Reshaping RIIO

Ofgem may have pulled a rabbit out of the hat with its Sector Specific Methodology Consultation which builds heavily on the established RIIO methodology. However, there are still two big strategic issues that need addressing – not to mention an incredibly tight timeline. Maxine Frerk reports.

Maxine Frerk

After a year in the wilderness trying to come up with a better mousetrap, Ofgem concluded last October that the way they had been doing price controls through RIIO was actually pretty good and had proved flexible in being able to include the Accelerated Strategic Transmission Investment (ASTI) approach that was a major step in speeding up decisions on transmission investment.

Mutterings from members of the Ofgem team working on RIIO revealed some frustration at their end around the delays. They had been left with only two months to produce a first draft of the Sector Specific Methodologies after publication of the Future Strategic Network Review (FSNR) decision announcing that, after all, we would be allowed to call it RIIO.

However, the Ofgem team seems to have pulled a rabbit out of a hat. The Sector Specific Methodology Consultation is a really solid piece of work that builds heavily on the established RIIO methodology, looking to simplify slightly where that makes sense. It feels like the grown-ups are finally back in charge.

However, the timeline remains incredibly tight.

The Sector Specific Methodology Decision (SSMD) will be published in June, together with the Business Plan Guidance. That doesn’t give the Ofgem team much time to consider consultation responses and hence they are relying heavily (as they have done in past price controls) on working groups to go through the detail. The Ofgem website advertises 46 working group meetings scheduled over the next few months. It’s inevitable that only the networks themselves will be sufficiently resourced or motivated to engage in all of these which creates risks in terms of ensuring the consumer voice is adequately taken into account. While the Ofgem teams do seem willing to engage bilaterally that isn’t the same as a full and open debate and Ofgem could usefully identify a few key topics where wider stakeholder input would be helpful and how best to get that.

And even for the networks, attending so many groups creates challenges when they have an extremely tight deadline for submitting their business plans – with drafts due in July, only a month after the SSMD. The networks will be busy trying to read the runes of Ofgem’s thinking in advance of the decision, and drafting their plans to cope with all eventualities.

Because much of what Ofgem is debating is relatively minor tweaks to the existing framework this is perhaps more manageable than it sounds. However, there are two big strategic issues that Ofgem has rightly raised and that need to be addressed but where the timelines make it very challenging.

The first is the introduction of a new concept of “investability”. This recognises the huge increase in investment needed on transmission which cannot be funded through retained earnings and will require the injection of significant new capital. Making the price control sufficiently attractive to investors is therefore a key concern. There has always been a focus on what is termed “financeability” which is strictly about the ability to pay debt interest – although historically it has also been used loosely as a measure of whether the sector will be of interest to investors. However, with the 2035 grid decarbonisation challenge driving the need for significantly more investment this now has more focus. The problem is, as Ofgem acknowledges, it is not clear what “investability” means in practice. If it’s just about a higher cost of capital that will be a hard sell given the pressure to keep near-term consumer costs down. Navigating through this will be challenging in the short time available.

The second issue is the implication of declining gas demand which Sustainability First recently published a paper on (Looking through the FOG – the Future of Gas). It’s welcome that Ofgem have grasped the nettle of the risk of stranded assets and the implications for inter-generational equity – never an easy concept. As flagged in Utility Week when the SSMC came out, reducing asset lives so that declining numbers of future customers do not face escalating bills – and to avoid the risk of stranded assets – would, Ofgem estimate, add £43 a year to customer bills. To me, something like this feels a necessary step but it is a difficult one for Ofgem to take in the current climate with customers struggling (and with no sign of government stepping in to provide any sort of social tariff).

The longer term issues around decommissioning of the gas grid – which according to the Arup report for the National Infrastructure Commission could cost up to £25 billion – are also flagged but Ofgem is taking the view that this is not an issue for GD3. While that is right at one level – you can only start decommissioning once all customers on a part of the network have moved off, which won’t be in the GD3 timeframe – the scale of the challenge is so huge that it does need thinking about now. There is a brief reference to “decommissioning” under potential areas for innovation, which is part of the answer and which the Sustainability First paper highlights as a priority for GD3. We should be exploring now how best this could be done when the time comes – including options for repurposing which go beyond hydrogen/ CCUS etc.

The other related area that needs more thought and which Ofgem don’t pick up (although it was flagged by Arup and by Sustainability First) is around the costs of individual customer disconnections. If you install a heat pump and want to stop having a gas supply, the arrangements are pretty opaque. If you ask the gas network to remove the supply (and cap it at the mains), they will charge you an average of £1,450 today. If you just tell your supplier then there is generally no charge though some suppliers warn that GDNs may levy a charge subsequently. GDNs have an obligation to make that disused part of the network safe and it seems at present as if the remaining customers are picking up the tab through general network charges. That feels unfair but charging the departing customer isn’t ideal either as it would serve as a further deterrent to heat pump take-up. This is not essentially a RIIO issue but is an area that needs clarifying as we can certainly anticipate a significant uptick in the numbers of individual customers moving off gas through GD3.

This brings me back to the question of engagement. These are hugely important questions with the potential for bill impacts that will dwarf any other decisions in RIIO. But at present they are buried deep in the RIIO3 Finance Annex. They are also highly political questions that will be difficult to handle in an election year, with energy costs inevitably high on the agenda. For both these reasons it would have been good if Ofgem could have started some of these big debates earlier. But the priority now is that these need to be the focus of broader engagement – not left to network dominated working groups. Ofgem need to pull another rabbit from the hat.

Maxine Frerk, is former senior partner at Ofgem