Cost of capital for ED2 revealed

Ofgem has set the baseline return on equity for investors in electricity distribution networks at 4.4 per cent for the next price control period.

In the finance annex to the RIIO-ED2 sector specific methodology decision, published this morning (11 March), the regulator confirmed a 4.65 per cent cost of equity with a downward adjustment of 25 basis points – the outperformance wedge – to reflect the expected outperformance of networks based on past outcomes.

The working assumption is that returns during the 2023-2028 price control would be on average a third lower than under the current price control (which is set at 7 per cent cost of equity when adjusted to a comparable basis).

The decision comes as Ofgem faces appeals to the Competition & Markets Authority (CMA) from all eight of the electricity and gas transmission and gas distribution networks over the final determinations for their price control, which begins next month.

The cost of equity – which was set at 4.2 per cent for these companies once the outperformance wedge is applied – is a core element of each appeal.

It also comes ahead of the CMA’s final decision on the appeals to Ofwat’s PR19 final determinations, which is due next week. The cost of equity has also been the main point of contention in these appeals.

Ofgem supported its calculation on the cost of capital by saying it was consistent with current market levels and in line with the average for EU regulators. It added: “This makes sure Britain’s stable and reliable sector remains highly attractive to investors.”

The regulator’s working assumption is that the new rates would lower network charges on bills by around 9 per cent, equal to c£2 billion, over the ED2 period compared to current arrangements.

Ofgem chief executive Jonathan Brearley said: “Our price control for local electricity networks paves the way for turning Britain’s streets green, unlocking the investment needed to support the UK, Scottish and Welsh Government climate change targets, particularly around the electrification of transport.

“We’re driving local electricity networks to help make sure that every watt of energy produced from plant to plug is better used, for example by ramping up their use of battery storage, saving bills and the planet.

“At the same time, these financial arrangements will significantly cut investor returns to make sure consumers pay a fair price for energy whilst networks attract the investment they need to be safe and green.”

Citizens Advice welcomed Ofgem’ stance, with acting chief executive Alistair Cromwell saying: “In the face of appeals by other energy networks over their price control, Ofgem has stood its ground by continuing to limit shareholder returns. This is a win for consumers. Energy networks have made billions in excess profits during the current price control and it is vital this isn’t repeated.”

However, Ross Easton, director of external affairs at Energy Networks Association, said: “The assertion that networks have made ‘excess profits’ is one we firmly refute. In actual fact, network costs have fallen 17 per cent since the mid-90s and customer service scores for the networks are at 9/10. Since 1990, we’ve invested more than £100 billion in national and local grids, with more to come to deliver the government’s net zero ambitions. Thanks to this investment, we operate one of the most reliable networks in Europe.”