Ofgem’s risky bet on gas innovation
Ofgem has been unbending in its refusal to consider the future of gas during the upcoming price control, but can we really afford to wait for policy decisions?
By Lucinda Dann, features editor
Ofgem’s risky bet on gas innovation
Ofgem has been unbending in its refusal to consider the future of gas during the upcoming price control, but can we really afford to wait for policy decisions?
By Lucinda Dann, features editor
The only two future of gas topics that will be funded through the Network Innovation Allowance during the upcoming price control period are biomethane and decommissioning. Ofgem has ruled out any spend on hydrogen, hydrogen blending and carbon capture and storage during the five-year period, saying “gas consumers should not bear further costs in this area at this time”.
It cited the lack of clear policy direction and the body of innovation work already undertaken in these areas as justification for the stance, adding that it would be open to reviewing its position if future government decisions require further innovation in these areas.
But both gas networks and industry insiders have questioned if the energy sector has the luxury to pause critical thinking on these topics, especially for the gas transmission network. They say Ofgem’s risk-averse position contradicts the government’s standpoints on hydrogen transport and blending, with government outlining a minded-to position to introduce 2% hydrogen blending into the transmission network from as early as 2028.
It would also severely hamper the network's ability to provide critical data to help inform government policy in these areas and could leave it on the back foot if a decision to introduce blending is taken in Europe.
Ofgem’s expectation that networks could utilise upcoming funding through the Hydrogen Transport Business Model (HTBM) cap and floor regime effectively puts any hydrogen transport projects on hold until the end of GD3, as networks have warned the proposal is an ill-fit for innovation work. Despite these arguments, Ofgem remained steadfast to its position in its final determinations. But while the front door is firmly closed to gas networks, fears have been somewhat allayed by some concessions by the regulator, albeit not to top line funding.
Funding levels for a decarbonisation project re-opener have been increased by 65% from its draft determinations, and networks will still be allowed to spend any remaining NIA funds from RIIO2 on future of gas work.
Meanwhile the Strategic Innovation Fund (SIF) presents an opportunity for gas networks but they will need to fight for more focus on gas industry issues for upcoming rounds.
Funding gap
Ofgem’s decision to remove hydrogen projects from the scope of the NIA in RIIO3 is to a certain extent a pragmatic one.
Gas networks have already undertaken huge amounts of innovation work in this area, and with the key decision on hydrogen home heating expected just months after the start of the next regulatory cycle, any new innovation work could not be done in time to inform that. But while a ruling against using hydrogen for home heating could prove an existential threat to the distribution networks, the same is not true for the gas transmission system.
A paper commissioned by the National Infrastructure Commission and Ofgem in 2023 analysing the potential costs for gas networks of three hydrogen scenarios found that 100% of gas distribution networks would be decommissioned in the low hydrogen scenario. Meanwhile, the paper estimates that 40% of the transmission system would be used for hydrogen storage.
Although Ofgem recognised that gas networks could have a role to play in the transmission or storage of hydrogen, it felt that providing a second funding stream through RIIO in addition to the upcoming HTBM funding would not be the right approach, saying that there was the “potential for overlaps”.
Currently the Department for Energy Security and Net Zero (DESNZ) is expecting to open the first funding round of the scheme this year, but National Gas believes both funding streams are needed.
“The HTBM is due to provide funding for hydrogen programmes to deploy repurposing and new build networks but will not drive innovative approaches to delivering hydrogen opportunities in the future,” it said in its response to Ofgem’s draft determination. “The statement that HTBM and other funding will be appropriate for future of gas innovation is misaligned with the funding guidance for the HTBM provided to date.”
The current funding guidance for the HTBM requires an onshore pipeline transporting hydrogen as a gas, project maturity operational by December 2032, to be ‘large’ and have at least one storage partner and be GB based.
“The inability for networks to progress hydrogen projects for a five-year period will significantly impact competitiveness of [repurposing the gas network],” National Gas added.
The gas transmission operator said its proposed innovation work would have focused on improving the efficiency of deploying hydrogen.
Similarly, the transmission network is expected to have a role in transporting carbon dioxide from Carbon Capture and Storage facilities. National Grid is already undertaking a project to repurpose 175 miles of gas pipeline in Scotland to transport the gas from the Acorn industrial cluster in Scotland’s central belt to the St Fergus Gas Terminal.
“The spending review decision to fund and progress Acorn and the subsequent SCO2T project will mean that in the timeline of RIIO-GT3 we will be transitioning assets to Carbon transportation. Whille we have undertaken some work on repurposing for carbon, we believe there is further technical innovation in the field of venting, emergency procedures and asset integrity that will ensure safety and reduce environmental impact of the repurposed system,” National Gas said in its response.
“To halt all activity in this space, while awaiting decisions aligned to the distribution network assets, seems counter to decisions being made by government. Repurposing the network is of consumer value and enabling future solutions through innovation projects is vital to ensuring this can occur.”
“To halt all activity in this space, while awaiting decisions aligned to the distribution network assets, seems counter to decisions being made by government.”
National Gas
Over cautious
Sustainability First’s Maxine Frerk and Judith Ward disagree with Ofgem’s position to prevent further innovation work until policy decisions are carried out. In a response to the draft determinations, they called ruling out initial evidence gathering until policy decisions are taken a “strange formulation”, adding: “We see the potential for low regret, preparatory work in these areas that would allow decisions to be implemented more quickly.”
