On 19 October the Department of Energy and Climate Change (DECC) published the long-awaited consultation on how it proposes to implement in relation to licence exempt networks the EU requirement that third party access is available to all gas and electricity distribution networks. It deals with the issues first raised by the 2008 Citiworks case1. The consultation also considers some associated issues arising under the 2009 Electricity Directive2 and the 2009 Gas Directive3 that may have implications for licence exempt networks. The consultation will close on 23 November 2010. The new legislation is intended to be in force by 3 March 2011. The good news for the industry is that the current exemptions regime is to remain in place, subject to the imposition of third party access obligations, as explained in more detail below.  

Background

A 2008 ruling of the European Court of Justice (ECJ) in the Citiworks case affirmed the principle that under the 2003 Electricity Directive operators of electricity distribution and transmission networks can only refuse third party access in the very limited circumstances set out in the Directive. We have set out a short snapshot of the facts of the Citiworks case at the end of this note.

As such, the Citiworks case brought into question the legality of exemption schemes which bring distribution systems outside of a third party access regime. While the Citiworks case considered the position under the 2003 Electricity Directive4, the position is the same under the 2009 Electricity Directive, as well as the 2009 Gas Directive, which both provide that Member States must establish a system of third party access to transmission and distribution systems which is based on published tariffs, applicable to eligible customers and applied objectively and without discrimination.

In Great Britain, the requirement to offer third party access is imposed via licence conditions. What this means is that currently operators of licence exempt networks are not subject to any third party access obligations.

For electricity, the legislation in question is both the Electricity (Class Exemptions from the Requirement for a Licence) Order 2001 (the Class Exemptions Order) and a variety of specific exemption orders relating to specific projects and entities. Under the Class Exemptions Order small-scale energy systems can obtain an exemption from the requirement to obtain a licence to generate, distribute and supply electricity. The main purpose of the Class Exemptions Order has been to free small-scale industry players from the regulatory burdens of licence compliance. For gas, there are a number of exemption orders made under the Gas Act 1986, as well as some exemptions set out in the Act itself.

New third party access provisions

DECC proposes to set out in legislation a requirement that all licence exempt distribution networks provide third party access. Ofgem will enforce the provisions. Ofgem’s current enforcement guidelines will be updated to deal with this issue and are expected to be published in March 2011.

In particular, DECC is proposing that amendments to the Electricity Act 1989 and the Gas Act 1986 are made in order to require that:  

  • exempt distribution networks, when asked, provide third party access to energy suppliers on a non-discriminatory basis, that is to say that the terms of access and tariffs applied should not favour one supplier (including the network owner) over another. Refusal will only be justified if the system lacks the necessary capacity to cope with any requested additional use;
  • where separate charges for use of the network are levied against third party suppliers, a tariff is prepared in accordance with a common a methodology determined by Ofgem or a methodology determined by the exempt network owner. The tariff must be approved by Ofgem before charges can be made, unless the network is a “closed distribution system” (see below);
  • where no charges for use of the network are to be made no tariff needs to be put in place or approved by Ofgem. To make transition to an approval-based system easier, Ofgem will consult on and publish a common methodology for the setting of tariffs;
  • in all cases, parties must act in such a way as to facilitate third party access where it is required and support third party suppliers in meeting their own obligations in relation to allowing customers to switch supplier.

These provisions are to be supplemented by a guidance document which is intended to assist exempt undertakings to assess what steps they may need to take to comply with the new requirements. The guidance will deal with issues such as the arrangements that may be used to provide third party access.

Importantly, DECC has said that it does not expect network owners to prepare to provide third party access (e.g. by installing meters or by publishing tariffs approved by Ofgem) until there is a realistic prospect of a request for third party access.

Timing

The consultation states that, once a customer confirms in writing its intention to switch to a named supplier, the exempt distribution network operator must act in such a way as not to prevent third party access within three weeks of the customer’s contract agreement with a new supplier (e.g. in relation to access to carry out works).

Closed distribution systems

Under the 2009 Gas and Electricity Directives, Member States may choose to allow certain non-domestic distribution systems to be classified as “closed distribution systems”, with the effect that they are exempted from certain requirements – for example, the requirement that tariffs and their underlying charging methodologies are approved by the regulator before coming into force. Note however that closed distribution systems are not exempt from the requirement to provide third party access.

