The debate over the next round of price controls for U.K. transmission companies was always going to be a heated one.
In July, Ofgem, the U.K.'s electricity and gas regulator, published its draft proposals for RIIO-2 — the price control framework for transmission networks in the period 2021-2026 — after lengthy consultations with the industry. The headline figure is a cap on equity returns of 3.95 percent. A separate framework for distribution networks is still in development.
That 3.95 percent figure is down from the real-world returns on equity across the three operators — National Grid, SSE and SP Energy Networks — of between 8 and 10 percent, according to data from Ofgem.
Ofgem insists the 3.95 percent cap is enough to attract investment to modernize the country's grid while also protecting consumers. But the proposals have been met with fierce opposition from the grid and gas network operators themselves. They claim such a low cap on equity returns will stall investment, put the country’s electrification agenda at risk and even reduce reliability across the network.
Ofgem’s price control framework, known as RIIO (that stands for "revenue = incentives + innovation + outputs"), will enter its second five-year period (RIIO-2) next year, covering both gas and electricity transmission.
The influential consumer rights group Citizens Advice publicly called out the operators for “raking in £7.5B in unjustified profits” during the first RIIO period.
Ofgem denies that political considerations are at play in the debate. But whatever its motivation for proposing the lower cap, there is a gulf between the draft plan and the companies charged with building much of the infrastructure required to transform the country’s energy landscape.
"Unfinanceable"
Ofgem insists that grid investments can continue under the conditions set out.
“The evidence makes clear that networks can attract investment at much lower rates of return,” an Ofgem spokesperson told GTM by email. “Given the uncertainties of the current economic climate and beyond, our stable, predictable and transparent regulatory regime makes British network companies an extremely attractive proposition for investors around the world.”
“There is strong evidence that investment continues without difficulty for similar returns to our proposals in the regulated U.K. water sector,” the spokesperson added.
But the grid operators disagree. Nicola Shaw, chair of National Grid’s electricity transmission business, signed a letter saying: “The impacts of these proposals are to create unnecessary delay and uncertainty to the delivery of projects supporting net-zero [carbon], perverse incentives to delay low carbon connections and avoidable regulatory burden and transaction costs."
“These consequences manifest as a material depletion in the ability to avoid power cuts in serious weather events, regional impacts associated with specific rejected investments, and higher costs in the future,” Shaw added in the letter to Ofgem, stating the company's position.
National Grid serves as the system operator in the U.K., while its transmission business holds the monopoly in England and Wales for transmission infrastructure and interconnectors to other countries.
Alistair Phillips-Davies, CEO of SSE, which runs the transmission network in northern Scotland, wrote in a blog post that a financial analyst had called the proposals “unfinanceable.”
“It’s absolutely right that Ofgem protects billpayers, but the cost of delaying critical investments will cause us to pay a much heavier price in years to come,” Phillips-Davies wrote.
Ofgem's proposal leaves the door open to reassessing the price control if extra net-zero investment is needed, for example in areas such as EV chargers. However, some in the industry fear this model could slow down progress and add extra layers of bureaucracy, compared to giving the grid operators access to greater revenue for reinvestment from the outset.
Two types of politics at work
RIIO-2 is not happening in a political vacuum. Ofgem has been criticized in the past for rising energy bills and the (very) delayed smart meter rollout. An annual industry poll of utility CEOs has routinely seen more than half claim that Ofgem is “not fit for purpose.”
The U.K.’s National Audit Office, a spending watchdog, said in January that Ofgem errors had resulted in billpayers being overcharged during RIIO’s first period.
At the same time, successive governments in the U.K. have targeted tough measures against the electricity sector as vote winners, be they suppliers or network firms. First, competition was opened up and the "Big 6" retail suppliers were cast as the villain. A price cap was introduced and recently lowered again. The price cap on consumer bills has been blamed, in part, for pushing new suppliers out of the market by limiting their returns.
One industry insider said the politics around Ofgem's price controls are less about party politics and voter-friendly attempts to cut bills and more about “Whitehall politics.” Boris Johnson’s government is looking to scale back the public sector. Those agencies considered to be underperforming or over-funded will be looking over their shoulder and keen to prove their relevance.
“[Ofgem] hasn’t listened to the customers,” the insider said, adding that the billpayers have demonstrated an interest in safety, reliability and net-zero carbon initiatives. “They’ve listened to a view that the network returns were too high in RIIO-1 and just decided to flex their muscles, and show that they are a 'tough regulator' by bringing in what many in the industry believe is a draconian level of return.”
Net-zero carbon is not an Ofgem objective
Other major infrastructure proposals, including road building and the expansion of Heathrow Airport, have seen the U.K.’s net-zero legislation used against them. After a long-running battle, Heathrow’s third runway was blocked by the courts after environmental groups said the climate impact had not been considered. Such an objection, on climate grounds, to RIIO-2 would be considered a desperate, last-ditch move. All involved parties would rather find an amicable resolution.
Until then, the network companies have threatened to refer the issue to the Competition and Markets Authority. The CMA would hear any formal appeal against the framework and can adjudicate over alleged errors in Ofgem's methodology.
One potential root cause of the standoff lies in Ofgem’s remit, which does not explicitly include helping the government reach its target of net-zero emissions by 2050, said Charlotte Hanson, an energy lawyer with ClientEarth.
“Given that Ofgem regulates the second-highest emitting sector of the U.K. economy, this massively impedes the country’s prospects for meeting its targets," Hanson wrote in an email.
“Through its recent decisions, we’re seeing that Ofgem is failing to build the framework for a decarbonized energy system. This is exactly why we need reform of the objectives that govern the regulator. Without that, how can this country credibly be fighting to meet its climate targets?”
