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UTILITY WEEK | 20TH - 26TH JANUARY 2017 | 15 Policy & Regulation Analysis A s plant margins continue at wafer- thin levels, the pivotal role of National Grid, currently capitalised at circa £36 billion, has 0come under increasing scrutiny. It is, aer all, the electricity system opera- tor and therefore is effectively charged with keeping the nation's lights on. This task is complicated not just by low plant margins but also by the increasing complex technical challenge, due mainly to the intermittent nature of renewable genera- tion units, of balancing the system 24/7. Importantly, too, as a major investor in electricity interconnectors between other EU countries, National Grid faces potential conflicts of interest. If, at times of power shortages, National Grid chooses interconnector-sourced elec- tricity rather than domestic generation out- put to make up the shortfall, it stands to derive financial benefit from doing so. Aer all, in 2015/16, National Grid reported an operating profit of £123 million from its joint ownership of the French inter- connector – chunky money indeed. Against that background, it was no sur- prise that the Energy and Climate Change Select Committee raised probing questions last summer about the potential conflicts of interest. The committee advocated a switch to an independent system operator (ISO), which has been used with some success in the USA: significantly, the committee did not make specific recommendations as to whether such an ISO should be publicly or privately owned. Subsequently, there have been various discussions between National Grid and Ofgem, which culminated in last week's key announcement – plans to force National Grid to legally separate its system operator (SO) role from the rest of the group. Although a consultation process is now under way, it seems set to produce a some- what different outcome from that advocated by the select committee. However, National Grid has agreed, with Ofgem, to separate its SO business from its many other activities as from April 2019. While it will have its own board, offices and employees, the 'ring-fenced' business will remain fully owned by National Grid – presumably, a non-negotiable issue for its leading shareholders. Not surprisingly, National Grid's chief executive, John Pettigrew, welcomed the agreement with Ofgem. He added – per- haps rather superfluously – that "we believe National Grid is best placed to deliver the role of system operator". More proactive role For Ofgem, the new arrangements will allow National Grid to take a more proactive role in managing the system and working with oth- ers, while crucially – in Ofgem's own words – "mitigating any conflicts of interest". And the government, too, focused on the apparent benefits of this agreement. Business and energy secretary Greg Clark stated that "separating our system operator will give greater confidence to investors that Great Britain offers a level playing field for companies wanting to be part of our clean, secure and flexible energy system". In recent decades, with a few exceptions, National Grid has eschewed generation- related investment. But its joint ownership of the 2GW French interconnector is pivotal – this business has proved to be a very nice little earner. National Grid is also investing heavily in new interconnectors, notably the circa £2 billion North Sea Link Norway project. More generally, similar issues have been raised in other utility sectors, particularly in the telecoms market, where BT's Openreach has a very powerful hold over the last mile of connections. Its competitors have been pleading with Ofcom to compel BT to divest Openreach, rather than undertaking an internal separa- tion; this plea has so far fallen on deaf ears. Indeed, under the strongest of pressure, Ofcom's director-general, Sharon White, has resolutely declined to go down this route, partly due to EU legal issues. And, as its final card, BT could play its joker – the cost of its accursed defined ben- efit pension schemes, which currently have a massive £9.5 billion deficit. Arguably, a compulsory divestment of Openreach would raise fundamental ques- tions about the solvency of BT's pension fund. Fundamental questions Of course, Ofgem's latest National Grid announcement is relatively small beer com- pared with the Openreach issue, but it does raise fundamental questions about whether – and how – dominant utility market play- ers should face constraints, which implicitly benefit their competitors. Aer Ofgem's announcement, National Grid's share price barely moved. The reality was that virtually no-one expected a radical divestment decision from Ofgem. Furthermore, most of National Grid's UK earnings arise from its ownership of price-regulated electricity wires and gas pipes – material changes to anticipated returns from those businesses are seriously price-sensitive. In fact, its share price is now more beholden to movements in bond yields, with the expectation of the Trump-led USA raising interest rates, which would narrow the yield gap between US Treasuries and National Grid's own dividend yield. While National Grid will undoubtedly be relieved by Ofgem's statement, its focus – and especially that of its investors – will increasingly be on the planned 61 per cent disposal of its gas distribution business, which is scheduled to complete this summer. Some £4 billion of net proceeds are ear- marked for National Grid's shareholders. Crucially, last year's auction placed a for- midable £13.8 billion valuation on the gas distribution business, well above market expectations – and a boost to the share price. In summary, National Grid will be pleased that the ISO proposal, put forward by the Energy and Climate Change Commit- tee, appears to have been unceremoniously rejected by both the government and Ofgem. Nigel Hawkins, director, Nigel Hawkins Associates Grid: electricity's ringmaster National Grid has agreed to separate its system operator business from its other activities from April 2019, but controversially it will remain full owner of the ring-fenced business, says Nigel Hawkins.