Regulators are increasingly out of touch with their sectors, according to this year’s survey. Nearly two-thirds (64 per cent) of CEOs across the utilities spectrum say their regulatory regime is not fit for purpose, up from 57 per cent last year.
The figure leaps to 100 per cent amongst energy retailers, energy generators and non-domestic water retailers, and to 75 per cent amongst domestic water wholesalers.
The two sectors with greater confidence in their regulators are gas networks (where 80 per cent believe they are fit for purpose) and power networks (71 per cent). As we said in the macro view section, regulation is seen as having the biggest impact on utilities sectors, so it is not surprising that opinions are strong.
Reasons adduced for lack of fitness for purpose included the following statements from CEOs (individual sectors undisclosed):
- “Water retail is almost designed to exclude new entrants”
- “The current regime is successful for cost, price and service discovery but it does not enable effective development and delivery of infrastructure and services to meet medium and long term strategic needs or enable multi-infrastructure challenges and opportunities to be identified or enabled”
- “Too intrusive, drives wrong behaviours, needs more radical approach”
- “Regulator doesn’t understand competition”
- “Address decentralisation”
- “Not focused on retailer needs, all about wholesalers”
- “Too much political interference and a lack of forward thinking about investment required to modernise the economy”
- “Eco obligations are out of date and impacting competitiveness and customer fairness”
- “Not sufficiently customer driven”
- “Short term focus”
- “There isn’t the flexibility to create a completely different strategy”
- “Too political, not objective, knee-jerk reactions”
In contrast, reasons given for fitness for purpose included the following statements from CEOs (individual sectors undisclosed):
- “Stability for the next few years is positive”
- “It has the right balance between customers and shareholder interests”
- “It encourages continuous improvement through investment, innovation and the deployment of improved practices”
- “Customers and investors benefit”
- “UK regulation is set up to deal well with the purposes we currently demand from it”
A number of the CEOs who spoke to Utility Week to comment on the findings had a certain sympathy with their regulators, on the basis that they are “damned if they do and damned if they don’t”.
David Bird, CEO of Co-op Energy, said: “It’s certainly not the job of the regulator to have suppliers feeling content – if we all thought Ofgem was great, then they are probably not doing the job properly”.
He adds, however: “I think regulatory frameworks will have to change soon to meet the challenges there are in the energy world. The regulator just needs to be more proactive, rather than reactive – they need to add value to consumers rather than just talk about price.”
Another energy CEO remarks of the findings: “It’s inevitably questioned by many because of the times we live in – the politicisation of the issue, the short-term focus – these things call regulation into question. And I also think that the survey results on regulation are so negative because a lot of those in the utility sector, who aren’t regulated don’t understand how regulation works. It’s worth reminding ourselves that the UK regulatory regime has been followed up the world over.
“As to the evolution of RIIO1 into RIIO2, no one is suggesting that we will be throwing out this model and establishing a completely new one. The RII02 parameters are likely to be tougher – targets and incentives might be different – but I don’t think it will have a big impact.”
Matthew Wright, managing director of Orsted, is concerned that regulatory change and policy is perceived to be impacting so much on the sector.” Naturally, I can understand that policy and regulation is important, but surely regulators themselves don’t want to top the list of sector concerns. Rather, they surely want to be seen as facilitating certain outcomes, such as customer focus. I’m sure regulators would prefer to see their role as not one of constraining and stifling businesses, but developing market competition and innovation.”
Obversely, Wright says that “energy companies expect too much from the regulator – they want certainty in a rapidly changing world but no regulator can provide that.”
Wright said he understood how difficult it is for the regulator to reconcile the needs of established energy companies with those of new entrants to the market. “From the incumbent’s perspective, too much change can be threatening to their business. But new entrants want more reforms and more quickly.
“In a market that is changing so rapidly – you can’t please all of the people all of the time. It’s a difficult job to reconcile those things. I think the regulator is doing the best it can in the face of enormous change in the sector.”
However, another CEO from the generation side, who prefers to be unnamed, was more critical, raising an issue that has been bubbling away for some time: “The question is whether the regulatory regime is adapting sufficiently quickly or is flexible enough to keep pace with the energy transition.
“Capacity market outcomes have revealed market distortions – some of which have been addressed, such as embedded benefits and lack of environmental standards for small-scale generators. More will need to be addressed through the EMR five-year review.
