RIIO2 framework for electricity distribution confirmed

Ofgem has confirmed the framework for the second RIIO price control for electricity distribution starting in 2023.

The regulator said it will reach a decision on the sector specific methodology by the end of next year.

The framework is essentially the same as those adopted for transmission and gas distribution price controls, which begin two years earlier in 2021. Companies in those sectors submitted their draft business plans to the regulator several weeks ago.

CPIH (or CPI) will likewise replace RPI as the new measure of inflation and the cost of equity will be calculated using the same methodology. Back in May, Ofgem said this would result in a real cost of equity of 4.3 per cent if applied at the time. The regulator will retain full indexation for the cost of debt.

The price control will be shortened from eight years to five and distribution network operators (DNOs) will be required to create independently chaired engagement groups to give customers a stronger voice.

Under the current arrangements, DNOs’ business plans undergo an initial assessment by Ofgem and those judged to be of sufficient quality are fast-tracked, allowing them to keep a greater share of any underspends again their totex allowance.

The other networks are required to submit revised business plans, which are then used alongside the regulator’s own cost estimates to calculate the information quality incentive (IQI) benchmark. Their sharing factors are determined based on the divergence between their submitted costs and the benchmark.

For RIIO2, the opportunity to be fast-tracked will be removed and the IQI will be scrapped. Ofgem will instead grade business plans on both their quality and cost. DNOs that excel will be rewarded with a percentage increase in their totex allowance. Those that fail to meet expectations will be penalised with a reduction.

A Return Adjustment Mechanism will be introduced to prevent network profits from straying too far from the baseline rate. This will take the form of “sculpted sharing” meaning the adjustment will be greater the more a company’s regulatory return on equity deviates from a predetermined cap or collar.

A Coordinated Adjustment Mechanism will be developed to enable the benefits of whole-system solutions to be shared across sectors. The Innovation Rollout Mechanism will be removed and the Network Innovation Competition will be replaced with a new scheme that focuses on strategic challenges.

Outputs will be split into three types: License Obligations (minimum standards), Price Control Deliverables (for specific activities or projects); and Output Delivery Incentives (for improvements in the quality of service).

The Network Asset Risk Metric – a combined measure of the probability and impact of an asset failing – will be used by DNOs as a tool to assess and justify replacements and refurbishments. Ofgem will also use the metric to track their performance.

The regulator gave an update on the current timetable for RIIO ED2. The sector specific methodology consultation will be held over the second quarter and third quarters of 2020 before a decision is revealed by the end of the year. DNOs will submit their final business plans by the end of 2021 and the final determinations will be made by the end of the following year.

Commenting on the framework, Frank Gordon, head of policy at the Association of Renewable Energy and Clean Technology, said: “Key features, including prioritising the delivery of net zero, changing allowable returns and bringing the default contract period to five years, are sound decisions although could conceivably go further given the problems with the networks in recent years.

“We note that this is only part of the overall process as the document does not include the decisions on how and whether to incentivise networks to speedily and affordably connect renewable energy and clean technologies. We also believe that procuring new flexibility capacity can reduce the overall level of new infrastructure, such as wires and pylons, needing to be installed which needs to feed into the process as well.”

He continued: “The REA cannot understate the importance of this process. Whilst many networks are presently becoming more involved in managing grid constraints, for example by tendering for energy storage services, distribution networks have traditionally been major obstacles for the deployment of renewable energy and clean technologies.

“Costly grid connections, slow decision making, and a lack of transparency in charging methodologies are often-cited problems for developers. The benefits of many clean technologies to the networks, such as energy storage and smart electric vehicle charging, are also often not reflected by the networks.”