Ofgem chief executive Jonathan Brearley has dismissed claims by network companies that its proposed cut to shareholders returns will slow progress toward net-zero emissions, saying they are only trying to squeeze more money out of the regulator.
“My job is to look at the evidence, to make sure we’ve made the right decision and then stand firm,” he told reporters in a media call this morning.
Brearley was responding to questions on the publication of the draft determinations for the RIIO2 price controls for gas and electricity transmission, gas distribution and the electricity system operators starting in April 2021. The price control for electricity distribution will begin two years later in 2023.
Ofgem announced it has approved £25 billion of upfront spending, disallowed more than £8 billion and identified a further £10 billion of expenditure that could be confirmed during the course of the price controls.
The regulator also revealed it currently expects the cost of equity to be set at 4.2 per cent in real terms based on the newly adopted CPIH inflation index. It intends to apply a further reduction of 25 basis points to reflect networks’ historical outperformance, giving an allowed return on equity of 3.95 per cent in real terms – a reduction of almost half when compared to the current price controls.
The decision elicited a sharp response from the network companies, in particular, from Scottish Power chief executive Keith Anderson, who said Ofgem’s approach was “gravely at odds with the UK government’s ambition to boost investment in green infrastructure to help drive the economic recovery and accelerate net zero”.
He added: “It’s a massive missed opportunity.
“Coming just one day after Rishi Sunak has taken welcome steps to kickstart the green recovery, Ofgem is now trying to slam on the brakes. It makes no sense whatsoever.”
Anderson said Brearley had “flunked” his first big test since becoming Ofgem chief executive at the start of the year: “Instead of investing more in creating green jobs and skilled apprenticeships in every community, at a time when the UK needs them most, this is a short-sighted return to austerity politics. Nobody benefits from this half-baked plan. It’s bad for jobs, bad for apprenticeships, bad for training and bad for the UK supply chain.”
He continued: “Net zero can be an accelerator of the economic recovery, but only if private companies are given the right conditions for investment. Slamming the door in investors’ faces by offering one of the lowest rates of return of any developed country traps the UK in an economic cul-de-sac.
“These proposals to drive companies to the lowest cost denominator leave us with big questions about how Ofgem can match its framework against the clear drive and leadership that we are seeing from government, at both UK and Scottish levels, where there is rightly a focus on how best to attract investment in a powerful economic stimulus that delivers long-term benefits.”
When asked this morning whether he believed Ofgem’s decision might lead investors to look to other countries or sectors for better returns, Brearley responded bluntly: “No, we don’t.”
“We’ve done extensive analysis into what is a fair balance between investors and part of that frankly is looking very practically at where the same investors are investing elsewhere,” he added.
“Even in our own energy regime, there are investors that are investing at these rates, and certainly across the UK in other sectors we are seeing investment coming forward at pace. Our job is to make sure that it does but it does so at a price that is fair to customers.”
Brearley continued: “We do extensive work on international financial markets that look at what investors will accept and that’s a fundamental part of our work. We’re confident with the evidence we have in front of us today that we’ve got that balance right and we expect the investment to flow.
“But, of course, at this stage of the process companies will be trying to say things to drive that number up, in part, because that’s their job for their shareholders. It’s our job to make sure there’s fair balance between what the shareholders get and what customers need to pay.”
Brearley said the proposals would allow investment to rise significantly whilst keeping customers’ bills roughly at the current level over the full five-five period: “We accept the system needs upgrading. We know there’s going to be a lot of change with the additional of electric vehicles and new forms of low carbon energy.
“Basically, as a result, we have said to companies that to allow us to do this in a way that is affordable to customers, more money should go to investment – more money should go towards to getting infrastructure in the grid – and that does mean that we change the balance that goes to shareholders.”
Here’s how others have responded:
David Smith, chief executive, Energy Networks Association
““While the proposals outlined today will take some time to review in detail, we are concerned that they don’t go far enough to encourage the investment needed to achieve net zero emissions and support the UK’s economic recovery. While network companies have historically been able to raise billions of pounds to invest in the networks and support the transition to a sustainable future at low cost to the customer, the proposals set out by Ofgem could significantly inhibit their ability to do so.
“Network companies listened to their customers and stakeholders and put forward plans informed and influenced by their extensive engagement through focus groups and events held around the country. The plans put forward by network companies would make this possible with little to no impact on the average energy bill.
“We need to attract significant investment in a competitive global market in order to reduce the UK’s carbon emissions, tackle the climate emergency and do so at least cost to customers. In the last few weeks, the Prime Minister and Chancellor have stated the need for much of this investment to be brought forward, delivering economic and societal benefits now as we recover from the pandemic.”
Gillian Guy, chief executive, Citizens Advice
“Today’s announcement is another step closer to a price control that stops network companies from overcharging energy customers by billions of pounds. These decisions are extremely technical, but they matter. Ofgem has struck the right balance between shareholder returns and value for money for energy customers, while making sure networks can continue to attract investment.
“Energy networks are key to meeting net zero, but future demands on the energy system are hard to predict. Decarbonising heat, electric vehicles and increased use of smart products in the home will pose different challenges. But measures outlined today should protect consumers by ensuring the transition to net zero is done at a lower cost.”
National Grid
“We are extremely disappointed with this draft determination which risks undermining the process established by Ofgem. This proposal leaves us concerned as to our ability to deliver resilient and reliable networks and jeopardises the delivery of the energy transition and the green recovery.
“Ahead of the final determinations which are expected in December, we will be pressing Ofgem to come forward with a regulatory framework that both incentivizes investment and protects consumers.”
Rob McDonald, managing director of transmission, Scottish and Southern Electricity Networks
“Whilst our stakeholder-endorsed and evidence-based business plan was in step with the government’s low carbon investment ambition, Ofgem’s first pass at a settlement resembles a worrying return to austerity. Ofgem’s draft determination is a barrier towards achieving net zero and damaging to the green economic recovery.
“At present the draft settlement does not strike the right balance for all stakeholders and without significant changes during the consultation period, there is a real risk that the critical investment in Britain’s electricity networks will be unnecessarily slowed down by an appeal process via the CMA, which is not in any stakeholders’ interests”.
Rebecca Williams, head of policy and regulation, Renewable UK
“These proposals won’t bring forward the investment that the government says it wants to kickstart a green economic recovery. That means fewer jobs and slower progress towards net zero. So it’s a missed opportunity by Ofgem to encourage investment in grid infrastructure and it means consumers would lose out as vital grid upgrades wouldn’t happen.
“However, we welcome Ofgem’s recognition of the importance of working with network companies to achieve net zero. Its proposals to build more flexibility into price controls by using a net zero “re-opener” mechanism to accommodate new technologies such as renewable hydrogen, as well as boosting innovation funding more widely, could unlock benefits for consumers.”
Jonathan Marshall, head of analysis, Energy and Climate Intelligence Unit
“Shifting focus to cutting carbon at the same time as keeping a lid on network profits is good news for hard-pushed families and for efforts to get the UK back on track to meet its climate targets. Ofgem appears to have listened to criticism that it hasn’t been pushing hard enough on environmental measures and has been giving the networks – which make up around a quarter of domestic bills – an easy ride.
“Until now there has been lots of talk on innovation from the network companies, but little action on the ground. Linking returns to carbon emissions will give them nowhere to hide, and should ensure that UK resources, such as a world-leading position in offshore wind, are bolstered by smart technologies needed to balance the grid at low cost.”