National Grid attacks Ofgem decision on funding plans for Hinkley connection

National Grid has attacked an Ofgem decision on the funding arrangements for the connection of Hinkley Point C to the power grid.

The company, whose share price dropped two per cent in the hours following the announcement, has suggested it may fight the regulator over the proposals which it argues offer insufficient returns on investment.

Ofgem has today (23 January) published its minded-to decision on its preferred funding model for Hinkley Seabank project. Ofgem says it should cost around £800 million to build, a significant reduction on National Grid’s quote of £839 million.

The regulator intends to use a new “competition proxy” model to fund the project, whereby National Grid would install the network upgrade itself but its revenues for building and operating the project would be set in line with the expected outcome if it had been procured through a competitive tender.

The allowed revenues would be partly based on Ofgem’s experiences from tendering for the connection of offshore wind farms to the transmission network through offshore transmission owners (OFTO) regime.

Ofgem said funding the project using this model would save consumers £100 million when compared to funding it through the RIIO T-1 price control, primarily due to lower financing costs.

The regulator has suggested a weighted average cost of capital of between 1.12 per cent and 2.7 per cent for the construction of the project and between 0.6 per cent and 1.75 per cent for its operation. The allowances would be adjusted for inflation using the RPI measure. National Grid would recover the project costs over a 25-year period following its completion.

Ofgem cautioned that the proposals “should not be read as an indication of the likely rates applicable for RIIO 2”. It expects to publish an update on the financial arrangements for the price controls in a consultation in March 2018. The regulator has previously warned it will get tougher on network returns for the second round of the price controls.

Responding in a statement, National Grid said, whilst it expected the cost of capital for Hinkley Seabank to be lower than for RIIO T-1 as the project would be funded on a standalone basis, it was “very disappointed” with Ofgem’s proposals.

“We have prepared for a number of financial scenarios however we do not believe that the proposed ranges for cost of debt and cost of equity included in the consultation reflect either the actual cost of financing this project or the risk being taken for construction of this complex project,” the company added. “We also believe that Ofgem has significantly overestimated the potential consumer savings in their consultation.

“These parameters do not, in our view, offer the level of returns that would allow sustainable investment in the UK energy sector needed to deliver good outcomes for both customers and investors.”

National Grid said it intends to work constructively with Ofgem in the coming weeks to reach “a fair and timely outcome for customers and investors”. However, it also warned that it will “consider all other options available to us if we are not able to progress this satisfactorily”.

The minded-to decision follows the conclusion of a consultation which Ofgem launched in August 2017. It also considered a “special purpose vehicle” model under which the transmission owner would run a competitive tender for the financing, construction and operation of the asset.

Ofgem said, whilst this model could unlock even greater savings for consumers, it could also increase costs if project risks were not allocated properly. The regulator noted that the model would be reliant on National Grid setting up and implementing the arrangements appropriately. It said it would still consider this option if National Grid came forward with sound proposals.

A final decision on the funding model and the methodology for determining the allowed rate of return will be made in spring 2018.

In a separate document, Ofgem also confirmed there is a “clear technical and economic case” for the Hinkley Seabank project but reiterated its previous complaint from August that National Grid has failed to adequately justify its plans to use T-pylons instead of traditional lattice pylons.

The regulator said the firm should share the analysis it used to come to a decision and to quantify the visual benefits that T-pylons would provide. Failing that, it should provide further evidence to demonstrate consumers are willing to pay the extra £65 million which would be required.

Nevertheless, as National Grid was granted a development consent order for the project on the assumption it would use T-pylons, Ofgem said the design should not necessarily be altered at this stage as this could cause significant delays, potentially to the detriment of consumers. It expects National Grid to submit a final cost estimate in summer 2018 so the main construction work can begin in early 2019.