Latest on RIIO2 appeals

All of the transmission and gas distribution networks have now announced plans to appeal elements of Ofgem’s RIIO2 final determinations. Utility Week brings you the latest updates and reaction in this live blog.

Update at 8.45 on 4 March: Northern Gas Networks (NGN) has announced that it too will seek to appeal its RIIO2 final determination with the Competition and Markets Authority (CMA).

The request will cover four issues: the cost of equity, the outperformance wedge, efficiency targets and the level of incentives.

Chief executive Mark Horsley said: “NGN is the frontier performing company in the gas distribution network industry and at the heart of NGN’s strategy is our desire to deliver efficiency gains for the benefit of our customers in a sustainable way.

“The final determination gives us clarity on what we need to deliver for our customers, and we’re in great shape as a business to continue doing this from April.

“Ofgem’s proposals do however present a very challenging environment for the RIIO-GD2 price control, and we consider that there are errors on specific aspects of the Determination that we are asking the CMA to adjudicate and conclude on.

“We will be following the formal regulatory process in order to seek a resolution and correct these errors.”

It means that all of the transmission and gas distribution networks are now known to be seeking appeals for the price controls beginning in April. The only company to accept its final determination in full is National Grid Electricity System Operator.

Update at 8.15 on 4 March: A spokesperson for Wales & West Utilities has said its appeal request to the CMA will cover five areas: the cost of debt, the cost of equity, spending allowances for gas mains replacement, efficiency targets and the construction of the license. They said the last of these concerns protection from unexpected costs which may be required to deliver amended or new obligations contained in associated documents during the price control.

Update at 7.20am on 4 March: Wales & West Utilities is the latest company to announce an appeal to the CMA against Ofgem’s final determination on its 2021-2026 business plan.

Launching an appeal for the first time in its history, the gas distribution network referenced feedback from over 25,000 customers which encouraged “investing for a green future” and enhancing the support available to look after the most vulnerable. It said Ofgem’s final determination did not provide the level of allowances required to deliver these priorities.

The company’s director of regulation Sarah Williams said: “As the UK recovers from coronavirus and aims for net zero, this is a critical time for the energy industry. It is essential that the regulatory settlement allows us to deliver our customer priorities: keeping the gas flowing safely and reliably, investing strategically to prepare for a green future, and looking after the most vulnerable across our operating region.

“Ofgem’s final determination puts this at significant risk and is not in the best interest of communities across Wales and south west England, nor our business.

“We have therefore asked the CMA for permission to appeal, which is the final step in the regulatory process, and is specifically designed to allow outcomes to be independently reviewed and underpins broader confidence in the UK’s regulatory system.”

The decision by Wales & West means that six of the seven networks covered by the final determinations published in December are seeking an appeal. Northern Gas Networks is the only one yet to announce its intention publicly. While National Grid is challenging elements of the determination for its electricity and gas transmission businesses, the Electricity System Operator has accepted its determination in full.

Update at 17.40 on 3 March: SGN has become the fifth network company to reveal it is requesting an appeal of its RIIO2 final determination with the CMA.

“For the five-year regulatory period covering 2021-26, SGN formulated a comprehensive and robust business plan which carefully reflected the views of many stakeholders and customers, whole preparing a decarbonised gas network for the future,” the company said in a statement.

“SGN has identified a number of technical issues in Ofgem’s final determination and, as a result, has referred these to the CMA. Specifically, SGN has decided to appeal on cost of equity, outperformance wedge and certain aspects of Ofgem’s efficiency methodology.

“Subject to the CMA granting permission to appeal, the process is expected to take until Autumn 2021 to reach a conclusion.

“While the CMA process is ongoing, SGN remains committed to delivering operational excellence and outstanding service for all our customers. SGN will continue to work constructively with Ofgem and the UK and Scottish governments to help meet net zero targets through our pioneering decarbonisation programme.”

