Establishing the National Energy System Operator

Introduction and background 

As of today, 1 October 2024 (“NESO Commencement Day”), Great Britain’s (“GB’s”) electricity and gas system will be planned and operated by a newly designated independent, publicly owned organisation – the National Energy System Operator Limited (“NESO”) – as part of the strategic approach to enable the Government’s target of a zero-carbon energy system by 2030.

Pursuant to a decision notice (the “NESO/ELEXON Decision Notice”) issued by the Secretary of State (“SoS”) for the Department for Energy Security and Net Zero (“DESNZ”) on 13 September 2024, with effect from NESO Commencement Day, the entire share capital of the current energy system operator, National Grid Electricity System Operator Limited (“NGESO”), will be acquired from the National Grid group for an enterprise value of £630 million by the Government pursuant to a transfer scheme under the Energy Act 2023 (the “Energy Act”). As a part of this, NGESO will be renamed the National Energy System Operator Limited.

Pursuant to these reforms, NESO will take on:

• the electricity transmission system operator role currently performed by NGESO (with certain important variations) by way of a direction from the SoS that the existing transmission licence held by NGESO has effect (in revised form) as a new electricity system operator licence (the “ESO Licence”), and
• a new “gas system planner” role by way of a new gas system planner licence granted by the SoS (the “GSP Licence”).

The combination of these roles as now performed by NESO is referred to under the Energy Act as the “Independent System Operator and Planner” or “ISOP”. NESO will also have general statutory duties that are broader than those of NGESO, extending beyond NGESO’s existing duty to develop and maintain an efficient, co-ordinated and economical transmission system and facilitate competition in generation and supply (the “Existing General Transmission Statutory Duties”), to new duties with respect to promoting net zero, energy security, and cost efficiency (the “New General Transmission Statutory Duties”).

The Energy Act 2023 (Commencement No. 3) Regulations 2024 make the necessary commencement amendments to bring such changes into force on the NESO Commencement Day.

The establishment of NESO will mark the outcome of legal and policy deliberations involving DESNZ and the UK Office of Gas & Electricity Markets (acting on behalf of the Gas and Electricity Markets Authority) (“Ofgem”) conducted over several years, alongside a number of stakeholder-informed consultations involving industry experts, policymakers, and the general public.

This Law-Now considers the impacts of the establishment of NESO across the operation of the GB energy system, in particular the changes to the current electricity transmission licensing regime and regulatory framework. We build here on our previous Law-Now on the early stage proposals for NESO – previously denoted as the Future System Operator (or FSO).

Licensing of the ISOP and the consequential changes

As noted above, NESO will hold two licences through which it will be regulated by Ofgem, taking effect from NESO Commencement Day. The ESO Licence, covering NESO’s obligations regarding its electricity functions, has come into force in accordance with a direction under Section 167(1) of the Energy Act). The GSP Licence covers NESO’s obligations regarding its gas functions, and is granted as a new licence in accordance with Section 7AA of the Gas Act 1986.

The NESO/ELEXON Decision Notice appends the ESO Licence and GSP Licence conditions that take effect today. The new ESO Licence diverges from the conditions of the electricity transmission licence formerly held by NGESO (the “NGESO Transmission Licence”) in a number respects. We discuss below amendments to two conditions that are familiar from the NGESO Transmission Licence, and a notable new ESO Licence condition, that immediately catch the eye.    

1. NGESO Transmission Licence condition: “Requirement to offer terms”
   NESO, pursuant to the new ESO Licence, will be (as NGESO was) responsible for offering transmission connection terms. As such, the familiar “requirement to offer terms” provision from the NGESO Transmission Licence will now be contained within the ESO Licence. Minimal amendments have been made to the process and requirements as previously outlined in the NGESO Transmission Licence condition.
   
   As in the NGESO Transmission Licence condition, the ESO Licence outlines a number of exceptions from NESO’s obligation to offer to enter into/enter into connection arrangements. The ESO Licence widens the scope of these exceptions when compared with the NGESO Transmission Licence. In particular, the previous exception for circumstances in which entering into transmission connection arrangements would put NGESO in breach of its Existing General Transmission Statutory Duties has been broadened to refer to duties “under statute” generally. This brings NESO’s obligations under all statute, including the New General Transmission Statutory Duties, within the contemplation of this condition the effect of which is, at least in principle, substantially to strengthen NESO’s right to reject transmission connection applications. In a similar vein, the solutions that NESO will need to implement in the terms of transmission connection arrangements will need to be informed by NESO’s New General Transmission Duties as well as the Existing General Transmission Statutory Duties.
   
