Investing in the energy decarbonisation transformation benefits consumers
National Grid's head of regulatory finance, Darren Pettifer, says that Ofgem's plans to slash in half the returns that energy networks can earn could put at risk a once in a generation opportunity to transform the energy system, and prevent longer-term benefits to consumers.
21st May 2019 by Networks
“This price control comes at a crucial time of tackling climate change – the most urgent challenge facing the planet with Britain well placed to be at the forefront of global efforts to reduce carbon emissions,” Pettifer (pictured) explains. “National Grid, believes this must be tackled through collaborative efforts. We need to see much greater progress in making areas like heat and transport cleaner and at a low cost for our planet and energy users. That is why our gas innovation projects are looking at how we can use hydrogen in our networks to support the low carbon transition and bring down costs for consumers. We are also making sure that the right electric vehicle charging infrastructure is in place across the country, to facilitate a rise in electric vehicles on our roads. To reduce electric vehicle range anxiety and improve uptake, we have identified 54 locations for strategic ultra-rapid charging along the motorway network. These can charge a car in the time it takes to buy a coffee. Ultimately, we need to transition to a new low-carbon, low-cost energy system where consumers can see the clear benefits of the energy transmission networks.”
Pettifer is calling on the energy regulator to avoid taking a low-cost, low-incentive approach to RIIO2 and instead look at a slightly higher-cost, incentives-rich approach that reduces consumer costs in the medium term through a little more investment in the short term.
The regulator published its second consultation on price controls in December and has been considering the responses since the middle of March. The RIIO2 price control framework covers the electricity and gas transmission networks together with gas and electricity distribution.
In the new price control period, which starts in 2021, the regulator has proposed that operators’ allowed cost of equity will be set at a baseline of three per cent, once inflation has been considered. The cost of equity comprises the dividends and capital gains that investors make on their investment.
The new baseline is less than half that of the previous price control regime, which set a figure of seven per cent for transmission networks.
According to Pettifer: “Ofgem has gone too far with the cost of equity. We agree it should be lower than it was in T1, with lower interest rates and lower market returns from a stockmarket perspective, but to more than halve it in the case of transmission is a big change. It won’t drive the future investment or future ability to deliver things like whole system outcomes, which is to ultimately help keep down consumers’ bills and improve our natural environment. As an industry, you’re not going to invest as much as you could or push yourselves as hard because you’ve not got the rewards there.”
In recent years, Ofgem has experienced mounting pressure to reduce the cost of equity range, in particular from Citizens Advice.
“They (Ofgem) have to listen to everyone and Citizens Advice have got some really good views and perspectives on things,” remarks Pettifer. “There is a risk that the networks haven’t listened to the likes of Citizens Advice enough over the last few years and equally we haven’t told our stories in the right way around why what we’re doing in T1 provides greater value for consumers that will carry on over the longer term. There is an adjustment needed and that’s why I think what Ofgem is doing is a step in the right direction.”
Pettifer acknowledges the engagement that National Grid have had with Ofgem has generally been positive.
He adds: “The engagement has been pretty good. We’ve got a constructive relationship with most of our stakeholders in Ofgem. We agree to disagree on certain things, but if both sides are willing to listen to the other’s argument and evidence, then we can engage on the right issues at the right time.
“On incentives, we probably agree to disagree for now. But some of our messages do seem to be making headway. We want Ofgem to take a much more whole package view of all the incentives. We feel that what they put out in December was quite siloed in nature around every individual part of the framework. They have assured us that the May document will look much more holistically and look at interactions between different elements across that framework.”
By the end of May, Ofgem will issue its final decision on how it intends to implement the RIIO framework for the next round of price controls starting in 2021.
National Grid say that a 5.5 per cent cost of equity would be a fairer reflection of the risks being managed and enable the behaviours and investment required to modernise GB’s energy system.
Pettifer believes: “It’s important that the public and the country as a whole benefit from the changes that are sweeping across the country’s energy system, but much more work still needs to be done by the regulator to understand the pace of that change, the risks that investors face and how that is reflected in the price control.
“We have said that 5.5 per cent is about right now. We recognise that the number has to come down from T1 and there are definite drivers for that. We do recognise there are arguments for why it could be lower, but 5.5 per cent represents the risk that we’re holding from a transmission company perspective. Historically transmission has been seen as higher risk than other regulated utilities reflecting greater certainty about how many and what type of new customers there will be.”
If this figure doesn’t materialise then, Pettifer says that National Grid could end up being more cautious on investment, needing funding security before beginning any work.
During RIIOT1 the price controls include a “reopener” mechanism for cost categories where there was uncertainty about expenditure requirements at the time of setting allowances. The mechanism allows network companies to propose adjustments to baseline expenditure allowances for these costs when there is more certainty.
“During this price control (period), we have invested ahead of funding clarity in a number of areas,” notes Pettifer.
“We can do that while we’ve got the financial capacity in cost of equity to live with that investment and have the risk of it not being funded. But a lower return starts my chief financial officer (CFO) getting really worried about that type of investment. The risk to consumers is not that you delay investment until after it is needed, because we have outputs we need to deliver, but you end up potentially constraining the delivery into a shorter time period and increasing costs overall. This would have the most impact in driving whole system focus where the requirements are far from clear.”
Summarising, Pettifer explains: “We need to make sure that networks can be enabled to deliver the transformation. Blocking anyone that can help in that space is not going to deliver the right output for consumers. The more everyone is enabled and empowered to help find the right solutions for Great Britain, the better.”
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