“Getting this right is critical to ensuring the availability of adequate flexible, baseload capacity plant to meet demand all year round. This is important, as the four-year-ahead capacity auctions will drive investment decisions in the future at a time when coal, older gas plant and aging nuclear will be coming off the system.
“Regulation has not kept pace with the growth in distributed connected generation and behind-the-meter generation when it comes to market transparency. Distinction in the regulatory arrangements between large generation plant that is connected to the transmission system and smaller distributed connected plant is becoming increasingly artificial.”
He adds: “Whilst it is important to retain cost reflective network charging arrangements, the ability to offer flexibility services to different buyers should rely on a consistent set of requirements in terms of information to the market. The price, volume, and location of each instructed MW should be visible to all market participants irrespective of size, technology and network that they are connected to. It is therefore important to ensure that market rules are applied consistently going forward to deliver effective competition and achieve the lowest cost energy system.
“We support the market framework – the energy wholesale, flexibility, and capacity markets. Competitive markets are central to delivering the most efficient and lowest overall cost energy system. Removal of commercial and regulatory distortions which impact outcomes from the energy, capacity and flexibility markets, as well as air quality regulations, is essential.
These markets should be technology neutral, identify their requirement in advance, and procure the same on a competitive basis. In other words, different technologies should be able to compete in all markets on a consistent basis, provided the technology in question can deliver the product needed and meets equivalent obligations. Investment is then based on how well technologies can compete in each of the markets. The framework is good, but market distortions are currently skewing signals to investors. They make it less attractive to invest in baseload capable gas plant which will continue to be needed to support a sustainable energy system in the future.”
Water wholesalers and regulation
PR19
Questioned about PR19, Ofwat’s price methodology proposals for the 2020-2025 regulatory period, water wholesaler CEOs were uniformly critical of every aspect of the proposals.
Asked if Ofwat’s proposal for reforming dividend policy are fair and proportionate, 25 per cent disagreed strongly and 50 per cent disagreed somewhat. The other 25 per cent have yet to make up their minds.
Asked if Ofwat’s structure for classifying company business plans provides a robust framework for incentivising high quality business planning and penalising low quality business planning for the next asset management plan (AMP) period, 50 per cent disagreed somewhat and 50 per cent reserved judgement.
Perhaps surprisingly, when asked if shareholders will accept lower rates of return over the upcoming AMP period, 75 per cent agreed somewhat and 25 per cent were neutral.
Colin Skellett, CEO of Wessex Water, does not think the regulatory regime is unfit for purpose but warns that the current direction of travel may present problems for the sector.
“We’ve seen regulation go from setting out a few high level performance standards that companies must meet into a more intrusive model, with almost 40 KPIs related to rewards and penalties. As it becomes more intrusive, there is a danger of there being unintended consequences.
“Working within the regulation regime is time consuming and expensive, but it’s there for a good reason – it’s there as a surrogate for competition and to drive a particular set of behaviours. However, I think we need real markets and less regulation. I think we should be driving down a different road – which is one where there is not so much regulation but more incentives to encourage and nurture competition. The question we need to be asking is, how do you have policy competition and markets that enable you to have less regulation? Ofwat fully understands the need to move in that direction, and the market for biosolids is a step in that direction,” he says, referring to the regulator’s approach to bringing competition into elements of the wholesale value chain.
Asked why water wholesalers feel so nervous about possible regulatory change, Skellett expresses surprise. “They may not like some of the answers, but there‘s a pretty clear steer in the direction. And I think Ofwat has tried hard to manage expectations.
“I’m also a little surprised that water companies are so concerned about PR19. Price reviews are likely to be challenging periods, but I think this process will be better than the last time. There has been a clear steer in terms of what was expected.”
Power networks and gas networks
RIIO-2
While RIIO1 may still feel fairly new, the first phase (T1 for transmission and GD1 for gas distribution networks) ends in 2021. The second phase, ED1, for power distribution networks, ends in 2023. Thinking for RIIO-T2 and RIIO-GD2 will feed into RIIO-ED2 two years later – and work on all three regulatory settlements is already well underway. CEOs in the power and gas sectors were asked about the RIIO2 price control framework and period, and views were largely aligned.
