It’s all a matter of judg(e)ment

The Competition & Markets Authority (CMA) is due to deliver its preliminary judgement on the appeals against Ofgem’s RIIO2 price controls next month. In her latest column exclusively for Utility Week members, Maxine Frerk examines what we can learn from the arguments put forward so far.

We’re roughly halfway through the Competition & Markets Authority (CMA) appeals on Ofgem’s RIIO2 final determinations and at the minute it seems like the match could go in either direction.

As a reminder, all of the gas distribution and gas / electricity transmission networks appealed Ofgem’s decision, with the objections focussed on the cost of capital, the efficiency targets for the gas distribution networks (GDNs) and a few other company-specific issues.

In previous articles, I’ve argued about the need for more transparency in the energy appeals process. In the electricity distribution (ED1) appeals nothing was published until the end. The good news is that this time the CMA has published all the submissions as it goes along, so geeks like me can see what’s going on. However, the hearings which have been happening over the last few weeks remain behind closed doors – unlike Ofgem’s own open hearings which, if nothing else, provided a window into the regulatory process.

The CMA process started with the companies setting out their grounds of appeal back in March. In April, Ofgem submitted its response to those appeals and the companies had the chance to submit additional comments following the CMA decision on PR19 in water. In May, Ofgem provided its response to the companies’ responses. That’s a lot of reading.

However, Ofgem’s argument can be largely boiled down to the idea that their decisions are all a matter of judg(e)ment and on that basis the CMA cannot find that its decisions were “wrong” – the test that applies in energy appeals. In Ofgem’s two responses (on cost of capital and efficiency) the word “judgment” appears 71 times and “judgement” 76 times. The companies pick this up in their responses though I don’t think any have spotted the spelling inconsistency so they actually understate the word count. And “discretion” appears 84 times in case the point was in doubt.

Ofgem does admit to two errors in its calculations – on the business plan incentive for Northern Gas Networks (which has gained an addition £3 million) and in the exclusions it applies for atypical projects in assessing Cadent’s efficiency on the local transmission system (LTS), the impacts of which can’t be quantified at this stage.

In their responses to Ofgem’s response the companies inevitably push back, accusing Ofgem of hiding behind a veil of regulatory discretion and failing to engage with the substance of the argument. I have argued previously that there is (rightly) a high bar in energy appeals – but it should not be an insurmountable bar or the appeals process is pointless. The energy appeals were intended to be appeals on the merits. The choice of the CMA as an appeal body reflects its specialist expertise – in contrast to a court hearing a judicial review which will be reluctant to go against the judgment of a specialist regulator.

Using discretion

Which way the decisions go will depend quite crucially on how much discretion the CMA allows. In my view, if the regulator has a range of options and the evidence in support of a particular option is much weaker then it should not be able to rely on its use of discretion to defend that choice. If however it is a genuine question of judgment where the regulator’s sectoral knowledge is important, then the CMA has no basis for intervening.

Of course, some of the arguments made by the companies as to why Ofgem was wrong are stronger than others – but even where they might appear to have a strong case they still have to get over this first hurdle. Many pages have been written by both sides on the question of regulatory discretion and where the CMA lands will be a litmus test as to whether we have an appeals regime that provides the system of checks and balances that any regulatory system needs, or whether reform is required.

There are also some important legal arguments that come out, in particular in the Wales & West Utilities (WWU) appeal on the cost of debt (but of wider relevance) about the importance that Ofgem has to attach to its financing duty in balancing its overall set of duties. Again, an important point to watch.

There is also a sense of worry among the gas distribution networks about whether Ofgem in correcting the errors it admits to on the Cadent benchmarking could end up reducing other companies’ allowances. This debate about how you treat “linkages” is one that has been brewing throughout the policy phases on RIIO with Ofgem and the CMA not necessarily seeing eye to eye.

Ofwat intervention rejected

In terms of process there have also been a few interesting developments.

As flagged previously the energy process is much more closed than the water one with third parties requiring the permission of the CMA to intervene. Both Citizens Advice and British Gas Trading were given permission to intervene on the question of the cost of equity and the outperformance wedge – Citizens Advice because it is the statutory consumer body and BGT because “its business is directly impacted” (a point I struggled with in the ED1 appeal knowing that they treat network charges as a pass-through cost that all suppliers face).

Ofwat applied to intervene on the cost of equity but was turned down because it was not directly impacted and it might leave the CMA having to deal with a proliferation of evidence. Similarly Electricity North West applied and was turned down on cost of debt and SP Transmission on TNUOS. While this might reflect a strict interpretation of the rules it confirms my sense that these are seen as bilateral disputes rather than matters of public interest. The CMA can take evidence from Ofwat without the latter being a formal intervener and it will be interesting to see whether it does.

The other procedural challenge that the CMA had was the sheer number of similar appeals on very similar but slightly different grounds. It granted permission to appeal on the condition that the relevant appeals were joined together. The companies were still able to submit individual responses but for the hearings that have been happening they have been required to nominate one of their number as the lead on each ground of the appeal. With every company having different advisers and slightly different positions this has inevitably prompted some tensions.

Aside from the question of consultants’ egos there are real questions about how far the CMA will be able to explore the differences that may genuinely exist between the sectors. In transmission it is clear that there is a huge wall of investment needed over the T2 period to accommodate the growth in renewables needed for net zero which should weigh in on any arguments around “aiming up” on the cost of equity. In contrast the GDNs face an existential threat from heat electrification and it is hard to see that the risk inherent in that wouldn’t impact in some way on the cost of equity. The CMA requirement for the appeals to be joined together was probably the only practical solution to the sheer number of appeals but one has to hope that there is still the flexibility for them to reach different conclusions on the different sectors if the evidence takes them there.

Looking ahead, the next step in the process is the CMA’s provisional determination due in August. Again, in ED1 this was not made public and so there is another test for the CMA around the transparency of the process as to whether it will publish that provisional decision this time. I hope it does.

Maxine spent 15 years at Ofgem, latterly taking on responsibility for all aspects of the regulation of distribution networks. Since leaving Ofgem she has been working as an independent consultant for a mix of regulated company and consumer / community group clients.