Why network price controls need a Haggle Hero

Reviewing the latest set of business plans submitted by the United Kingdom’s electricity distribution network operators for the RIIO-ED1 price control, I was reminded of a MoneySuperMarket.Com advertisement featuring a ‘Haggle Hero’ played by Omid Djalili. Chris Alexander, policy manager at Citizens Advice, writes.

It goes like this:

Woman on phone at work: It’s just very expensive, but I suppose if that’s your best quote than I…’

Haggle Hero: (interrupting) ‘No, no, no you people can’t haggle for toffee, give me that!’ (snatches phone from woman)

Woman: (taken aback, hands over phone)

Haggle Hero: (yelling down phone line) ‘It’s a hatchback not a limousine, she’s not paying for that, you’re having a laugh!   

Haggle Hero: (covering phone and speaking to woman) ‘You don’t have to worry about hurting his feelings, he’s a professional’.

It’s easy to lose sight of what is at stake in regulatory prices control processes like RIIO-ED1. These negotiations between the companies and the regulator, in this case Ofgem, take place over years, and involve thousands of pages of documents going back and forward between them. For example, UKPN’s business plan consists of nearly two hundred separate documents – that’s right documents, not pages. Packed with a dizzying array of financial and engineering calculations, models, and forecasts, networks’ business plans are virtually impenetrable to the lay reader.   

But at its heart, this is no different than the interaction between buyer and seller for the hatchback in the advertisement. So as we near the end of the two year negotiation between Ofgem and the networks over the terms of the RIIO-ED1 price control, it’s the right time to ask a couple of simple questions. Are we being offered the product or service we need? Is the price fair?

What would the Haggle Hero make of the latest set of business plans submitted by networks? How confident would he be of us extracting a good deal from the networks? Or are we being sold a hatchback for limousine prices?  

The networks’ marketing pitch is clear: consumers stand to benefit both in prices and quality of service during the eight years from 2015 of the RIIO-ED1 price control. They promise to make big new investments in their assets, not only to cater for load growth and deliver improvements in reliability and safety, but also to make the network ‘smarter’. They also commit to meet tighter interruption standards, pay more compensation when they breach them, and better support vulnerable customers.

But the clincher is price. Most offer to reduce prices compared to the last regulatory period, DPCR-5, that ran 2010-2015. Energy North West Limited’s (ENWL) offer is representative:

“We are reducing our average prices by 16% compared to DPCR5, delivering the benefits of RIIO-ED1 early by not having to increase our prices for domestic customers in 2014-15 and kick-starting RIIO-ED1 with a price reduction of 18% in 2015-16.”

A great deal – right? The first thing Haggle Hero would look at is the process of RIIO-ED1: how well have we haggled?

Although the key interaction for RIIO-ED1 is a bilateral one between Ofgem and the networks, the extent to which there is broader public engagement in the process will influence the outcome. Unfortunately, price control processes tend to fly under the radar, and RIIO-ED1 has been no exception.

It is remarkable that with energy pricing one of the most prominent issues in the current political environment, a process that will lock in tens of billions of pounds of investment and costs over the eight years 2015-2023 has received so little public attention.  

But this shouldn’t surprise us. It’s a feature of our disaggregated energy system, where generation, transmission, distribution and supply operate as separate businesses, that public commentary tends to focus on the last link in the chain, the suppliers, who have the direct relationship with consumers.

The absence of media coverage of the process wouldn’t necessarily be a problem if there was strong engagement by other individual consumers and organisations in the process. But this is mixed at best. Only two suppliers responded to the Energy and Climate Change Committee’s recent call for evidence on network costs.  What explains the disinterest of the others?  For those that also own networks perhaps it’s driven by a desire to avoid squeezing the prospects of sister companies.  For others, it may be because inflation or deflation in network charges affects all suppliers in similar ways.  But at least in part it’s plausible that it’s because the network price controls are as impenetrable to suppliers as they are to other stakeholders. And Ofgem’s latest call for input on the networks business plans only yielded 16 submissions.  Because of the length and complexity of the plans it’s a real challenge for interested parties, even if they are motivated to try and engage with the process, to get to grips with the true character of the business plans.  

The networks will argue, and not without some justification, that they have gone to great lengths to present their business plans in a way that describes the key features in a clear and straightforward way. Each now have glossy websites dedicated to the business plans, often with clever animations depicting spinning wind turbines and moving trains to try and tempt readers in.

I’m not suggesting this is a bad thing – if it stimulates engagement then we should be all for it. But when the networks continue to bury critical information about consumer impacts in the dark recesses of their plans, or present it prominently but in a way that can give the wrong impression of what it really means, you can’t help but be a little cynical.   

Missing from the executive summaries of the plans is a clear explanation of the impact of the new depreciation rules Ofgem has introduced for RIIO-ED1. Because networks can now recoup their costs over 45 years rather than the former 25 years, it means prices can be cut in the short term, but only at the expense of higher prices later. So a big part of the decline in prices that the networks are offering isn’t the result of a dramatic improvement in their efficiency, it’s an incident of an accounting change.     

But our biggest gripe is the lack of clarity on the total revenue the networks will collect over the life of RIIO-ED1. While much of the discussion about returns centres on the 6.0 per cent allowed rate of return on equity set by Ofgem, if the various incentives that are available to the networks are added to the pot, this number could double. Now to be fair, the networks are also subject to penalties as well that could mean they earn less than the 6.0 per cent central reference point. But what you don’t get from the business plans is a sense of the probability distribution of these returns. If the curve is skewed towards the upper end of returns – if 6 per cent isn’t the real midpoint – then this needs to be made absolutely clear to consumers.

There’s no way Haggle Hero would let us sign off on RIIO-ED1 until the networks answer these questions.

And neither should Ofgem.