Ofgem confirms RIIO2 price control methodology

Ofgem has confirmed plans to almost slash in half the returns that energy networks can make.

Ofgem confirms RIIO2 price control methodology

The energy regulator has this morning (24 May) ratified its price control methodology for the new RIIO2 framework, which covers the electricity and gas transmission networks together with gas distribution.

If applying the agreed methodology today, Ofgem would set the allowed baseline return on equity at 4.3% (CPIH) in a cost of equity range of 4% to 5.6% – almost 50% lower than under the previous price control (RIIO1) and the lowest ever capital rate for energy network companies.

In a statement Ofgem said that a lower allowed return on equity of 4.3%, combined with a lower allowed return on debt, will reduce costs passed on to consumers by £6 billion over the five years of the RIIO2 price control period (2021-2026) when compared to RIIO1. However, the final savings figures for consumers will depend on a number of other factors like operating expenditure, which Ofgem will make a final decision on in 2020 after companies have submitted their business plans.

Jonathan Brearley, executive director for systems and networks, said: “Our proposals are on track to deliver a tough, fair settlement that strikes a better deal for consumers.

“Lowering the cost of capital for network energy companies will put money back into consumers’ pockets while service standards are required to remain high.

“Our new price control for networks will pave the way for a cheaper, smarter and more sustainable energy system and is a key step in our journey to a low carbon future.”

But the Energy Networks Association has hit back at the announcement. Chief executive David Smith said: “These proposals, if implemented, will have damaging impacts on the energy networks’ ability to deliver the government’s plans for clean growth and the wider economy, undermining efforts to build a smarter, more efficient energy system for the public. Costs are down, power cuts are at record lows and the amount of renewable energy connected to the grid is at an all-time high. Ofgem needs to build on this track record.

“The approach needs to evolve in response to experience and the lessons learnt under the RIIO1 price control. Central to this is ensuring that Britain’s energy networks are able to continue to attract significant levels of investment over the next decade and beyond, at lowest cost to the consumer.”

As part of the RIIO2 price control framework, Ofgem will also increase the support provided by network companies to consumers in vulnerable situations, for example by strengthening licence conditions and by incentivising companies to take vulnerability into account when interacting with their customers. Ofgem will also reform current innovation funding, and provide new dedicated funding, to support projects that specifically benefit vulnerable or poorly-served consumers.

Ofgem’s regulatory framework will also facilitate the decarbonisation of power, heat and transport and the transition to a smarter energy system, enabling consumers to reap the benefits of technological change. Each company’s environmental action plan will be taken into account when funding allowances are set, and a strategic fund will be set up to support large transformational investments that improve the system as a whole.

National Grid’s head of regulatory finance Darren Pettifer recently told Network that a 5.5% 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.

 

Industry reaction

Gillian Guy, chief executive of Citizens Advice, said: “Energy networks have been able to overcharge customers by £7.5 billion under the current price control. This announcement takes us another step towards a settlement that prevents this from happening again.

“Ofgem has made significant progress so far, but the acid test will be the final outcome. The regulator will face intense industry pressure to water down these measures in the coming months. It must hold its nerve and deliver a price control which is good value for consumers.”

 

In a statement, Scottish and Southern Electricity Networks (SSEN) said: “Although Ofgem has revised its position in some areas, SSEN retains its concern, as set out in its response to Ofgem’s consultation, that the proposed framework fails to fully balance stakeholder and consumer needs with the requirement to provide investor confidence and attract the significant investment needed to enable the clean energy transition. 

“In particular, SSEN remains very disappointed with the proposed cost of equity range which runs contrary to the independent analysis provided to Ofgem on the level of risk inherent in the delivery of critical electricity transmission infrastructure. 

“A key strength of the RIIO1 price control was in the positive consumer outcomes gained through a targeted and robust incentive package. SSEN believes further change is required in the incentives for RIIO2, where Ofgem continues to propose a framework which blunts existing efficiency incentives in an attempt to secure predictable outcomes. This will risk harming consumers in the long run and jeopardise progress in achieving government policy objectives.

“SSEN is currently preparing to submit its first draft business plan for the next transmission price control, where Ofgem has said the role of stakeholders, including consumers, will be key. It is, therefore, even more critical that Ofgem remains open to feedback and substantive change that will allow the development of business plans that fully deliver on stakeholder ambitions.

“There remains much to be decided and final proposals are not due until late 2020. During that time, SSEN will continue to advocate constructively and robustly for a regulatory framework that strikes the right balance between ensuring efficiency and affordability with delivering the necessary investment to improve services for consumers and drive further progress towards a low carbon, flexible energy system.”

 

More reaction to follow.


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