Ofgem approves £20.9bn of spending by DNOs

Ofgem has approved more than £20.9 billion of spending by electricity distribution networks as part of its draft determinations for the RIIO ED2 price controls.

The figure is down by £4.3 billion – or 17% – from the more than £25.2 billion of total expenditure (totex) allowances requested by distribution network operators (DNOs) in their business plans submitted in December.

The regulator said the approved allowances include £2.7 billion of upfront investment to boost grid capacity over the five-year price controls beginning in April 2023. This represent a 90% increase in annual load-related expenditure when compared with the current eight-year regulatory period.

Ofgem has set the allowed return on equity – the baseline rate of return for investors – at 4.75% in real terms based on the CPIH measure of inflation. The regulator said this is down roughly 30% when compared to the equivalent rate for the current price control period of 6.8%.

In line with the ruling of the Competition and Markets Authority (CMA) in the appeal of transmission and gas distribution networks against their final determinations, the rate does not include the outperformance wedge proposed by the regulator in its sector-specific methodology for the RIIO ED2 price controls.

The outperformance wedge – a downward adjustment to the cost of equity of 0.25% – was intended to counteract information asymmetry between Ofgem and networks, reflecting investors’ expectations that companies would outperform the baseline on average.

Although the CMA recognised Ofgem’s concerns over information asymmetry, the body removed the measure from the price controls for transmission and gas distribution, leaving the appellants with an allowed return on equity of 4.55%.

Ofgem said excluding real price effects, ongoing efficiency and non-controllable and passthrough costs, DNOs requested £25.2 billion of totex allowances in their business plans submitted in December. It said its own modelling of expenditure put the figure at £23.2 billion, representing an 8% reduction.

The regulator then applied a demand-driven reduction of £0.7 billion (3%) to align the plans with its common scenario for achieving the 2050 net zero target. It additionally applied downward adjustments of £0.3 billion (1%) and £1.3 billion (5%) to reflect the catch-up and ongoing efficiency challenges to give a final totex figure of £20.9 billion. This equates to a 14% increase in annual expenditure when compared to the current price control period.

Ofgem said the combination of efficiency savings and reduced investor returns means customers will see no increase in DNOs contributions to energy bills, which currently average around £100 per year, despite a significant rise in net zero investment.

Chief executive Jonathan Brearley said: “Ofgem’s job is to ensure energy networks have achievable and affordable plans that will attract the investment needed for a more resilient energy network and achieve the government’s net zero ambition at the least cost to the consumer.

“These are challenging times, and this is the path out of relying on expensive and polluting imported fossil fuels and moving to a home-grown energy system, that exploits the best of modern technology to level out demand and reduce costs for consumers.

“We’re determined to get the best possible deal for consumers and the proposals we’ve published today will mean that substantial additional investment can be made to deliver net zero without placing any further pressure on bills.

“We’re confident that the five-year vision we’ve outlined will help build the world class energy infrastructure needed to connect consumers to reliable, cleaner energy at an affordable price.”

David Smith, chief executive of the Energy Networks Association, said: “The final determinations will need more work to give us confidence that RIIO-ED2 will be compatible with customers’ expectations of an energy system that enables the transition to net zero. We will work with Ofgem over the coming months to meet this challenge.

“As record numbers of electric vehicles, renewable energy and heat pumps are introduced to our energy system, the ED2 price control period is crucial, recognising the scale of transformation and the leading role networks will play in enabling decarbonisation.

“As well as supporting increasing numbers of low-carbon technology through flexibility and innovation, networks need both sufficient certainty and agility around investment to meet the scale of the challenge at the time customers and communities need them.”

Gillian Cooper, head of energy policy for Citizens Advice, said: “Today’s announcement is a good move towards making sure consumers get better value for money. The proposals mean networks can deliver the infrastructure needed for the net-zero transition, while limiting increases to our bills.

“Ofgem is right to challenge the networks to operate as efficiently as possible – particularly when many families are being squeezed from all sides amid rising bills.

“Networks have been allowed to make excessive profits for too long and they’re still able to make too much. Ofgem must continue to tackle this by limiting their returns even further.”