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Ofgem has given upfront approval to £22.2 billion of investment by electricity distribution networks over the five-year RIIO ED2 price controls beginning in April next year.
The final determinations represent a £2.9 billion decrease when compared to the total expenditure (totex) allowances requested by distribution network operators (DNOs) in their business plans but a £1.3 billion increase when compared to the regulator’s draft determinations in June.
Ofgem has reduced its assessment of the net benefits to consumers from £1.3 billion in its draft determinations to £428 million as a result of changing market conditions, specifically the recent rise in interest rates, which impacted both the cost of capital and totex allowances.
In the case of the former, the cost of equity has increased when compared to the draft determinations from 4.75% in real terms based on the CPIH measure of inflation to 5.23%. This reflects a rise in the risk-free rate of return expected by investors based on observed yields of index-linked gilts. The cost of equity is nevertheless down when compared to the equivalent figure for the current electricity distribution price controls of 6.7%.
The allowed cost of debt has also risen when compared to the draft determinations from 2.32% to 3.07% for most DNOs, giving a weighted average cost of capital (WACC) of 3.93% based on a notional gearing of 60%.
Totex allowances (£m)
As part of the package, Ofgem has approved £3.1 billion of upfront investment in network upgrades to support the rollout of low-carbon technologies such as electric vehicles, heat pumps and wind and solar generation. The regulator said this figure factors in a £429 million uplift to totex allowances to reflect the outcome of its significant code review of network access arrangements.
The totex allowances incorporate an ongoing efficiency challenge of 1% per year.
All six DNOs have seen an increase in annual totex allowances when compared to the latest figures for annual expenditure during the current regulatory period.
Annual Totex Allowances (£m)
Incentives
Ofgem has set seven common financial output delivery incentives (ODIs), three of them new. The regulator has increased the strength of the upside incentives for the DSO and Interruptions Incentive Scheme ODIs by 20 basis points and 50 basis points respectively, raising the upper limit of the incentive package from +1.95% to +2.65%. The lower limit remains -4%.
| Output Delivery Incentive | New or existing | Incentive Range (Return on Regulatory Equity) |
| Customer Satisfaction Survey | Existing | +0.4%/-0.4% |
| Complaints Metric | Existing | 0%/-0.2% |
| Time to Connect | Existing | +0.15%/-0.15% |
| Major Connections | New | 0%/-0.35% |
| Vulnerability | New | +0.2%/-0.2% |
| DSO | New | +0.4%/-0.2% |
| Interruptions Incentive Scheme | Existing | +1.5%/-2.5% |
The regulator has decided to implement a symmetrical return adjustment mechanism to limit excess profits or losses. Positive or negative returns in excess of 300 basis points above or below the baseline allowed return on equity will be adjusted down in size by 50%. Returns in excess of 400 basis points above or below the baseline will be scaled down by 90%.
In its draft determinations, Ofgem only issued rewards to two DNOs under the business plan incentive mechanism – £3.6 million to National Grid Electricity Distribution (formerly Western Power Distribution) and £2.8 million to Scottish and Southern Electricity Networks. In both cases, these rewards were for the second stage of the assessment covering consumer value propositions (CVPs), which demonstrate ways in which their business plans go beyond minimum requirements and business as usual.
In its final determinations, Ofgem has increased these rewards to £4.6 million and £3.5 million respectively. It has also awarded £29.7 million to UK Power Networks for stage four of the assessment, which rewards companies for submitting ambitious cost estimates that beat its benchmark.
| DNO | Cap/collar (+/-2% totex, £m) | Total reward /penalty (£m) |
| Electricity North West | 36.5 | 0 |
| Northern Powergrid | 60 | 0 |
| National Grid Electricity Distribution | 128.7 | 4.6 |
| UK Power Networks | 108.8 | 29.7 |
| SP Energy Networks | 62.9 | 0 |
| Scottish and Southern Electricity Networks | 76.3 | 3.5 |
Ofgem interim director of infrastructure and security of supply, Akshay Kaul, said: “The investment set out today delivers value for consumers, safeguards security of supply and helps ensure Britain is no longer at the mercy of international energy prices or geopolitical events. We’ve set the initial amount of investment that local electricity distribution network operators can make in the 2023 to 2028 period, with every pound representing value for money for consumers and no increase in bills.
“The economics of energy have shifted with home-grown cleaner renewables like wind and solar energy proving cheaper than costly imported gas. Together with more nuclear and potentially hydrogen fuelled power, these renewables will contribute to a lower carbon energy mix, better protected from geopolitical events and energy price shocks.”
He added: “These new low carbon sources of generation will also need to be connected to an expanded electricity network to meet the growing demand for electricity with millions more electric heat pumps in homes and electric vehicles on the road expected over the coming years.
“We’ve carefully considered all the work that will be required and set the budget for the networks, accordingly, driving the increase in capacity needed for net zero as well as delivering more reliable and resilient networks, at no extra cost to consumers.”
Reaction
Gillian Cooper, head of energy policy for Citizens Advice, said networks had been allowed to make “excessive” profits for far too long and that Ofgem was right to challenge them on efficiency.
She added: “Today’s announcement shows some progress in getting better value for money for consumers. It should also mean networks can reinforce key infrastructure so there is the capacity to connect electric vehicles, heat pumps and wind-farms, helping to deliver the net-zero transition.
“However, network profits will still be too high and targets too easy. We believe Ofgem could have gone further and cut at least £1.5 billion more off people’s bills.”
Basil Scarsella, chief executive of UK Power Networks said: “We welcome today’s publication of the RIIO ED2 final determinations by Ofgem. We are pleased to see Ofgem applying its guidance and rewarding the most ambitious and customer focused business plans.
“The final determinations are the culmination of a two-year process which has involved significant customer and stakeholder input to develop a suite of costs, outputs and commitments that ensure that our region will continue to see the highest levels of reliability, customer service and safety.
“We will need time to assess the final determinations in detail before giving our view on the overall package.”
Vicky Kelsall, chief executive of SP Energy Networks, said: “Today marks the next step in our proposals to invest £3 billion in our communities, delivering jobs, apprenticeships, economic benefits – and ultimately, making sure our country meets net zero. All whilst keeping our portion of the bill broadly flat across the ED2 period, at 30p per day per household.
“We’re pleased Ofgem has recognised the strength of our plan by accepting 95% [including uncertainty mechanisms] of the investment outlined and we will now review the detail to ensure it delivers for the customers and communities we serve.”
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