Ofgem has “learned some valuable lessons” in the first RIIO-determined price control periods, it has admitted, as it opened a consultation on toughening up the regime for its next application from 2021.
The RIIO methodology for setting prices was intended to drive innovation and reward companies for exceptional performance. Instead, the regulator said, “Returns across companies have been higher than we expected and do not reflect the low level of risk these companies face.” The regulator also admitted that it needs mechanisms to “correct the price control” when early assumptions do not play out as expected. Otherwise, “when things change, companies can earn additional profits when these turn out in their favour.”
It promised changes that would cut costs for consumers by £5 billion – £15-25 per year for each household – and ensure gas and electricity network companies could not continue making ‘double digit’ returns on extremely stable assets.
It promised to crack down on company financing, including reassessing companies’ tax arrangements. It will push down the allowed cost of equity range (the amount network companies pay their shareholders) to between 3% and 5% (if applied today). The cost of debt, which is currently adjusted on a rolling average, will also be tightened. But it considered ‘backstop’ arrangements such as a ‘floor’ revenue level to ensure company financeability was maintained.
The regulator plans to ensure networks are driven by consumers. It will set up both consumer engagement groups that will embed customer priorities in companies’ business plans, and a ‘challenge group’ to drive further improvements. It wants to maintain incentives for innovation, but it will be stricter on how companies benefit from incentives. It has to making sure that companies only benefit from their own innovation – not because other issues, such as lower labour costs or a slower renewables rollout, have improved their returns.
In addition, networks will face more competition. Ofgem has revived plans for competition to own and operate network assets, which it previously signalled alongside specific plans for transmission network assets (dubbed CATOs). Legislation to enable the CATO regime has been delayed but Ofgem has pressed on with an interim arrangement for transmission assets. Alongside this the regulator promised to open the door for ‘early stage’ competitions that would invite new solutions to network problems. That could include demand reduction as an alternative to reinforcement: the regulator also promised to consider the role network companies could play in driving energy efficiency.
The revised RIIO framework will be applied to the gas and electricity networks at both transmission and distribution level. It will return to five years but networks may be able to argue for individual allowances to be set for longer. It will also apply to the new System Operator, being spun out of National Grid, as Ofgem said it planned to separate the price review for that body from the one for National Grid’s electricity transmission business.
The consultation closes on 2 May