Update at 14.30 on 3 March: A spokesperson for Cadent has told Utility Week their appeal will seek to challenge the data used and the methodology applied by Ofgem to determine the price controls and will not only focus on the rate of return for investors but also on total expenditure allowances and risk.

Update at 14.10 on 3 March: Cadent has publicly confirmed that it will submit an appeal to the CMA.

Tony Ballance, chief strategy and regulatory officer for the gas distribution network, said: “Cadent plays a vital role keeping the energy flowing to over 11 million homes and businesses across the UK – and a leading role in transitioning the gas sector to a low carbon economy.

“To enable us to lead the way in this role over the next five years, we submitted a robust and very ambitious business plan to Ofgem in December 2019.  This was a plan built on the most extensive and tailored customer and stakeholder engagement programme, providing what we believe was the best option for our customers – ensuring Cadent can continue to deliver a safe and reliable energy network now, and lead the development of a net zero future.

“We have thoroughly reviewed Ofgem’s final determination on our plan, published in December 2020 and have engaged with them very collaboratively throughout the process.

“After a great deal of careful deliberation, Cadent has decided to take the next step in the regulatory process and appeal their decision to the Competition and Markets Authority.  This is because we do not believe the final determination strikes the right balance between bill reductions and future investment, that is necessary to enable us to deliver the very best service to customers and wider society.”

Update at 11.50 on 3 March: Consumer charity Citizens Advice has voiced its opposition to the appeals.

Acting chief executive Alistair Cromwell said: “Networks’ decision to appeal what is already a generous price control is about trying to go back to the days when they could make billions in excess profits at consumers’ expense. There is no benefit to energy customers from this course of action.

“Funding networks for the shift to net zero is one of the main purposes of this price control and Ofgem’s settlement allows that to happen. These appeals are an unnecessary distraction.”

Update at 10.30 on 3 March: Utility Week understands that Cadent has decided to appeal its final determination for gas distribution to the CMA.

Update at 17.00 on 2 March: Fitch Ratings has downgraded a number of credit ratings for National Grid and its subsidiaries, partly due to its reduced earnings prospects for the RIIO2 regulatory period. The long-term issuer default rating has been lowered from BBB to BBB- for National Grid and from A- to BBB+ for National Grid Electricity Transmission (NGET) and National Grid Gas (NGG). The senior unsecured ratings of National Grid, NGET and NGG have all been downgraded by one notch to BBB, A- and A- respectively.

Update at 16.20 on 2 March: SP Energy Networks has said it will also appeal its RIIO2 final determination for electricity transmission, stating it “recognises the progress that has been made in agreeing a number of aspects of our business plan, but we remain concerned at Ofgem’s approach on a number of discrete issues.”

Update at 15.00 on 2 March: The transmission arm of Scottish and Southern Electricity Networks (SSEN) has announced its intention to appeal “certain elements” of its final determination for the RIIO2 price controls to the Competition and Markets Authority.

The company said the appeal will be “both technical and narrow in scope” and focus on areas where “Ofgem’s decision does not reflect the robust evidence provided throughout the price control process, alongside material errors”.

As with the appeal announced by National Grid on Tuesday morning (2 March), SSEN Transmission said these will include the cost of equity, which it “remains disappointed does not reflect market conditions”, and the outperformance wedge, which it argued “goes against established regulatory practice by assuming, rather than incentivising, outperformance.”

However, the company said it will also seek to challenge the decision to “unfairly expose” transmission owners to the under recovery of transmission charges by National Grid Electricity System Operator, as well as the loss of the right to appeal additional total expenditure (totex) allowances released through uncertainty mechanisms and totex adjustments made following an outputs assessment.

It said the latter also “goes against established regulatory practice, creating unacceptable risk and precedent for future price controls.”

SSEN Transmission managing director Rob McDonald said: “Our appeal raises technical but very important issues that we are asking the CMA to correct. In the meantime, we can start to deliver against our stakeholder-led business plan and build our network for net zero, supporting government climate change targets and the green recovery from the coronavirus pandemic.

