Ofgem explores alternatives to RIIO approach

The current price control process “may not be the most appropriate model for the energy system we need to build”, an Ofgem director has admitted.

Akshay Kaul, who heads up the RIIO2 team for the regulator, said the energy transition and the need for whole system transformation was likely to “strain” the current framework.

In an open letter to the industry, Kaul, set out the case for changing the network price control review process for gas and electricity networks and some high-level options.

The letter is the first stage in a review of the price control process ahead of a consultation next year.

Kaul identified the increasing pace of transformational change; the need for whole-system optimisation and the importance of managing uncertainties as key features to consider.

The regulator’s director of infrastructure and security of supply went on to highlight the successes of the RIIO framework in delivering investment, service improvements and driving innovation

However, he added: “This periodic review model works well in relatively forecastable environments in which the actions of one regulated company have few knock-on effects for other companies in the sector. However, as the need for whole system transformation and optimisation and uncertainty grow, the model strains. The need for system optimisation means that decisions of actors need to account for the decisions of others; and uncertainty means that there can be a need for substantial changes of plan.

“The central question for this review is whether it continues to be practical and proportionate to follow periodic processes across the full remit of company activity when wider system challenges indicate a growing proportion of investment activity that requires decisions to be made in a faster and more coordinated manner?”

He highlighted the “resource intensive” nature of the current model as well as the different types of uncertainties set to be faced by the gas and electricity sectors. He also pointed to the potential impact of the future system operator (FSO) on the activities regulated by Ofgem.

He also suggested that because decisions on business plans are generally being undertaken before all the information is available, “this has led to judgements on the allocation of risk which have predominantly turned out in favour of the network companies”.

Kaul set out four examples of how the regulatory framework could develop, including adaptation of the RIIO process.

The other variants cited were:

• An alternative ex-ante incentive regime, where the control is set in advance, but is based on a simpler target to improve operating efficiency, for example based on a longer-term productivity incentive that is reviewed only as and when necessary
• A model involving greater user/stakeholder participation, for example negotiated settlements with customer representatives or with body such as the FSO
• An ex-post regime, where allowances are set based on a pre-determined rate of return, subject to effective operational delivery

Kaul said an alternative approach to price reviews could allow Ofgem and networks to “re-orientate the focus of regulation towards forward-looking considerations, including enhancement projects and whole-system optimisation”.

However, he stressed that the affordability of any changes for billpayers would have to be factored in and urged respondents to identify ways in which these alternatives could be implanted with significant costs.

Finally, Kaul said there would need to be a debate as to whether the regulatory framework should focus on gas and electricity separately or if incentives could be aligned. He added: “A one-size-fits-all model may no longer be appropriate to meet the distinct sectoral challenges. A combination of regulatory approaches may be best suited for different activities.”

Responses to the letter can be submitted to futurenetworkregulation@ofgem.gov.uk by 31 October to inform a consultation early next year.

The role of regulation in tackling the trilemma will be discussed at Utility Week Forum on 8-9 November in London. Find out more here.