   It is worth noting in this context that this arguable erosion of NESO’s licence obligation to make connections to its network comes amid a time of significant wider reforms in the context of electricity transmission network connections, including via the TM04+ workstream (see our latest Law-Now on this process here). Ofgem’s open letter of 16 September 2024 envisages that further amendments to NESO’s licence will be required in order to realise the increasingly ambitious vision for TM04+, including the facilitation of new methodologies for managing the connection queue and prioritising certain connection applications.
    
2. NGESO Transmission Licence condition: “Prohibition on discriminating between users”
   
   The ESO Licence condition on prohibiting discrimination between users is broadly consistent with the original NGESO Transmission Licence condition.
   
   Within this ESO Licence condition, the drafting of the prohibition on discriminating between users when providing connection works/use of system varies between a prohibition not to “unduly discriminate”, and a prohibition not to “discriminate” (whereas the prohibition throughout the NGESO Transmission Licence was not to discriminate).
   
   In the setting of Use of System Charges, NESO’s obligation under the ESO Licence not to “unduly” restrict, distort, or prevent competition now also applies to the supply, shipping, transportation or production of gas (as well as the generation, transmission, supply or distribution of electricity and participation in the operation of an interconnector, as under the previous NGESO Transmission Licence condition).
    
3. ESO Licence new conditions: “Licensee's obligations regarding critical national infrastructure” and “compliance with directions related to national security”
   
   These new ESO Licence conditions require NESO to:
   • take or refrain from certain actions as directed by the SoS where “there is a risk relating to national security that may detrimentally impact the resilience, safety or security of the energy system”, or “the continuity of essential services”, and where “it is in the interest of national security that a direction should be issued to NESO”, and
   • review and apply methodologies for the identification of critical national infrastructure across the whole energy system, including the transmission and distribution system, electricity interconnectors and any plant or apparatus for the production of electricity.

Other impacts resulting from the establishment of NESO 

Establishing NESO involves a number of other moving parts, notably:

• As mentioned above, the acquisition of 100% of the share capital of NGESO by the SoS by way of transfer scheme. The transfer scheme is used from a public interest perspective, preventing the operation of certain rights (including pre-emption, reverter, forfeiture, compensation, termination, etc.) arising or becoming exercisable under any contract to which NGESO is a party as a result of the transfer.
• The resulting change in ownership of ELEXON (currently wholly owned by NGESO), the manager of GB’s electricity Balancing and Settlement Code. As NESO will be a publicly owned entity, the Government and Ofgem have determined in the NESO/ELEXON Decision Notice that ELEXON will remain an industry body with the shares held by a subset of the industry parties that fund ELEXON.
• In addition to the adaptations of the NGESO Transmission Licence required to establish the new ESO Licence, and the grant of the GSP Licence, the Government/Ofgem has (in the NESO/ELEXON Decision Notice) identified required modifications to other licences impacted by the creation of NESO. The other licence documents in which related amendments will take effect today include:
  • Electricity Generation Standard Licence Conditions 
  • Electricity Interconnector Standard Licence Conditions 
  • Electricity Supply Standard Licence Conditions 
  • Electricity Distribution Standard Licence Conditions 
  • Gas Transporter Standard Licence Conditions 
  • SP Transmission plc and Scottish Hydro Electric Transmission plc: Transmission Licence Special Conditions 
  • Electricity Distribution Licence Special Conditions (including additional changes to Scottish Hydro Electric Power Distribution plc’s Special Conditions only) 
  • Smart Meter Communication Licence 
  • National Gas Transmission plc (NGT): Gas Transporter Licence (Part C) Special Conditions 
  • Gas Transporters to whom Standard Special Conditions Part D apply: Gas Transporter Licence Special Conditions 
  • Gas Transporter Standard Special Conditions (Part A)  

CMS Comment

NESO steps into the electricity system operator function at a time of unprecedented reform, as policy makers and stakeholders grapple with the challenges of fairly allocating capacity on the electricity transmission system against a context of unprecedented electrification and the challenges and opportunities posed by our growing fleet of intermittent renewables and battery storage.

At a broad level, the transfer and re-setting of the system operator role to that of a government owned Independent System Operator and Planner is of course designed to assist with meeting these challenges. However, for those seeking or holding transmission connections - or otherwise now dealing with NESO rather than NGESO - the combined impact of the existing reforms, the move to public ownership, and the reshaping of duties and obligations should be borne in mind and carefully considered.

If you would find a discussion useful in respect of any of the areas touched on in this note please don’t hesitate to get in touch with your usual CMS Energy & Climate Change contact or any of the contacts listed on this Law-Now.