“We would like to thank Ofgem for its constructive engagement following publication of its draft determinations and while it is regrettable we have been unable to reach agreement on all aspects of the final price control settlement, we will continue to work constructively with Ofgem and all stakeholders as the CMA considers the merits of our appeal.”

The company said it will accept the rest of the package, including the proposed baseline totex allowances.

Reaction

Martin Young, an analyst at Investec, said SSEN had made “the right call”, arguing that “energy deserves a higher return than water and the outperformance wedge lacks validity”.

“The appeals have been made without the benefit of knowing the CMA’s ruling on PR19, but in a January update, the CMA’s point estimate for the cost of equity was 4.83 per cent pre any changes to the risk-free rate, beta and total market return, and ahead of Ofgem’s 4.55 per cent,” he explained.

“This point estimate is positioned at 25 basis points above the range midpoint, which if applied to Ofgem’s range would point to a cost of equity of 4.80 per cent.”

He continued: “We have been consistent in our belief that energy should attract a higher return than water given the risks and uncertainties and we are not persuaded by arguments to the contrary. We have also struggled from the start on the validity of the concept of the ‘outperformance wedge’, suggesting that a regulator should address expected outperformance via cost allowances.

“With the multi-period investment needs of energy, we suggest that a CMA referral is not just about RIIO2, and that settling these, and other issues, via this route is the best course of action for both net zero and shareholders, despite the disruption it would undoubtedly cause in the short-term. It is a brave call, but the right call, in our view.”

However, former Ofgem partner Maxine Frerk, said she saw no real downside from the perspective of network companies to a “tight and narrow” appeal against the cost of equity and the outperformance wedge. The latter is intended to offset the expected outperformance by networks by reducing the allowed cost of capital by 25 basis points below Ofgem’s central estimate.

Frerk said this type of challenge will be relatively low cost to undertake and will only involve a small section of networks’ management teams: “The rest of the organisation can get on with delivering what it’s got to deliver and working out how to do that within the envelope that has been set.”

Speaking to Utility Week shortly after National Grid made its announcement, she said by accepting the rest of the package the company should limit any damage to its relationship with Ofgem: “If you keep it tight and narrow then I can’t really see there’s any downside. It would be a silly not if you think there’s a prospect of even a bit of movement.”

“Why wouldn’t you,” she asked, “because you’re going to look pretty stupid to shareholders and the board if you don’t and then the CMA come out with a favourable ruling? There’s a lot of water companies kicking themselves.”

She said National Grid’s decision to keep the scope narrow is likely encourage others to do the same: “The fact that they’re only appealing on the cost of capital might mean that others think they don’t want to be the only ones causing broader trouble”.

As to the prospect of success, Frerk noted that CMA cannot overrule Ofgem just because it would have made a different decision: “They have to say if Ofgem is wrong as opposed to what would they do.” If Ofgem’s position merely represents the opposite end of a range of figures, “then it’s harder for them to say Ofgem are wrong”.

She said the increase between the draft and final determinations was probably a conscious effort by Ofgem to push the cost of equity into this acceptable range and ward off a successful challenge and that networks may have stronger case to make when it comes to the outperformance wedge, which represents a “point of principle”.

“It’s a bit of a novel or contentious idea,” she added. “There’s certainly a good argument to be had there.”

Ofgem director of networks Akshay Kaul said: “Our price control drives a fair price for consumers, improves services and boosts green energy investment.

“We respect the Competition and Markets Authority appeal process, where we will defend robustly our decisions which are in the best interests of consumers and tackling climate change.

“While the appeals could take around six months to resolve, they will not delay any investment and we look forward to working closely with industry to accelerate investment for a green recovery.”

Ross Easton, director of external affairs at the Energy Networks Association, said: “The UK’s energy network operators remain focused on providing a low cost, net zero energy system to the public. To deliver this, it is essential that the regulatory environment is attractive to the significant investment the country needs over the coming years.”