Energy networks face ‘lowest ever’ returns under RIIO2

Ofgem has confirmed the methodology it will use for calculating the second round of RIIO price controls.

If applied today, the baseline allowed return on equity would be set at 4.3 per cent based on the new CPIH measure of inflation that Ofgem intends to adopt.

Although slightly higher than the 4 per cent figure suggested by the regulator in December, Ofgem says it is the “lowest ever” rate proposed for energy networks and represents a 50 per cent reduction on the current level.

When combined with lower allowances for the cost of debt, the cut is expected to save consumers £6 billion over the five-year price controls – the equivalent of £25 per household per year.

Ofgem executive director for system and networks Jonathan Brearley said: “Our proposals are on track to deliver a tough, fair settlement that strikes a better deal for consumers.

“Lowering the cost of capital for network energy companies will put money back into consumers’ pockets while service standards are required to remain high.

“Our new price control for networks will pave the way for a cheaper, smarter and more sustainable energy system and is a key step in our journey to a low carbon future.”

The announcement was welcomed by Citizens Advice, which has previously claimed energy networks are on course to earn £7.5 billion of “unjustified profits” over the current price controls.

“This announcement takes us another step towards a settlement that prevents this from happening again,” said Citizens Advice chief executive Gillian Guy.

“Ofgem has made significant progress so far, but the acid test will be the final outcome. The regulator will face intense industry pressure to water down these measures in the coming months. It must hold its nerve and deliver a price control which is good value for consumers.”

Network operators insist the allowed returns have been set too low and could leave them unable to secure sufficient investment.

Energy Networks Association chief executive David Smith said: “These proposals, if implemented, will have damaging impacts on the energy networks’ ability to deliver the government’s plans for clean growth and the wider economy, undermining efforts to build a smarter, more efficient energy system for the public.

“Costs are down, power cuts are at record lows and the amount of renewable energy connected to the grid is at an all-time high. Ofgem needs to build on this track record.

“The approach needs to evolve in response to experience and the lessons learnt under the RIIO1 price control. Central to this is ensuring that Britain’s energy networks are able to continue to attract significant levels of investment over the next decade and beyond, at lowest cost to the consumer.”

National Grid head of regulatory finance, Darren Pettifer argued in a recent interview with Utility Week’s sister title Network that a 5.5 per cent return on equity would be more appropriate.

Click here to read more about how network companies have responded previously to Ofgem’s proposals.

Speaking to Utility Week earlier this week, former Ofgem technical director John Scott raised concerns that the regulator has become too focused on driving down returns at the expense of encouraging ambitious action by network companies.