Ofgem confirms crackdown on DNO investor returns

Electricity network companies will be expected to get by with less after Ofgem confirmed a cut to the cost of equity allowance on Monday.

The regulator is to assume returns of 6 per cent for equity investors in distribution network operators (DNOs) over the next 8-year investment period. That is a material cut compared to the assumptions of 6.7 or 6.8 per cent DNOs made in their business plans.

Industry experts told Utility Week the cut would make an estimated £60 million hole in business plans across the country.

Western Power Distribution, the only DNO to be fast-tracked through the RIIO-ED1 price review process, must bring its finance plan in line or rejoin the “slow track”. Ofgem is allowing WPD a more lenient figure of 6.4 per cent, down from 6.7 per cent in its business plan, saying it is still the most efficient DNO overall. The change will shave an estimated 54p off the bill for customers in WPD’s area.

The five slow-tracked DNOs must resubmit their business plans for 2015 to 2023 in March, taking into account issues flagged up by the regulator. The cost of equity allowance will be finalised as Ofgem rules on each business plan.

Ofgem’s guidance brings the weighted average cost of capital (Wacc) down to 3.8 per cent in 2015/16, even lower than the 3.85 per cent proposed by Ofwat for water companies. Industry insiders say the average over the 8-year period could fall as low as 3.7 per cent, as the indexed cost of debt allowance is expected to fall.

The change in guidance follows a draft determination by the Competition Commission on the price control for NI Electricity that takes a hard line on equity costs. It signals that transmission and gas distribution networks could also face tighter financial controls at the next perice review.

Peter Atherton, analyst at Liberum Capital tweeted that Ofgem and Ofwat were getting “tough” on the cost of capital. He added: “Looking at the Wacc it is hard to conclude they are materially wrong. Financing should still be available.”

Deutsche Bank said the decision was “slightly disappointing but not a huge surprise” and a “slight negative” for SSE and Iberdrola, which own distribution networks.

Analyst Martin Brough said: “As long as companies still have the opportunity to earn higher returns for operational outperformance we believe the UK energy network regulatory regime will still be seen as relatively attractive by investors. Nevertheless the 6% figure is a full 100bp lower than the return on equity allowed for Scottish electricity transmission in last year’s review. It may add to the general perception that the regulatory (and political) regime facing UK energy companies is becoming less favourable.”