Northern Powergrid calls for shorter ‘mortgage’ on network investments

Northern Powergrid has urged Ofgem to return to a shorter asset life for new investments by electricity distribution networks to ensure intergenerational equality and prevent a future rise in energy bills.

Speaking to Utility Week following the publication of its draft business plan for the RIIO ED2 price controls, the company’s policy and markets director Patrick Erwin also accused the regulator of becoming “politicised” and “behaving in a way that could be trying to get the right headline rather than the right outcome.”

Following privatisation in 1990, existing network assets were depreciated over a period of between 10 and 15 years, while new assets were depreciated over 40 years at a rate of 3 per cent over the first two decades and then 2 per cent over the following 20 years.

To prevent a sudden drop in network revenues once the pre-privatisation assets were fully paid off, Ofgem subsequently moved to a 20-year asset life with linear depreciation.

However, the regulator has been transitioning to a 45-year asset life for new investments over the current RIIO price controls ending in 2023 for electricity distribution. Existing assets at the start of the regulatory period retained a 20-year asset life.

Justifying its decision back in 2011, Ofgem said the longer depreciation period was more reflective of the actual economic lives of network assets and would avoid the kind of “cliff edge” situation that the 20-year asset life was introduced to address.

Erwin called for Ofgem to “look again” at the issue: “In ED1, Ofgem moved from 20 to 45-year regulatory depreciation and that had the effect of supressing bills.

“But effectively what it means is customers are paying more in the long term, and while they’re paying less now, future customers are paying a lot more. We think that’s a crazy thing to do in a world where we’re trying to deploy a whole load of extra capital for decarbonisation”.

Erwin claimed a 45-year asset life will result in the regulatory asset value (RAV) for electricity distribution network rising to at least double what it would otherwise have been, increasing overall costs to consumers by hundreds of millions of pounds: “The longer period of time customers are borrowing money for, the more they pay. It is just like taking out a longer mortgage”.

“That just feels wrong to us both in terms of intergenerational equality and financing,” he added. “You’re letting the network get very expensive in the future and that will make financing even more difficult.”

Erwin said the transition to a 45-year asset life will also result in a drop in income for distribution network operators (DNOs) over the medium-term as investments for decarbonisation swell but pay-outs from depreciation initially decrease. He said Ofgem would therefore be forced to raise allowed returns on equity for a period to fulfil its duty to maintain the financeability of DNOs.

In the financial annex to its business plan, Northern Powergrid said this would create “enormous scope for public and pollical pressure on the regime,” making the sector less attractive to investors and raising the cost of equity. The company said a 25-year asset life would be more appropriate.

Erwin dismissed Ofgem’s prior argument that the depreciation schedule for investments should reflect the economic lives of network assets. He said its description of the asset life is somewhat misleading as it is essentially a regulatory construct, particularly since the introduction of the totex arrangements whereby operational expenditure is capitalised as part of the RAV.

Jury’s out on Ofgem leadership

He also accused Ofgem of becoming “very politicised” in recent years and “behaving in a way that could be trying to get the right headline rather than right outcome,” stating: “I think the jury’s out with Jonathan Brearley and Martin Cave.”

“The regulator clearly got burnt in the last price control where, at least its perceived, returns got a bit out of control, so it’s created a very complicated price control with lots of mechanisms to try to limit outperformance,” Erwin remarked.

“The effect of that means you reduce the incentives of companies to outperform their plans and that’s a bit disappointing. I think you could have done it with a return adjustment mechanism and then let the rest of the mechanisms properly incentivise. I think that Ofgem as it finalises the price control just needs to make sure that it maintains the strength of the incentive mechanisms to get the right outcomes for customers.”

He continued: “Linked to that, there’s an awful lot of after the event judgement led processes that create regulatory risk and also create complexity. We’ve now got a very complicated price control that’s difficult for a member of the general public to understand and frankly difficult for Ofgem to operate, and if you look at the struggle it is having in defending the gas and transmission appeals, a simpler thing which is easier to operate, which its properly resourced to do so, might have been the better outcome for everyone involved.”

“We’d like to see more evidence of the regulator acting in the disinterested best interest of customers in the long term and we’d like the confidence of seeing the regulator be less obviously political because the whole point of having a regulatory structure is its meant to make the regulated industry at arm’s length from political interference and certainly in recent years that degree of depoliticization seems to have been eroded.”

A spokesperson for Ofgem said: “We’ve worked with industry to make our price controls as effective as possible. This will deliver affordable net zero carbon emissions for consumers, both today and in future, as network spending ultimately comes from their bills.”