DECC proposes to make provision in legislation which enables Ofgem to classify systems as closed distribution systems, on the basis that some network operators may find reliance on this useful.

Application of other requirements to licence exempt undertakings: a new approach

As mentioned above, the 2009 Gas and Electricity Directives impose various additional requirements on energy companies, particularly in the area of consumer rights. The consultation makes it clear that many of these requirements are intended to apply to exempt undertakings, including licence exempt suppliers, as well as licensed energy companies. Therefore there will be a number of new requirements on licence exempt undertakings set out in legislation.

This is a departure from the approach previously taken, which to a large extent resulted in licence exempt entities not being subject to many of the requirements imposed on licensed entities. This new approach may be the result of two separate factors. Firstly, following Citiworks, there is probably greater emphasis on compliance with the Gas and Electricity Directives for all undertakings. Secondly, there may be an acknowledgment that, with growing emphasis on the benefits of renewable, decentralised energy, supported by schemes such as the new feed-in tariff, going forward there are likely to be a large number of licence exempt entities distributing and supplying energy to customers.

DECC has said that it recognises that the exemptions regime is intended to lighten the regulatory burden on small projects, and therefore it proposes “the least burdensome solution” in the way the requirements will apply to licence exempt undertakings.

For example, under the 2009 Directives all suppliers (including exempt suppliers) must allow customers to switch suppliers within three weeks of the customer’s request, subject to any conditions such as an early exit charge. DECC has said that this requirement will not apply to licence exempt suppliers. Exempt suppliers will be able to delay switching beyond three weeks if that has been agreed between the supplier and its customers. DECC has said that this will not allow licence exempt suppliers to prevent customers from switching. However, DECC’s approach indicates a pragmatic approach to implementing the requirements of the Directives in relation to licence exempt industry participants, perhaps recognising that a rigid approach would be inconsistent with the objective of the exemptions regime.

Heat

There is growing interest in GB in renewable heat. While it is early days, the recent Spending Review announcement that the Renewable Heat Incentive is going ahead from June 2011 may mean that at some point in the future heat distribution networks, of the kind found in many places on the European continent, will be as important as gas and electricity networks. The consultation does not deal with heat networks, because of course they are not currently regulated in the same way as gas and electricity networks. However, this does raise some interesting issues for industry players to consider for the future, about whether the Government will introduce more fulsome heat regulation.

Impact of proposals on distributed energy projects

While the consultation document does not say so expressly, presumably the new regime will apply to all existing licence exempt networks, as well as future ones.

Any project companies currently in the early stages of planning small-scale energy projects which will be licence exempt should take the new regime into consideration when planning the project structure, and the contracts that will be entered into with customers using the network.

For existing projects with operational private network systems or new projects which have not yet been commissioned, but for which all the project documentation has been entered into, it is important to consider the provisions of the relevant contracts to see how they may be impacted by the new regime. In particular, consideration should be given to whether there are any provisions in the project documents dealing with change in law and its consequences.

The Citiworks case in a snapshot

The parties in the case were FLH and Citiworks. FLH is an entity which operates the Leipzig/Halle Airport and also maintains an energy supply system for the supply of its own energy needs and those of 93 other undertakings at the Airport site. Citiworks is an electricity supplier which since 2004 has supplied a customer at the Airport. During 2004 85.4 per cent of the electricity supplied by FLH’s energy supply system was consumed by FLH itself. FLH applied for its energy supply system to be classified as a “site network” under the German law on electricity and gas supply. The consequence of such a classification would be that FLH would not be required to grant open access to its network to any other supplier. The relevant regulator (the Ministry of the Economy and Employment of the Land of Saxony) granted FLH’s application. Citiworks appealed the decision to the German court. The ECJ considered the case because the German court referred a question of interpretation of the 2003 Electricity Directive to the ECJ. The ECJ was asked to consider a question of interpretation of Article 20(1) of the Electricity Directive (2003/54/EC), dealing with regulated third party access to electricity transmission and distribution systems. The ECJ concluded that the German law in question was contrary to the Electricity Directive and therefore precluded by the Directive.