‘Skewed’ incentives will leave networks scared to take risks

National Grid has warned that incentive arrangements “skewed” towards penalties will make networks overly cautious and averse to taking any risks.

Chief financial officer Andy Agg made the comments on a call with investors covering the company’s response to Ofgem’s draft determinations for the RIIO2 price controls beginning in April 2021.

As well as reiterating the group’s well-known concerns over the drastically reduced baseline rates of return being offered to networks, Agg also complained that this level would be very difficult to achieve, with the “limited rewards” on offer giving little room to make up any shortfall.

“Whilst we believe allowed returns are inadequate relative to the risk we undertake and compared to comparable industries elsewhere, we are also concerned about our ability to achieve these baseline returns,” he told investors.

“Incentive arrangements are of very low value, and coupled with the cumulative impact of excessive efficiencies, clawbacks, penalties and the outperformance wedge, we would likely start the RIIO2 period with a substantial gap to the allowed return.”

He continued: “On incentives, the draft determination proposes a package for electricity transmission that is skewed towards penalties and ex-post clawback and away from incentives to deliver for consumers.

“This matters for consumers because it strongly encourages us to focus on low-risk cautious investments to avoid penalties and discourages us from innovating and seeking efficiencies given we would not be rewarded for the risk we were taking.”

Agg noted that despite their “complex capital programmes” and the “inherent uncertainty arising from the energy transition”, the incentives on offer to networks are significantly weaker than those available to water companies following the PR19 price review.

Output/outcome delivery incentives for the energy and water sectors

Source: National Grid. Figures by Ofwat, KPMG and National Grid Electricity Transmission (NGET) 

“Not only is energy incentivised much less than water, but electricity transmission is incentivised less than either gas transmission or gas distribution,” he added. “In fact, we see six more times downside risk than upside opportunity in the proposed arrangements.

“Consequently, the skewing of incentives towards penalties, together with Ofgem’s steep efficiency challenges, means it will be very difficult for electricity transmission and gas transmission to meet the allowed return.”