The road to RIIO2
Ofgem should review the detail of the networks' regulatory framework, but not throw the baby out with the bath water, warns Maxine Frerk
Ofgem is due shortly to kick off the process for the second round of RIIO price controls covering electricity and gas transmission and gas distribution.
RIIO is the new price control regime for energy introduced after an extensive review known as RPI-x@20. RIIO itself stands for the idea that Revenue is based on Incentives for Innovation and Outputs.
This early phase of RIIO2 is vitally important as it will shape the nature of Ofgem’s approach to price controls for all the networks – including electricity distribution who aren’t formally in scope. Now is the time to engage.
While the initial open letter should be – as its name suggests – “open”, what it will reveal is whether Ofgem has a desire to fundamentally change its approach or to build on what exists.
It’s always tempting for someone new to come in and want to stamp their mark by developing a new regime and way of doing things – and superficially it can seem that there is large scope to do better.
But RIIO is actually one part of the regulatory regime that doesn’t need fundamental overhaul to cope with the challenges of the energy transition. My predecessors did a good job with the root and branch review that led to RIIO, anticipating the low carbon shift and the challenges it brings.
What Ofgem have done on price controls is seen as a role model internationally as all regulators look at how to encourage alternatives to investment in copper and drive a strong customer focus and greater innovation. I did a tour of the US last year talking to US regulators interested in this British export.
It also stood up well in the face of the twin appeals to the CMA (the Competition and Markets Authority) by Centrica and Northern Powergrid on RIIO ED1.
Of course that doesn’t mean that Ofgem has got everything right. There is still plenty of room for improvement – but it’s in the detail. The questions I would be asking are:
- Is 8 years too long in what we now recognise as an increasingly fast changing world?
- How do you encourage transmission and distribution integration if the controls are run separately on different timelines?
- Do customers get a fair share of any outperformance by the companies? (There’s a single simple parameter that affects this – the “sharing factor” – but it doesn’t get debated)
- Can indexation be used to avoid windfall gains (or losses) due to changes in real wage rates or the cost of equity (as Ofgem has already done on cost of debt)?
- How do you cope with the transmission companies where there is limited scope for benchmarking? Could users of the system play a greater role in determining what is required building on the model of constructive engagement used in airports for example?
- How do you cope with the risks of gas networks not being needed in a future of decarbonised heat? The idea of moving to shorter asset lives is a natural response but was shown in the RIIO-ED1 appeal to create new issues.
- How does Ofgem respond to the one substantive criticism by the CMA about the need for greater transparency on the basis for certain decisions so that other stakeholders such as suppliers and consumer groups can more readily engage? This can’t be seen as a negotiation behind closed doors with the companies.
So there is plenty there for the regulator to get its teeth into – but please don’t throw the baby out with the bath water. The essence of RIIO – the focus on incentives, innovation, outputs and greater consumer and stakeholder engagement – has been hugely successful. Ofgem should make clear in its open letter that the essence of RIIO is here to stay.