Shake-up of ‘short-termist’ regulatory regime proposed

Regulators should be equipped with new powers to ensure utilities invest in sustainable infrastructure and a tougher price control regime introduced for monopoly companies, the National Infrastructure Commission (NIC) has concluded.

The commission, which was tasked by ex-chancellor of the exchequer Phillip Hammond to undertake a review of utilities regulation just over a year ago, has produced its report outlining a series of recommendations.

Entitled Strategic Investment and Public Confidence, it warns that the UK will not hit its 2050 net-zero target unless regulators are equipped with new powers to boost investment in sustainable infrastructure.

The report concludes that while the current model has mostly achieved what it was set up to do, such as encouraging investment and better performance, it has created a culture of “short-termism”.

The commission’s recommendations include new duties for the regulators, including Ofgem and Ofwat, to ensure that their decisions promote the achievement of net zero and improve the resilience of the UK’s infrastructure.

It says Ofgem and Ofwat should split out ‘strategic enhancements’ to the networks they regulate from the “standard” periodic price control, which should be focused on “maintenance of existing networks and marginal” upgrades.

The report also recommends changes to the price control regime governing energy networks and water companies.

It proposes that regulators should evaluate the case for an absolute cap on natural monopoly companies’ gearing levels.

And where gearing levels are above 70 per cent, regulators should also ensure that benefits from financial outperformance are shared with consumers, as in the new system being introduced under Ofwat’s 2019 price review methodology.

When assessing the weighted average cost of capital and total expenditure allowances during price reviews, regulators should account for mismatches in information between consumers and companies, which are ‘likely to be biased’ in favour of the latter.

The NIC also says regulators should ensure that executive salaries in firms with a natural monopoly, such as energy networks and water companies, are “demonstrably linked” to long-term performance for consumers.

It recommends that the UK Regulators Network should appoint an independent chair to “promote collaboration and co-ordination”.

But, the report stops short of recommending that the existing system for regulating the utilities, which has been in place since privatisation, should be scrapped.

Sir John Armitt, chair of the NIC, said: “The government has committed the UK to net zero by 2050, but if regulators aren’t equipped with a new duty to specifically reach this target, then it is simply unattainable.

“The regulatory system must adapt to meet the demands of the future – and the great challenge we face to bring down emissions and build resilience against increasingly frequent extreme weather.

“This will place unfamiliar demands on regulation and it will need to respond in ways it has never had to before.

“The commission does not believe wholesale change would deliver better outcomes than strengthening the existing model. The whole system does not need to be redesigned. But it needs to be updated to achieve a well-regulated market economy which can respond to the coming challenges.”

Responding to the report, David Smith, chief executive of Energy Networks Association, said the commission’s push for a new regulatory focus on sustainability is a “major step forward” in reaching the UK’s net zero target.

He said: “By providing greater certainty, the duty will help deliver access to Britain’s world-leading, innovative energy network infrastructure for more renewable energy projects, more clean transport and new types of low carbon heating. It will help ensure that our country takes the smartest, most innovative and fairest approach to delivering decarbonisation.”

Rebecca Williams, head of policy and regulation at RenewableUK, said: “Ofgem is not currently delivering on what is needed to meet out climate change goals, so we welcome the recommendation that it should have new duties to promote the UK’s legally-binding net zero emissions target.

“This will help to ensure that the renewable energy sector can attract the investment needed to build a low-carbon energy system as swiftly and as cheaply as possible for consumers.”

Dr Jonathan Marshall, head of analysis at the Energy and Climate Intelligence Unit, said: “Ensuring that decisions made by Ofgem are seen through the lens of decarbonisation is essential and will stop innovation and technological advancement being held back in the UK, to the detriment of both British businesses and British bill payers.

“Recent years have seen decisions to damage the economics of small scale and renewable generation, tardy progress on rules that allow batteries to operate on an even playing field, and uncertainty around technologies such as demand side response, all of which are set to be vital as an increasing proportion of the UK economy is run on low-cost and low-carbon energy. Shifting Ofgem’s focus onto facilitating the energy transition should see more joined up thinking on such issues.”