Net Zero: Legal and regulatory challenges

9th August 2021

The UK’s ‘Net Zero’ commitment imposes a legally binding duty on the UK (enshrined in law under the Climate Change Act 2008) to ensure that by 2050 it removes from the atmosphere all greenhouse gases it emits.

A more ambitious government target – to reduce emissions by 78% compared to 1990 levels by 2035 – was to be (but has not been) enshrined in law by the end of June 2021.  To add to the picture, a variety of more detailed regional targets across the UK have been set by city regions such as Bristol City Council and Greater Manchester Combined Authority, and further pledges may be announced at the upcoming 2021 UN Climate Change Conference (COP26).

While the aim of Net Zero is well-known, the legal and regulatory landscape is uncertain and constantly evolving. As recognised by Ofgem, meeting the UK’s ambitious climate change goals requires a transformation of the energy system at unprecedented scale and pace, to design and deliver a much smarter, more flexible, and better integrated energy system.

How will the role of the regulator need to change? How will future energy systems be operated and regulated? Will climate change continue to be a ground for strategic litigation?

The role of the regulator

Much of the regulatory framework of EU law on energy and the environment has been retained following Brexit. This includes that the regulator (Ofgem) must be independent and cannot take or seek instructions from Government and other entities [1].

Much of the domestic regulation of the energy sector comes from the Electricity Act 1989. Section 3A(1) sets out Ofgem’s principal objective in carrying out its functions: to protect the interests of existing and future consumers in relation to electricity conveyed by distribution systems or transmission systems. Ofgem has made it clear that this includes making sure that vulnerable consumers are not left behind in the transition to low carbon energy [2].

Given its independence and proactive duty to take actions that promote effective competition, what then is the role of Ofgem with regard to Government strategy on Net Zero? Although the requirement for sustainable development is enshrined in the Electricity Act, this is in the context of Ofgem’s principal objective. The Secretary of State is required to issue guidance about how the regulators can achieve social or environmental policy goals, but ultimately such guidance cannot influence regulator independence. Therefore, in the absence of statutory limitations on its power, Ofgem has wide discretion to act in accordance with its functions and is likely to rely heavily on cost-benefit analyses of Net Zero strategies to promote competition and protect the interests of customers over time.

Emerging policy challenges

A number of policy challenges are surfacing in the area of Net Zero. For example:

• How does the way in which electricity network costs are recovered affect regional renewable energy projects?
• Should the Capacity Market [3] reflect the wider locational benefits that generation can bring to the electricity system including resilience and security of supply?
• Can the Contract for Difference [4] mechanism and the next auction round in 2021 unlock a wide geographical spread of renewable investments?
• What further support is needed for small scale renewable electricity generation?
• What measures are needed to encourage regulated energy network companies to engage in local energy planning processes?
• What role should the oil and gas sector continue to play in the UK’s energy mix?

A major question is how should the energy system be operated to facilitate Net Zero while maintaining energy security and protecting the interests of consumers?

Future system operator

Calling for a radical re-structuring of the energy system [5], BEIS and Ofgem propose an independent Future System Operator (FSO) which is able to look holistically at long term electricity and gas challenges to support the transition to Net Zero, taking a stronger role in network planning and providing expert advice across the energy (gas and electricity) system on how to deliver Net Zero ambitions. Its roles and functions would include:

• system planning and network development
• driving competition in energy networks
• energy market design
• coordination with distribution networks
• heat and transport decarbonisation
• energy data
• engineering standards and energy code development
• hydrogen
• CCUS

The consultation raises interesting questions on what organisational structures could bring proper oversight in place of the current private shareholder mechanism that is accountable to the market. It proposes two alternative models:

• a standalone privately owned model, independent of energy sector interests (incentivised through its profit to drive performance); or
• a highly independent corporate body model classified within the public sector, but with operational independence from government (not be driven by shareholder or profit interest).

Under both models the FSO must be independent of central government influence and free from conflicts of interest, and will need strong relationships to energy market participants, consumers, regulators and other organisations with energy interests, especially where objectives cannot be delivered without cross-sector co-operation.

Climate litigation

In a climate change environment there is a rising tide of litigation relating to climate and the energy transition.

Strategic litigation is increasingly being used as a mechanism for influencing climate governance by holding government and businesses to account or testing a legal point that would apply to other cases, create awareness, encourage public debate or spark policy change. Examples include challenges to the Heathrow expansion, the Good Law Project’s challenge of the Energy National Policy Statements, a challenge to the Drax Power Station and Transport Action Network’s challenge to the Road Investment Strategy.

This is a trend that looks set to continue, with recent case law indicating an expansion in the types of organisations which could be targeted, and the variety and reach of claims which could be brought [6].

How we can help

The focus on Net Zero and climate change together with the transformation of the regulatory and technological landscape present risks for companies operating in the energy sector and the wider economy. By preparing now and taking a long term perspective on these risks businesses can position themselves for the challenges and opportunities of a sustainable future.

As a multi-disciplinary commercial law firm, with specialist lawyers experienced in all aspects of the Net Zero agenda, Walker Morris can help with specific practical tasks, such as contract reviews and reviewing/improving policies and procedures, as well as carrying out Net Zero due diligence, assisting clients to secure ‘green finance’ or investments based on climate change criteria, delivering low carbon, sustainability and other green projects, and assisting with measuring and reporting of energy, carbon and climate risks.

Walker Morris can also provide comprehensive, cross-disciplinary advice and transactional assistance, as well as risk management and dispute resolution strategies if/when any strategic litigation queries or concerns arise.

Finally, Walker Morris can provide tailored training to staff at all levels within a business on any Net Zero-related area or issue.

Please do not hesitate to get in touch.

[1] Article 35 of the Electricity Directive (Directive 2009/72/EC)

[2] https://www.ofgem.gov.uk/news-blog/our-blog/role-consumer-achieving-net-zero

[3] A mechanism introduced by the UK government to ensure that electricity supply continues to meet demand as more volatile and unpredictable renewable energy generation comes online, the Capacity Market provides a regular payment to reliable forms of energy to ensure capacity is available when needed. See BEIS’ Capacity Market consultation, open until 18 October 2021

[4] The UK government’s Contracts for Difference scheme incentivises investment in renewable energy to support low-carbon electricity generation

[5] Energy Future System Operator Consultation

[6] See our recent briefing for practical solutions in the face of rising strategic litigation risks