Innovation in energy and water - Keeping out of the way or aiding experimentation: What’s an appropriate role for Government and regulators?

Sharon Darcy summarises the latest New Energy and Water Public Interest Network (New-Pin) thinking on innovation.

Innovation is a hot topic.  In this period of significant economic, social and political uncertainty, and powered by big data and new technologies, experimenting with new ways of doing things is in itself becoming the ‘new normal’ in many walks of life.

The energy and water sectors are not exempt from this change.  External and often global threats, driven by digitisation and evolving customer expectations but also demographic and climate change, means that the counter-factual to many new ideas is not necessarily the status quo.  To provide short and long-term affordability and resilience, new ways of doing things may be needed.

Innovation in energy and water poses some specific challenges.  Markets can help innovate in many areas in the sectors.  However, even markets need frameworks and rules.  On their own, markets are also unlikely to innovate around certain desirable public interest outcomes, including long-term resilience, fairness and place.  And when there are monopoly activities, and / or imperfect competition, as is frequently the case in energy and water, the extent of innovation may be limited.

Government and regulators have a difficult tightrope to walk here.  Innovation is not an end in itself and is frequently a journey of discovery.  Keeping out of the way may allow ideas to flourish but these may not meet public interest outcomes.  Intervene too early or too generously and accusations may follow of picking winners or actually creating new barriers to doing things differently.

Getting this right is difficult. Innovation will not always work and Government and regulators are acutely aware of the risks of failure in services that directly impact on consumer, environmental and economic wellbeing.  They also know that to get people to take innovative risks, they need to be rewarded.  The public don’t like monopolies in particular making profits and may not support them being given the time and space needed for experimentation.

Government and regulators recognise these challenges and are starting to address them through vehicles such as the Clean Growth Strategy. New-Pin has identified four questions that may be worthy of further consideration as they review their approaches to innovation in the sectors.

First, is appropriate focus being given to consumer facing, commercial and institutional innovation?  Much of the existing Government and regulatory focus on innovation is on technology (often still in terms of ‘grey’ assets). Given the recognition of the need for greater flexibility and a more active demand side in energy and water, encouraging consumer facing and commercial innovation is becoming increasingly important in itself, and as a way of enabling technological change.  Greater focus on institutional innovation may also be needed.  Energy and water provide services that are frequently connected and are part of more complex systems.   Change in one area is likely to impact on change elsewhere. Institutions may need to evolve if they are not to become a brake on new ways of doing things.

Secondly, given the potential distributional impacts from disruptive innovation, and the possible low public appetite for change, should Government and regulators play a more active role in innovation where this is the case?  Existing approaches to innovation have largely been successful at encouraging incremental innovation.  Such an approach may not be sufficient to deal with some of the significant future challenges facing the sectors.  In energy, there is sight of a burning platform – driven by the low carbon transition – which may require a more transformative approach to change.

If transformative innovation is needed, there are likely to be winners and losers, raising ethical questions for wider society.  This may mean that accountable Government and regulators may need to play a greater role in innovation in these areas.  Government and regulatory action may also be needed if the public appetite for disruptive change is limited given the essential services that the sectors provide.

Thirdly, what more can Government and regulators do to look at innovation ‘in the round’ and avoid duplication or confused / contradictory signals?  We’ve developed a New-Pin Tool Kit to help do this. This builds on existing thinking from the UK Regulators Network but looks at the roles and responsibilities of Government and regulators together rather than just focusing on regulation.

The New-Pin Tool Kit highlights the need for Government to frame the challenges, identify desired outcomes and signal priorities in a strategic way.  It proposes that Government signals need to meet the test of Sustainability First’s ‘5 Cs’: culture of innovation supported; clear high level challenges and priorities flagged for short, medium and long-term; co-ordinated and joined up between Government and regulators; collaboration enabled with clarity as to when this can and can’t be done within competition law constraints; and consistent over time with an adaptive approach helping ensure any interventions are more ‘predictable.’

The Tool Kit goes on to explore the enabling frameworks that Government and regulators can create to facilitate transformative change in the sectors that can help simplify, clarify and better communicate the basic ‘rules of the game’ to help existing players seize the day and new entrants and capital come in.  It then examines the incentives and funding mechanisms that can support disruptive change. Lastly, the Tool Kit identifies that direct interventions to enable transformative change may be needed in certain areas if existing licences and vires for both monopolies and retail activities restrict innovation.

In addition to the Tool Kit, New-Pin has identified ten principles for Government and regulators to consider when considering an appropriate and holistic approach to innovation in the sectors:

Innovation activity needs to be focused, inter al, on the desired long-term public interest outcomes.

1. Incentives for innovation need to align with these outcomes.
2. Interventions for innovation activity need to incentivise collaboration across and between systems.
3. The outcomes sought should be framed in terms of tomorrow’s problems, not todays and focus on long-term objectives.
4. Access to innovation support, incentives and funding needs to be transparent, simple, clear and coordinated.
5. The timing, form & durability of any innovation interventions need to be clear. Any interventions should be time limited.
6. To enable evaluation, innovation activity needs to be measurable. It is important to be able to: identify the counterfactual (the world doesn’t ‘stand still’); and honestly assess the positive and negative quantitative and qualitative impacts of the innovation activity (including around cultural change / lessons from failure).
7. The potential distributional impacts of any innovation interventions need to be recognised and taken into account by Government and regulators.
8. Clear red lines are needed of where interventions for innovation do not serve the wider long-term public interest / are outside the public ‘risk-appetite’ for change.
9. Government/regulators need to be able to articulate what success/failure look like in terms of innovation in the sectors.

The final question that New-Pin’s work has raised is whether sector specific factors fully explain the differences in approach to innovation in energy and water. BEIS and Ofgem are together allocating significant funding to innovation in energy and have a range of mechanisms to support transformative change in the sector (eg the Innovation Link and the Network Innovation Competitions).  Much of this is due to the need to prepare for the low carbon transition and the fact that the energy network and retail market are nation wide.  Water is clearly in a different place here.   Significantly less funding is being allocated to innovation in the sector. If it too faces a burning platform, however, particularly in resource-constrained areas, calls for a different approach to innovation may grow.

A New-Pin workshop on innovation was held in November 2017. The resulting briefing and discussion papers on this topic can be found on the Sustainability First website.