Citizens Advice says RIIO2 proposals still ‘too generous’ to networks

Citizens Advice has argued Ofgem’s proposals for RIIO2 are still “too generous” to networks, saying the regulator would be justified in cutting another £1.7 billion from their revenues over the five-year price controls.

Chief executive Gillian Guy urged Ofgem to “hold its nerve in the face of the significant pressure from the networks and look at whether it can go further”.

Citizens Advice gave its full support to the drastic reduction in the cost of equity already being proposed by Ofgem as part of its draft determinations for the RIIO2 price controls beginning in April 2021.

However, the charity said the latest indicative rate of 4.2 per cent in real terms – a reduction of around when compared to the current price controls – remains too high and should be lowered to just 3.1 per cent.

Under the capital asset pricing model, the cost equity is calculated using three metrics: total market returns, the rate of return an investor could expect to receive from a company on average; the risk-free rate, the rate of return an investor could expect to receive from a risk-free investment; and the equity beta, a measure of the financial riskiness of a particular company or sector when compared to the market average.

Citizens Advice said Ofgem’s estimates for total market returns are excessive and should be lowered from between 6.25 per cent and 6.75 per cent to no more 4 per cent. It said the rate should not be calculated based merely on average returns on UK equities and should instead cover a “wider and more diversified portfolio”.

The charity said the equity beta is also too high and should at most be set a 0.3 rather than 0.34 to 0.39: “This alone would imply a reduction in Ofgem’s allowed return on equity to at most 2.87 per cent”. It said further reductions to the cost of equity on these grounds could save consumers between £1.7 billion and £2.8 billion in total.

As well as lowering its estimate for the actual cost of equity, Ofgem has also proposed subtract a further 0.25 per cent to reflect investors’ expectations that networks will outperform the baseline, giving an allowed return on equity of 3.95 per cent. Instead of reducing the estimated cost of equity, Citizens Advice said the regulator could alternatively increase the size of this wedge to 1.6 per cent, thereby saving consumers around £1.2 billion.

“Nearly three years ago we set out how the previous price control had allowed energy networks to make billions in unjustified profits,” said Guy.

“Ofgem has made significant progress on delivering a price control that is value for money for consumers. But right now, energy networks are aggressively pushing back against the regulator’s proposals. They’ve even claimed the price control will put more people at risk of blackouts and jeopardise the net-zero transition.

“But the only thing really at risk here are the excessive profits these companies have made by overcharging consumers,” she added. “The regulator must hold its nerve in the face of the significant pressure from the networks and look at whether it can go further.”

Citizens Advice also highlighted the impact of the coronavirus pandemic on consumers, noting that one in nine people has fallen behind on their energy bill because of the virus and its fallout.

As well as lowering peoples’ ability and willingness to pay, the consumer advocate said the pandemic is also impacting the wider energy system through new working habits, depressed demand and new usage profiles.

“The costs of responding to these changes is likely to impact consumers, alongside higher unemployment and redundancies, increasing consumer debt, and general pressure on household incomes,” the charity stated in a summary of its response to the draft determinations.

“These issues could have potential implications for the operations of networks over the period of the price control. For example, they could potentially lead to a more pressing need for affordable balancing, less investment in some areas due to demand changes, reduced consumer willingness to pay for new projects and potentially less ability or appetite for consumers to support extensive infrastructure expansion.”

It continued: “In our view there needs to be a robust, evidence-based approach set out by final determinations for reflecting the important changes in consumer situations caused by Covid-19.

“Both Ofgem and regulated companies need to consider the possible scenarios for the duration and economic impact of the pandemic and focus on the potential range of impacts.”