Northern Powergrid is alone among the DNOs in appealing against its final determination from Ofgem for the RIIO-ED2 price control. Maxine Frerk, former senior partner at the regulator, explores the technicalities behind the challenge, the company’s chances of winning and what the result could mean for other networks.
It had seemed as if the changes that Ofgem made between draft and final determinations (plus a few further corrections made after final determinations) would be enough to deter companies from appealing. On the big issues such as cost of capital and the efficiency challenge Ofgem used the same figures in ED2 that had been supported by the CMA previously, further reducing the prospects for an appeal.
However, Northern Powergrid which had been alone among the DNOs in appealing against ED1, clearly felt driven to try its hand again.
The appeal is on a relatively technical question around cost allocation. One of the features of ED2 was the huge uncertainty that exists around the level of take-up of electric vehicles, heat pumps, batteries etc – and hence the level of investment that will be needed in the local networks over the next five years. Ofgem left it to the companies to decide what assumptions to make and then at the eleventh hour realised that it couldn’t actually benchmark the companies without picking a central scenario to do the analysis around. At draft determinations it therefore based its analysis on the lowest cost scenario consistent with net zero (which was the ESO’s System Transformation scenario that has more reliance on hydrogen and less on electrification). As the companies had all put in their plans based around different scenarios Ofgem then had to adjust the costs in the companies’ plans to align with that chosen scenario.
Northern Powergrid’s appeal isn’t about this process per se – it’s a long way from ideal but could easily be defended by Ofgem as regulatory discretion. Northern Powergrid’s issue is with how Ofgem did that adjustment and in particular how it then allocated the reduced total costs between different cost categories. This is important because the other feature of ED2 is the heavy reliance being placed on uncertainty mechanisms / volume drivers to adjust the cost allowances through the course of the price control depending on, for example, the levels of demand growth that actually materialises. In doing this allocation Ofgem used a 50-50 mix of the original cost breakdown from the company plans and the cost breakdown from Ofgem’s own modelling.
The problem for Northern Powergrid is that its plan, which was based on a high level of electrification, included a high level of load-related expenditure. If that same proportion of load-related expenditure is assumed in the scaled back total costs and is then stripped out into an uncertainty mechanism Northern Powergrid gets left with a lower baseline allowance than it should.
Ofgem accepted this point to some degree and moved from using 100% company cost allocations at draft determination to the 50-50 approach at final determination. Northern Powergrid argues that this is a question of principle not degree. Ofgem will no doubt argue, as it did at final determination, that the alternative to its own model is not perfect either, that the 50-50 approach is therefore a reasonable compromise and that this a point of regulatory discretion.
In my view Northern Powergrid has a point but Ofgem will probably win. But let’s see.
For Northern Powergrid the motivation seems to be in part about money – the cost allocation is worth £157 million – but also pride. The second strand of their appeal is that as a result of the approach Ofgem has taken it was not awarded a Business Plan Incentive. On other metrics of efficiency which Ofgem uses Northern Powergrid (Yorkshire) was judged second most efficient with two of UK Power Networks’ licence areas coming first and third. The two UKPN areas then secured a BPI reward and Northern Powergrid didn’t. This feels like it’s a matter of pride for Phil Jones rather than a real concern about the £15 million reward.
The next step is for Ofgem to make a submission as to whether the appeal should be allowed (and it will no doubt say it shouldn’t be). The CMA will then have to decide whether to allow the appeal (and will almost certainly say it does). There’s then a six-month process of submissions and hearings.
One other question is what interest the other DNOs take in the appeal. At ED1 all the DNOs ended up heavily involved in part because there was a parallel appeal by Centrica that would have directly impacted their allowed revenues. However, in this case the outcome has no direct bearing on the other DNOs so I would expect them to watch quietly from the sidelines (unless UKPN pride leads them to want to defend their BPI reward!).
Given concerns about the costs of these appeals – including the impact on an already stretched Ofgem team – minimising the number of interveners and keeping the process as streamlined as possible would be a good thing.
The subject matter of this appeal is very much a technical question down in the detail of the price control cost models. However, how it is approached remains of interest given that the appeals regime itself is one of the topics that government has said it will be looking at as part of its Review of Economic Regulation. In its original paper government said it was looking at moving water (where there is a full re-hearing) onto the energy appeals model. However, the energy model is not without its faults. In my view what is required is a hybrid. Or does that sound too much like the 50-50 approach that Ofgem proposed for its cost models?