Networks set to earn strong returns over RIIO

Network returns are set to significantly exceed the baselines set by Ofgem during the first RIIO periods, the regulator has confirmed in its latest annual reports on the price controls.

The only network operator expected to exceed its spending allowance is National Grid Gas Transmission and none are forecast to receive returns below their baselines.

The reports cover 2016/17, which is the second year for the ED-1 price control and the fourth year for the rest. They show network operators have, in general, performed strongly against their targets.

Here’s a roundup of the findings:

Electricity Distribution

Distribution network operators (DNOs) scored well against five out of six output categories, the exception being connections. Connections targets were missed by Northern Powergrid, UK Power Networks and SP Energy Networks across all of their license areas. SPEN also marginally missed its customer interruptions target for one of its license areas.

DNOs are collectively forecast to spend £25.4 billion over the ED-1 period, representing a 5 per cent underspend when compared with their £26.7 billion allowance. The DNOs spent £6.6 billion over the first two years of the price control – an underspend of £531 million or 7 per cent.

Return on Regulatory Equity (RoRE) for individual networks over ED-1 is forecast to range from 6.8 per cent to 11.8 per cent. The average has risen to 9.4 per cent from last year’s figure of 9 per cent. This compares to a baseline cost of equity of 6.4 per cent for Western Power Distribution and 6 per cent for the other DNOs.

For eight of the 14 license areas around Great Britain, outperformance was primarily driven by financial rewards for meeting targets. Underspending against allowances was the main cause of outperformance for the remaining six.

Underspends predominantly occurred in three cost categories – replacement and refurbishment of assets, network reinforcement and other operational capex costs. Some of this was down to external factors beyond the controls of DNOs such as changing economic conditions which dampened demand for electricity. Improvements in efficiency and the timing of investments also played a role.

There were relatively high levels of overspend in two cost categories – faults and operational support. External factors, such as the impact of Storm Doris in February, were the main cause of these overspends.

The average domestic customer is expected to pay £83 to cover distribution network costs in 2018/19, down 3.5 per cent from £86 in 2017/18.

Electricity Transmission

Transmission operators (TOs) met or exceeded their targets for five out of six outputs, with only Scottish Hydro Electric Transmission (SHET) being penalised for failing to meet their target for SF6 leakages in the environmental category. All three TOs are expected to underspend against their allowances over the ET-1 period.

National Grid Electricity Transmission (NGET) is forecast underspend its allowance by 20 per cent – or more than £1 billion – due to the rescheduling of work and improved strategies to maintain and replace existing assets.

SHET is predicted to underspend its allowance by £180 million – or 6 per cent- owing to lower than expected costs for the delivery of three strategic wider works. The impact is expected to offset somewhat by an overspend on the maintenance and replacement of existing assets by around £100 million – or 33 per cent.

Scottish Power Transmission is forecast to underspend its allowance by £80 million – or 4 per cent – partly as a result of reduced requirements for new capacity and improved contracting processes.

In its role as system operator, NGET is expected to underspend its allowance by £47 million due to lower than anticipated operational costs over the next four years.

RoRE is forecast to average around 9.5 per cent across the TOs, compared to a baseline cost of equity of 7 per cent, with individual returns ranging from 9.3 per cent to 10.1 per cent. The average customer is expected to pay £37 to cover transmission network costs in 2018/19.

Gas Distribution

The gas distribution networks (GDNs) have made good progress in delivering their outputs so far, with the exception of Cadent, which failed to meet customer satisfaction targets. They are all expected to meet their targets by the end of the GD-1 period.

They are collectively forecast to spend £15.5 billion over the price control – 12 per cent less than their £17.6 billion allowance. The figures do not reflect SGN’s recent voluntary return of £145 million of allowances.

The underspend is partly the result of improved efficiency, but also variations from estimates made at the time of setting the price control – for example over the cost of iron mains replacement – and external factors such as reduced emergency and repair bills during milder winters.

RoRE is expected to average 10.6 per cent compared to a baseline cost of equity of 6.7 per cent. Forecasts for individual networks range between 9.6 per cent and 11.9 per cent. The average customer is expected to pay £118 to cover gas distribution costs in 2018/19.

Gas Transmission

National Grid Gas Transmission (NGGT) met most of its output targets bar two. The company missed its greenhouse gas emissions targets due to increased use of its compressor fleet resulting from higher volumes of gas arriving at its St Fergus terminal. It also missed a target for reliability and availability after failing to hold several daily capacity auctions due to IT problems. The company is predicted to meet all of its targets over the GT-1 period.

NGGT is forecast to overspend its £2,256 million allowance by £295 million – or 13 per cent – due to costs associated with improving the health of its assets, which are in worse condition than was originally anticipated. The bulk of the costs are expected to be incurred towards the end of the GT-1 price control and NGGT has so far underspent its allowance by 2 per cent.

Despite the predicted overspend, the company’s RoRE is expected to be 7.5 per cent compared to a baseline cost of equity of 6.8 per cent. The average customer is expected to pay £7 to cover gas transmission costs in 2018/19.

Reaction

Responding to the reports, Citizens Advice noted that Western Power Distribution is anticipated to earn £340 million more in profits over the ED-1 price control than was previously predicted by Ofgem.

According to analysis by the charity, profits across all DNOs are expected to be £273 million higher than originally forecast, whilst earnings by GDNs and NGGT are expected to be £30 million and £50 million lower respectively.

“Some energy network companies are benefiting from an additional windfall at the expense of customers,” said Citizens Advice chief executive Gillian Guy.

“Our research shows that energy networks are already raking in £7.5 billion in unjustified profits. The extra profits revealed yesterday are not a reflection of good performance, so it will be difficult for consumers to understand why they are paying for this through their bills.

“Electricity distribution companies should follow the example of Scottish and Southern Electricity Networks and SGN, and return money to consumers.”

Energy Networks Association chief executive David Smith welcomed the findings from the reports: “Record levels of customer satisfaction, a halving of the number and length of power cuts since 2002 and costs that are down 17 per cent since privatisation and in recent years are either stable or falling, today’s annual reports are proof Britain’s energy network companies are delivering for households, businesses and communities and the price control system is working, and working well.

“As our energy market goes through some of the biggest changes it has faced since it was first set-up, these reports make clear how network companies’ are building on their track record of performance, affordability, investment and innovation to help deliver that change.

“We’re pleased that Ofgem recognises the hard work and strong performance made by all network companies and we look forward to working with them to deliver continued strong performance across the current price control period and into the next.”

Earlier this month, Ofgem launched a consultation on a potential mid-review for the ED-1 price control. Based on the responses to a call for evidence, the regulator said it may expand the scope of the review to cover “financial and incentive performance and design”.

A decision on whether to proceed with a mid-period review is due in spring 2018.