A mid-point review: the arguments for and against

The new model for regulating network companies’ outputs and allowed revenue – RIIO (Revenue = Incentives + Innovation + Outputs) – is fixed for eight years until 2021. It was designed to give network companies the security to make long-term investment to benefit consumers and improve service. But a one-off window of opportunity is fast approaching to review certain elements of the price control in the form of a mid-point review (MPR).

The energy industry is divided over whether an MPR is needed. Regulator Ofgem has signalled its intent to hold an MPR for transmission (T1) to address several issues, but not for gas distribution (GD1). Network companies welcome Ofgem’s findings for gas distribution but claim the issues on the transmission side would be better addressed through other ongoing mechanisms. British Gas and Citizen’s Advice are calling for an MPR across the board, pointing to consistent underspend by networks and overachievement against targets as warranting investigation. And British Gas, unsurprisingly given its challenge of the price control through the CMA, has criticised the entire nature of the consultation, calling Ofgem’s approach restricted and “likely to lack credibility”.

Ofgem will make its decision on an MPR this spring.

Why have an MPR?

An MPR was built into the mechanism to allow outputs to be reviewed if changes could be justified due to government policy or if new outputs are deemed necessary to ensure the needs of consumers and other network users will still be met at the end of the sizeable eight year period.

It does not provide the opportunity to re-open the RIIO-T1 and GD1 price control to change the key financial parameters, such as cost of capital.

Arguments for an MPR for transmission

Ofgem – Has identified certain issues it thinks could be addressed within an MPR including the network output measures, the customer and stakeholder incentive mechanism and the strategic wider works submissions, among others.

British Gas – The supplier has pointed to the fact total expenditure for transmission is expected to be £1.8 billion below that allowed, which it says is “not necessarily from efficiency, but from spending no longer being needed due to events out of the networks’ control”.

It has also called for a recalibration of output measures unless Ofgem can publish “firm evidence of genuine high performance” against virtually all the output measures by all companies.

Citizen’s Advice – Said the average return on investment for network companies in T1 and GD1 is forecast to be 9.4 per cent which is “well in excess of what appears appropriate for such low-risk investment”.

Haven Power – Said the price control is failing to increase the stability of allowed revenues and ultimately Transmission Network Use of System charges, which is raising costs for consumers.

Arguments for an MPR for gas distribution

British Gas – Identified the exit capacity incentive, the broad measure of customer satisfaction and the iron mains reduction programme as potentially being issues an MPR could address.

Citizen’s Advice – Said a review should be conducted to investigate the “exceptional financial returns” experienced by GDNs, which Ofgem has indicated is “not rewarding actions taken by networks themselves”. Ofgem suggests that £840 million of GDNs’ outperformance relates to uncontrollable factors, such as the level of real prices, fewer new connections due to the economy in the first year and a relatively mild winter reducing the adverse effects of cold weather on network assets.

Arguments against an MPR for T1

Energy Networks Association said the proposed scope of the MPR for T1 risks the intended longer term certainty by splitting it into two shorter four-year periods. Transmission operators (TOs) do not think the issues identified by Ofgem justify a review “on the scale proposed”. They urge Ofgem to “consider the longer term customer interest…and not just the short terms benefits within the last four years of this price control”.

The ENA adds that changes witnessed since the start of the control are within the range of uncertainty anticipated, and although TOs acknowledge that new outputs are evolving in some areas, such as onshore competition, many of these are still in the policy development stage and their full impact is uncertain. The ENA says “consequently, they may best be dealt with outside any mid-period review once the impacts are better known and using existing mechanisms”.

It said the inconsistent mechanism for investment in T1 for the delivery of outputs in T2 needs identified requires guidance rather than a MPR and “dealing with these issues through existing mechanisms could provide the same benefits for customers and be a better use of limited resources for Ofgem”.

Arguments against an MPR for GD1

The majority of feedback to the consultation on an MPR for GD1 agrees with Ofgem’s findings. The ENA said: “GDNs consider that the outputs set in final proposals remain effective measures of GDN performance. In addition, GDNs are not aware of, or received any stakeholder feedback to suggest, any new outputs which are required”.

Criticism of the consultation

British Gas has also slammed the entire consultation, calling Ofgem’s approach of presenting just the issues it sees as warranting an MPR as “restricted” and “likely to lack credibility”.

“In pursuing this approach, Ofgem is effectively depriving itself of the ability to be adequately equipped when determining whether price controls are set in a way that genuinely maximises efficiency in accordance with Ofgem’s duties and obligation”.

British Gas has previously taken issue with the price control, wiping £105 million off the amount of revenue networks are allowed to recover through the price control by referring it to the Competition and Markets Authority last year. Four out of five of its grounds of appeal were dismissed, however.