from any parent and affiliate undertakings involved in gas production or storage (unless they benefit from a minor facility exemption);
  • a requirement for Ofgem to publish criteria regarding the availability of the exemption from the requirement to provide negotiated third party access for minor facilities, and to publish details of facilities to which negotiated third party access is available; and
  • a requirement for gas storage operators and owners of gas processing facilities to consult system users when developing commercial conditions for the provision of ancillary services.

Operators of gas storage and LNG facilities will be affected by:

  • changes to the application process for third party access exemptions for new or expanded infrastructure, including requirements to comply with capacity allocation rules and an increased role for the European Commission and ACER; and
  • confidentiality requirements restricting the use and disclosure of information by operators of gas storage and LNG facilities.

Further legislative amendments:

  • bring the third party access provisions relating to offshore gas storage into the Gas Act 1986 instead of the Petroleum Act 1998; and
  • extend the regulation of gas storage and LNG facilities to cover the whole of the UK Continental Shelf so that onshore and offshore facilities are treated alike.

Ofgem will be given enforcement powers by making the obligations for gas storage and LNG facilities into "relevant requirements" for the purposes of the Gas Act 1986 (allowing Ofgem to issue enforcement orders and impose financial penalties of up to 10% of annual turnover). Obligations on owners of gas processing facilities relating to accessing or operating a gas transporter's pipeline, an interconnector, a gas storage facility or an LNG import facility will also become enforceable as "relevant requirements".

Licence exempt undertakings and access to private networks

The Third Electricity and Gas Directives require Member States to implement a system of third party access to electricity and gas transmission and distribution networks "based on published tariffs, applicable to all eligible customers and applied objectively and without discrimination". Essentially these measures give customers a choice of supplier, which are intended to encourage competition and drive down costs.

Following the decision of the European Court of Justice (ECJ) in the Citiworks case in May 2008, the UK Government is obliged to make provision for third party access to private unlicensed electricity and gas transmission and distribution networks rather than just licensed networks. Citiworks concerned a complaint brought by an electricity supplier seeking access to a private electricity network at Leipzig airport to allow it to compete with a monopoly supplier. Access had been denied on the basis that the network was a small private, unlicensed network serving only certain customers (commercial users of electricity at the airport, such as airlines and retail units) and had been exempted under German law from the obligation to provide third party access. The ECJ ruled that this exemption was incompatible with the Second Electricity Directive (which has now been replaced by the Third Electricity Directive). As the third party access regime is currently only applied to licence holders in Great Britain, the UK Government is making changes apply the third party access requirements to unlicensed electricity and gas networks.

The Government has elected to take a light touch approach, which will not involve an overhaul of the existing distribution and/or supply licence exemptions. However, the changes will mean that network owners, and operators (where the operator is not the same entity as the owner), will need to consider whether their electricity and gas supply infrastructure constitutes a "distribution network".

For more information on the obligations placed on network owners/operators, including requirements to prepare and submit charging methodologies for use of system charges to Ofgem for approval, see our e-bulletin dated 10 June 2011.

Where a network owner/operator refuses to grant access on the basis that the capacity of its network would need to be increased and that to do so is not technically feasible or would have a significant adverse economic impact on the network operator or any other person, a prospective supplier can apply to Ofgem seeking a determination that access should be granted.

Ofgem will be responsible for enforcing the requirements to grant third party access to unlicensed private networks and will be given the power to do so through amendments made to the Gas Act 1986 and the Electricity Act 1989. The amendments will make certain obligations imposed on network owners/operators "relevant requirements" for the purposes of these Acts, with the consequence that Ofgem will be able to issue enforcement orders and impose financial penalties on network owners/operators who do not perform their obligations. Any such fines can be for "such amount as is reasonable in the circumstances of the case", but cannot exceed 10% of turnover.

Other changes stemming from the Third Energy Package will impact on all unlicensed suppliers of electricity and gas by requiring them to provide customers with annual billing information including details on how bill disputes can be resolved. Domestic customers must also be told how they can obtain a copy of the "energy consumer checklist".

Next steps

The UK was required to transpose the requirements of the Third Gas and Electricity Directives into national law by 3 March 2011. The draft Regulations are subject to the affirmative procedure, and will need to be approved by both Houses of Parliament before taking effect. Debate and voting on the draft Regulations will take place after Parliament's summer recess ends on 5 September 2011.

The vast majority of the provisions in the draft Regulations will take effect as soon as they are approved, with the exception of the transmission network unbundling and certification requirements which take effect from 3 March 2012. Ofgem may permit certification by a later date, but the backstop date for any such extension is 4 March 2013.

The text of the draft Regulations is available here. Transposition notes detailing how the UK has implemented the requirements of the EU Third Energy Package can be obtained from DECC or from the library of either House of Parliament.