To decarbonise the UK, the long term use of gas for heating, including any potential for hydrogen, is limited. Getting off gas is now an obvious climate change and energy security necessity. Both the UK government and its adviser, the Climate Change Committee (CCC), have signaled the need for the gas network to be wound down.
It should be crunch time for the regulation of gas network infrastructure. With government due to make a decision on the future of the gas grid in 2026 and Ofgem now planning for the next price control period (to start in 2026), this is a critical juncture in UK energy network regulation.
But, to all appearances, it’s still business as usual for these heavily regulated parts of the UK energy system, which continue to have capital poured into them. This is exposing UK citizens to significant financial risk while bolstering gas network returns.
The system is risky for consumers
There are large financial liabilities associated with the gas grid, related to stranded assets and decommissioning costs. Yet little thought is being given to them or how they should be managed, apart for some work by Frontier Economics for the CCC seven years ago.
The UK’s gas distribution networks are privately owned and split across four companies. These are regulated by Ofgem to operate the networks and, where they are allowed, to invest in new or replacement assets. Assets in these networks are costed by Ofgem to give something called a ‘RAV’, or regulatory asset value, and networks get a financial return on this. Networks can also profit from their operations. Ofgem assumes a certain amount for running costs and if the networks do better, consumers and networks share the difference. This system hasn’t always worked in the best interests of consumers.
The current regulatory model assumes that gas network assets have long lives; assets are given a 45 year financial lifetime; ie gas network owners recoup the costs of their investments over a 45 year period.
As the customer base shrinks, costs will rise
And herein lies the first problem: If we’re going to move to low carbon heating by 2050 and, as seems to be increasingly clear, the gas network will only play a very small role at that point, there is a significant stranded asset problem. Even with ‘front-end loaded’ depreciation, we are still talking about multiple billions (perhaps £3 or £4 billion) of stranded assets in 2050. And that’s assuming all capital investment stops in 2026, which it won’t; the Iron Mains Risk Reduction Programme (the big yellow plastic pipes you see when roads are dug up) is expected to continue to 2032, so these assets won’t be paid off until 2077.
Compounding this issue is that, over time, the number of consumers attached to the network will decrease rapidly if climate targets are to be met. So gas network charges will increasingly fall on a smaller number of customers. Without mitigation, increasing transportation costs could lead to a gas disconnection network death spiral and major equity impacts, as those without the means to switch, end up trapped.
The second issue is about the decommissioning of the gas grid. For obvious safety reasons, leaving a pressurized network of pipes full of an explosive gas across the entire country would not be sensible. In the UK currently, as was the case for me, if you get rid of gas appliances and have your gas meter removed, eventually the local gas network operator will come and make the supply line safe. This can involve digging, cutting the service pipe and then capping it underground as close to the main as is possible. This comes at a cost, borne by the network, unless (bizarrely) you ask them to come and do it, in which case you pay. This strange process and cost allocation is currently being considered by the government but highlights the need to think about what happens to the gas grid in a much more co-ordinated way.
The government needs a plan to manage the risks
If all 23 million connected homes do eventually remove their gas meter, there is a big question about how such a programme should be funded and what needs to happen in practice. This is a big unknown but, as cost estimates suggest around £8 billion, clearly efforts should be made to understand the practical and financial implications. In any case, decommissioning is an uncosted liability, the costs of which will sit with UK energy consumers.
In a briefing, just published, I consider the options for government and the regulator to attempt to manage these risks. Each has upsides and downsides.
Under option 1, the government could maintain the current regulatory model, and Ofgem could shorten the depreciation timescales to reflect the net zero target, and also collect a levy to fund decommissioning. This would mean higher gas bills and probably very significant equity impacts.
Under option 2, Ofgem could regulate gas network companies to become clean heat providers, mandating a shift towards becoming heat network owners and operators. This would make use of existing skills and relationships but comes with risks around how to regulate such a complex transition, particularly when network companies have been unwilling to shift their business models and have lobbied heavily for continued gas use.
Under option 3, the government takes a much more active approach and, as Denmark has done, renationalises the networks, with the express goal of running them down. Such an approach would enable a more co-ordinated and planned exit from gas, but it would transfer all stranded asset risks and decommissioning costs to the government. Equity impacts could potentially be more actively managed.
All of these options require a significant change from business as usual and there is no obvious frontrunner. But business as usual does not seem able to run-down and decommission regulated infrastructure rapidly in response to major external pressures.
Alongside broader reforms needed for the heating sector, I recommend four government actions, none of which should be particularly controversial, considering what’s at play, and all of which reduce risks for consumers. These are: to improve understanding of what’s needed and the costs; for the Department for Energy Security and Net Zero, Ofgem and others to work together on a plan to allocate the high costs and risks associated with stranded gas assets and decommissioning; to consider whether the Iron Mains Risk Reduction Programme is value for money and intervene if not; and, finally, to ensure heating policy and planning across the country is properly co-ordinated with gas grid decommissioning.
This is a problem laden with consumer risk and significant equity implications. The sooner something is done, the more those risks and costs can be limited and the faster climate action will be.
The original version of this article appeared in Inside Track, the Green Alliance blog.