Ofgem to shield consumers from network windfalls

Ofgem is moving ahead with plans to introduce new protections against windfall gains by energy networks as part of the RIIO2 price controls.

The regulator says the measures, referred to as return adjustment mechanisms, will help maintain the legitimacy of the price controls by ensuring network returns do not exceed its expectations by too much.

In a consultation published in December, Ofgem proposed to implement the mechanisms in two different forms – sculpted sharing for gas and electricity transmission and anchoring for gas distribution.

Under the sculpted sharing approach, individual deviations from a set range would be reduced to bring them closer.

The anchoring approach, by contrast, would see returns adjusted on a sector-wide basis. If the average moved outside of a proposed 3 per cent collar above or below the baseline allowance, then the returns of all companies in the sector would be adjusted proportionally to bring it within that range.

However, following strong pushback from network companies, the regulator has decided to drop the anchoring model for gas distribution and instead apply sculpted sharing across all three sectors. With Cadent alone accounting for more than half of its total regulatory asset value, Ofgem accepted the argument that the gas distribution sector is “not sufficiently diverse” to implement anchoring.

Ofgem says the baseline allowed return on equity for energy networks would be set at 4.3 per cent if the methodology it has chosen for calculating the RIIO2 price controls was applied today. The figure is based on the new CPIH measure of inflation which the regulator is adopting and incorporates a downward adjustment of 0.5 percentage points when compared to its central estimate of the cost of equity to reflect investors’ expectations that network companies will exceed the baseline.

Several network operators claimed the reduction is duplicative with return adjustment mechanisms. Ofgem has dismissed this argument, saying it is necessary to take account of the “systemic nature of information asymmetry” between itself and the companies it is regulating.

Speaking to Utility Week, PA Consulting energy regulation expert Mark Fitch warned that return adjustment mechanisms could “dampen the spirit of the companies to go all out for higher levels of performance”. He said network operators which are nearing the thresholds for adjustment could be encouraged to delay or defer actions to allow them to reap more of the benefits.