CMA issues final determination on RIIO2 appeals

The Competition and Markets Authority (CMA) has issued its final determination on the RIIO2 appeals by transmission and gas distribution networks.

The CMA made no significant changes to its provisional decision in August, upholding Ofgem’s reduction to the cost of equity but removing the outperformance wedge introduced by the regulator to counteract information asymmetry between itself and the networks.

On the cost of equity, the CMA said networks had argued it had not considered the merits of the appeals; that it had “failed to grapple properly with the evidence” and deferred to Ofgem’s judgement too much.

“We disagree,” the CMA responded. “We have carefully scrutinised the evidence as well as the substance of GEMA’s decision-making in line with the grounds of the appeal advanced before us and are satisfied that we have correctly applied the standard of review in our assessment of this joined ground.”

On the outperformance wedge – a downward adjustment to the cost of equity to reflect the expected outperformance of the price controls by networks – the CMA reiterated its acknowledgement that “regulators inevitably face information asymmetries, and that those asymmetries can make the setting of appropriately stringent and robust price controls challenging,” particularly in relation to totex allowances.

However, the CMA said Ofgem has not demonstrated sufficiently why “the extensive set of tools it used for RIIO2 should be regarded as providing insufficient protection for customers.”

“We have ordered that the decision to introduce the outperformance wedge should be quashed and substituted with our decision to remove the outperformance wedge and associated backstop,” it stated.

The removal of the outperformance wedge – worth 25 basis points – will leave the appellants with a cost of equity of 4.55% based on the CPIH measure of inflation.

The CMA additionally maintained its provisional decision to remove Ofgem’s uplift to required improvements in cost efficiency to reflect the benefits of past innovation projects.

Recognising that past innovation is likely to have resulted in cost reductions, the CMA said it had since considered whether the uplift could be set at a more appropriate level than the 0.2% chosen by Ofgem but ultimately decided to remove it entirely.

The CMA did retract its provisional finding that Ofgem was wrong to adopt a figure of 0.5% for Cadent’s embedded ongoing efficiency challenge based on subsequent responses and additional evidence.

It upheld its decision that Ofgem had acted beyond its legal authority – “ultra vires” – in introducing special license conditions that could be modified during the price control to manage uncertainty and contingency allowances – a process Ofgem described as “self-modification.”

The body said it had quashed such license conditions for the transmission arms of SP Energy Networks and Scottish and Southern Electricity Networks and directed Ofgem to use the “standard licence modification process by which any modifications to the relevant license conditions can be appealed to the CMA”.

Responding to the CMA’s final determination, which has not yet been published in full, Ofgem director of networks Akshay Kaul said: “We welcome the Competition and Markets Authority’s final determinations, which we believe achieve the right balance between affordability, sustainability, and practicality, while broadly supporting and reaffirming Ofgem’s decisions on setting price controls.

“Ofgem’s role is to ensure consumers get the best possible value for money while taking into consideration the need for energy networks to have sufficient investment to deliver safe, secure, and sustainable future energy supplies.

“The government has this week set out a clear and comprehensive strategy for net zero. We now look forward to working with the industry to deliver these goals for the benefit of consumers and the planet.”

David Smith, chief executive of the Energy Networks Association, said: “The CMA’s decision will take time to review in detail but we remain committed to keeping energy flowing and maintaining world-class levels of reliability and customer service. In the run-up to COP26 we are focused on delivering net zero at the best value for customers.”

Andy Manning, principal economic regulation specialist at Citizens Advice, described the CMA’s final determination as “good news for customers.”

Writing in a blog, Manning said: “The CMA’s decision to confirm lower returns on investment is a significant step forward in tackling the excessive profits made by network companies at the expense of their customers. Our evidence showed that, if successful, the appeals by networks could cost consumers an additional £1.5 billion.”

But he said the RIIO2 price controls are still “naturally skewed” towards energy networks: “As is often the case, the price control settlement falls between the companies’ and Ofgem’s starting positions. This means returns are higher than necessary.”

Manning said the process is further skewed by the appeals process which allows network companies to “cherry-pick” issues that they can easily afford to challenge and offer a “good bet” given the amounts of money at stake. He said it is much harder for organisations like Citizens Advice to justify the legal costs of mounting an appeal in instances where the price control is too generous to networks and called for reform to the process.