Ofgem toughens up on energy network returns

Ofgem has published plans to slash in half the returns that energy networks can make.

The energy regulator has this morning (18 December) published its proposals for the new RIIO2 price control framework, which covers the electricity and gas transmission networks together with gas distribution.

In the new price control period, which starts in 2021, the regulator has proposed that operators’ allowed cost of equity returns will be set at a baseline of 4 per cent, once inflation has been taken into account. The cost of equity comprises the dividends and capital gains that investors make on their investment.

The new figure is nearly 50 per cent lower than the previous price control regime which set a figure of 7 per cent for transmission networks.

Ofgem has also said that it wants to adjust the cost network companies face to borrow annually so that consumers can benefit from falls in interest rates.

The combined reductions in the cost of capital is expected to save consumers £6.5 billion in the next price control round, estimates Ofgem.

It calculates that each 10bps on the cost of equity translates into approximately £172 million on consumer bills over the course of the RIIO2 period.

Ofgem’s consultation document outlining its proposals says that the low risk environment, which the network companies operate in, points to a reduction in the cost of equity distribution network operators (DNOs) should be allowed.

The returns Ofgem allowed the DNOs to make under the RIIO1 framework have attracted criticism during the past year for being too generous and a factor in rising household energy bills.

In another change to the way it estimates networks’ cost of equity, Ofgem has said it will replace the retail price inflation measure with the newer and generally lower consumer price inflation housing rate as the basis for indexing fluctuations in prices.

Ofgem estimates that the proposed cuts to the cost of capital for networks should save customers £30 per year on average.

Combined with Ofgem proposals to introduce fixed charges to recover some electricity network charges, which are designed to ensure that those who generate their own electricity pay their fair share towards the cost of running the system, the savings could add up to £45 per year.

David Smith, chief executive of the Energy Networks Association, warned that Ofgem’s proposed clampdown threatens to jeopardise the investment required to modernise the UK’s energy system.

He said: “It’s important that the public and the country as a whole benefit from the changes that are sweeping across the country’s energy system, but much more work still needs to be done by the regulator to understand the pace of that change, the risks that investors face and how that is reflected in the price control.

“Energy network companies are building a smarter, more efficient, cleaner energy system that is fit for the British public, so we can all benefit from things like more electric vehicle charge points to help improve our air quality and a lower-carbon gas grid to heat our homes.

“But as things stand, the proposals could jeopardise the innovation and investment that is critical to delivering these important outcomes. Britain’s people and businesses risk missing out.”

Frank Mitchell, chief executive of SP Energy Networks, said: “It is essential that Ofgem strikes an appropriate balance between customers and investors at this critical next stage of decarbonising our economy in its future price controls to encourage the necessary investments.”

But Ofgem’s proposals to crack down on network returns were welcomed by Gillian Guy, chief executive of Citizens Advice.

She said: “Energy network companies have had it too good for too long. Ofgem’s commitment to a tougher price control should curb the excess profits networks have been allowed to make. This is good news for people as this should result in lower bills. It is vital now that Ofgem continues to hold its nerve in the face of the inevitable push back from industry.

“The widespread adoption of electric vehicles and smart appliances in our homes will bring benefits for many people, but will also put different demands on the network.

“It’s crucial that everyone benefits from these innovations and that no-one is left behind. We want to make sure everyone, especially vulnerable people, can make the most of these products and services and are protected from undue costs.”