Economic Insight's associate director Christopher Pickard tells Utility Week that Ofgem’s stance on hydrogen is potentially over cautious given the likely timeframe for its deployment.
“Most long-term forecasts see hydrogen and CCUS playing an important role, especially in industry, from the mid to late 2030s. That’s only ten years from now,” he said. “If we wait for total clarity over how these technologies will be used, we risk stalling the transition. Mass deployment may only be a decade away, according to some credible scenarios, so do we really have the luxury of delaying?
“Innovation and uncertainty go hand in hand. You need to be able to experiment and explore uncharted paths, which requires a tolerance for the risk that some innovations won’t succeed.”
Pickard says the fact bills will need to increase in the short term due to the new accelerated depreciation mechanism has heightened Ofgem’s focus on cost control in other areas. This has meant the regulator has potentially lost sight of the big picture benefits of innovation.
“There is understandable caution about pre-empting policy decisions on the future of gas, but granting innovation funding to explore our options in an uncertain environment isn’t the same as a commitment to full-scale deployment.”
As well as being influenced by cost pressures, Frerk and Ward suggest Ofgem’s stance on innovation is symptomatic of a wider lack of strategic future vision by the regulator for the upcoming regulatory period.
Writing in their submission they say: “We are concerned that in painting GD3 largely as ‘business-as-usual’, Ofgem risks selling the future short. For Final Determinations, Ofgem must ensure that the GD3 price control is based on a strategic narrative which is far more future-facing, with a clear vision for the role of innovation.
“GD3 must not be simple ‘business as usual’ nor five years of ‘wait and see’… Ofgem must commit to making best use of the GD3 period to 2031, and in particular the first two years that precede the start of planning for GD4. This means moving beyond a focus on cost control, to focus on the outputs needed to become ‘future-ready’.”
Rowing back
Although the final determinations did not contain a clearer strategic vision, there was some acknowledgement that its original position was potentially over cautious. While declining to amend its top line funding, Ofgem has increased the funding and scope of two key decarbonisation re-openers. The Net Zero and Development (NZARD) reopener has been rebadged as the Decarbonisation Project Development reopener.
Ofgem has increased its pot to 0.5% of basline totex to fund early design and pre-construction work for decarbonisation projects, representing an increase of between 80-90% on RIIO-2 levels. This is up from a 25% increase in the draft determinations.
Meanwhile the Net Zero Pre-Construction and Small Projects reopener is now the Small Decarbonisation Projects (SDP) reopener. Designed to fund projects supporting both nearer-term and long-term decarbonisation goals, the scope has been widened to specifically include hydrogen blending, depending on the outcome of a safety case and the establishment of a “clear government directive for implementation”.
For Frerk, continuing innovation work on hydrogen blending should have been a “no-brainer”, she told Utility Week, due to the risk a decision to introduce hydrogen blends in Europe could see it forced upon Britain via interconnectors.
Another key area where Ofgem can be seen to have rowed back is on projects gas networks wished to undertake to support the Regional Energy Strategic Planning (RESPs).
Gas networks had planned to spend a significant chunk of innovation funding on regional planning activities, but these had been ruled out by Ofgem on the basis that it would be a duplication of the RESP work being undertaken by the National System Operator (NESO).
However, this has also now been included in the scope of the SDP reopener after NESO stressed the critical contribution GDNs had to make.
In its response to the draft determination it said: “It is important that GDNs are appropriately resourced to enable them to actively support the development of RESPs with delivery of these types of critical inputs into the strategic planning NESO is responsible for to deliver net zero.”
These changes, combined with gas networks being allowed to carry-over NIA funds from RIIO-2 on future of gas works have helped gas networks accept the ruling. But they will also need to make better use of the Strategic Innovation Fund (SIF) if innovation programmes are not to be completely derailed during RIIO-3.
“I was always very critical of the GDNs because none of them really mentioned what they might do with SIF funding, and that’s the big pot of funding that has been used in the past to do some of the bigger bits of work on hydrogen,” says Frerk.
The gas networks say they don’t know what they will be able to do through SIF as the challenge areas change every year. “I still think they could have made a better fist of saying it’s an important funding stream and pitching for some of the things they want to do to be in scope there,” Frerk adds.
Ofgem’s plan to adopt a more programmatic approach to the SIF could help gas networks to plan their innovation as challenge areas will be set on a more long-term basis, but National Gas is concerned this will lead to fewer opportunities for gas networks.
In round 5 of the SIF gas networks were only eligible for two out of seven challenges as the others were focussed on electricity specific technologies. The gas transmission operator fears that as the targets will be set by a taskforce they will be dominated by electricity priorities.
Frerk, who sits on the SIF advisory group agrees there is a problem with the SIF being skewed towards electricity. “I do think there’s a problem, all the debate does tend to be about electricity with no real interest in the gas side.
“SIF can be an opportunity provided they make sure they are engaging in the debates to get the right challenge areas. So just because it’s not in NIA there are other routes for things to be included either as policy evolves or through reopeners. The GDNs will make the most of whatever mechanisms are there because this is key to their future.”
With a decision on hydrogen heating expected later this year, the industry will hopefully not have long to wait for a decision, but it remains to be seen what the knock-on effects of waiting for further clarity will have on the transition.
