Not as easy as it looks

In a price control, companies will always claim the regulator has made errors but the RIIO2 draft determinations do appear to contain an unprecedently high number of basic arithmetic mistakes, says Maxine Frerk.

The headline messages from the network companies’ responses to the RIIO2 draft determinations have been primarily around the implications for net zero and a green recovery. However, a common theme running through most – if not all – of the responses is around the level of errors in Ofgem’s calculations of allowed revenues.

Of course, the companies will always claim that Ofgem’s proposals are full of errors and in many cases that simply means that they take a different view on key assumptions. The language of “errors” is used routinely as that is the basis for any appeal that the companies wish to make to the Competition & Markets Authority (CMA) in due course. However, it does seem that on this occasion there are an unprecedently high number of basic arithmetic mistakes.

For the transmission and gas distribution companies this creates a real challenge in that they don’t really know what Ofgem’s methodology will mean for their allowed revenues once the mistakes have been corrected. Without that visibility, it is hard for them – or indeed other stakeholders – to work out the impact of the points that are genuinely open for debate.

In the RIIO ED1 appeal, the CMA was critical of Ofgem for not having consulted on changes to its approach to calculating Smart Grid Benefits between draft and final determinations. The fact that we didn’t have time in the overall process to do that – and had done some informal consultation with the companies – didn’t cut much ice.

While that was arguably a bigger issue it does illustrate the importance that the CMA will attach to the process of consultation if companies decide to appeal. It is hard to see how Ofgem would slot in another round of consultation on the corrected figures given the controls are due to go live next April, but the companies are arguing that this is needed and Ofgem will have to think about how to address it.

It then also needs to think about any lessons for the ED2 process. One reason that this is problematic is that by getting rid of fast track Ofgem has got rid of an opportunity to road test its benchmarking and left itself with only one bite at the cherry.

In water, by contrast, Ofwat produced an initial assessment ahead of draft and final determinations. As well as giving the companies the chance to improve their plans (where perhaps it hadn’t been clear what level of evidence was required) it also gave everyone time to iron out any issues with the benchmarking methodology.

Ofgem can’t change tack totally for ED2 but it has already asked for initial projections from the companies in the autumn. This hasn’t been popular but if it was clear that this would help avoid errors later on there might be more support.

And finally, Ofgem needs to reflect on what the lessons are for its ambition to make more use of reopeners as a part of a move to more adaptive regulation. It is perhaps not surprising that the companies are nervous about Ofgem’s ability to make timely and robust decisions on these reopeners given this experience.

As almost all stakeholders have said, there needs to be more assurance on how that process will work and allow for adequate engagement. It would seem that it also needs to be made clear how adequate assurance will be provided on the numbers in what will inevitably be a tight timetable.

Of course, we all understand that Covid-19 has made Ofgem’s job particularly hard this year and many of the members of the price control teams are new to the process. However, it’s a core competence for a regulator to get its sums right. It’s not as easy as it looks but if the companies’ concerns are correct then Ofgem needs to be learning the lessons.

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.