Energy Systems Catapult commissioned Frontier Economics to look at the reforms needed to make gas network regulation ready to deliver Net Zero. For a discussion of why we think this a key topic which is about to become much more high-profile see: How should we regulate gas networks for Net Zero?

To decarbonise the natural gas grid, the UK needs to decide for each section of network whether to convert it to carry hydrogen, decommission it or maintain it for a small number of large natural gas users. This needs to be coordinated with the potential development of hydrogen grids.

In the new report, Frontier Economics considers the gas network regulation reforms and interventions needed to navigate this complexity and deliver Net Zero. They explore the challenges of coordinating gas network investment, using three different illustrative scenarios. They then outline the rationale for intervention, the potential options and consider how the costs could be distributed across citizens.

Recommendations for Policymakers

Near term

• Third party access. Including provisions for third party access under non-discriminatory conditions is likely to be appropriate. Given that the costs of early investments in production are likely to be at least partly funded by government support, these terms could be inserted in any early production/consumption subsidy contracts.
• Revenue sharing. Early support contracts for production/consumption could also factor in potential future revenue streams from third party access. However, investors may discount future revenue streams from third party access heavily (partly due to policy risk). Instead of reducing support payments, mechanisms for sharing third party access revenue and avoiding windfall profits could be considered in the development of the subsidy regime.
• Establish processes to enable coordination across the whole system. Given the likely move towards greater sector coupling under all scenarios, it will be important to consider factors across energy vectors to deliver:
  • System wide cost benefit analysis to inform decisions; and
  • system wide alignment of incentives to avoid distortions between the use of different energy carriers (electricity, natural gas and hydrogen).
• Distribute costs across a wide base. To get hydrogen investment off the ground, a wide base may be used to fund government support to production/consumption, and this support may also fund vertically integrated network and storage investments.

Medium to long term

• More extensive regulation of low carbon hydrogen assets may be required to avoid exploitation of monopoly market power and to achieve potential gains from coordination.
• New processes to coordinate across the whole system may be required to ensure decisions are made based on comparison between low carbon gas and other vectors (e.g. electrification), and that the full system costs of decisions are taken into account. This process will help with decisions on where and when new investments, conversions or decommissioning takes place.
• Decisions need to be made on the regulatory model for future sections of networke. a tendering model or Regulated Asset Base (RAB).
• When the market is functioning well, an approach to distributing costs based around cost-recovery and cost-reflectivity principles should deliver an efficient outcome. This could mean charging:
  • Hydrogen users only for forward looking cost-reflective elements; and
  • A broader set of users (e.g. all taxpayers/energy users) for residual cost elements.