They were broadly supportive of Ofgem’s initial framework plans, scoring an average of 3 when asked if the plans appropriately reflect the changes and challenges facing UK energy networks.
However, they don’t believe their investors are willing to accept lower returns in the next price control period, registering an average score of 2.
Reversion to a five-year timescale was supported across the power and gas sectors, scoring an average of 3, with gas networks slightly less supportive at 2.8.
Aligning price controls for transmission and distribution drew some support, scoring an average of 2.8 amongst gas CEOs and 2.7 amongst power CEOs.
Ofgem’s suggested methodology for securing customer input into the business planning process was viewed as reasonably effective and appropriate – scoring an average of 3.2.
A similar response emerged to Ofgem’s plans for innovation support for networks in the next control price period: they were seen as reasonably appropriate, scoring an average of 3.1.
Ofgem’s position on network ownership of storage is broadly supported, with power networks scoring it 2.7 and gas networks 2.6.
Peter Emery, CEO of Electricity North West, certainly has a positive view of RIIO, seeing it as a force for improvement. “It allows us to succeed if we meet the required standards.”
He is confident that the same impact will be felt from the just-issued RIIO2 paper, saying: “There are no surprises – the direction of travel is clear. We are involved in the process and it has to have a positive outcome for investors, customers and the industry.”
He says that the regulator faces “a challenging prospect”. “ needs to keep costs down; and effect change in terms of decarbonisation. Our job is to respond to decarbonisation as quickly as we can and in a way that still allows us to attract UK and foreign investment, so the returns have to be at a level to do that.”
Steven Edwards, director of regulation and commercial, Wales & West Utilities (WWU), says: “The existing regulatory framework is flexible enough to allow competition but I’m worried that RIIO2 will be too narrowly focused.
“We need to make sure that RIIO2 builds on the success of what has been delivered in RIIO1 – lower bills and improved customer service. I’d also like to see incentives for trialing low carbon heat.”
Edwards said he was concerned about Ofgem’s call in June 2017 for voluntary contributions from network companies that were earning the highest returns for shareholders. “It’s not helpful when it starts asking for voluntary contributions. The frameworks were set up to encourage companies to make more money by innovating and becoming more efficient. The mechanisms exist already for Ofgem to take actions within the framework against networks that are not delivering. It is important that Ofgem acts with its regulatory commitments – that way companies know what the risks are they are taking on and are happy with the environment, which is ultimately better for consumers.”
John Morea, CEO of SGN, does not agree with the two-third of respondents who believe their regulatory regime is unfit for purpose. He says: “RIIO-GD1 has worked well to promote innovation and change in our industry and this has been for the benefit of everyone. It’s also helped bring down the network cost element of gas bills, deliver record customer satisfaction and improve safety.
“There are clearly opportunities to improve the regulatory regime, but I don’t see any evidence to support the complete re-write of the regulatory structures. It wouldn’t be in anyone’s interest, least of all customers.
“I do, however, see the need for long-term thinking for the next regulatory period which looks beyond political and regulatory cycles and puts in place a platform to allow investment and innovation to meet our 2050 targets, while delivering long-term value for money.
“Policy and regulatory decisions for RIIO-GD2 and for the long-term future of heat, will not only shape the industry for the next five years but out to and beyond 2050. This is why we need alignment between both policy and regulatory frameworks to avoid any higher cost (and unnecessary) decarbonisation pathway.”
Neither the gas or power network CEOs are happy with the policy and regulatory plans for tackling the decarbonisation of heat in the UK. Power CEOs are the more unhappy with the plans, with half of them saying they’re not at all satisfied, compared to 25 per cent of gas CEOs.
WWU’s Edwards, acknowledges that compared with the focus on renewable electricity, and its push on electric vehicles, the decarbonisation of heat, has been something of a government Cinderella. However, he also acknowledges the technological solutions are not straightforward. “Decarbonising heat is different to decarbonising electricity, it’s more complicated. Decarbonising heat will affect consumer homes and their appliances. For electrical appliances, it’s about putting a plug in the wall – it doesn’t matter whether the energy is generated by fossil fuels or renewables.”
The company is currently piloting a scheme involving the installation of 75 hybrid heating units and is measuring the usage and costs (known as Project Freedom).
SGN’s Morea picks up this theme, saying: “We do have today a sense of urgency to provide an effective platform for investment and innovation in areas such as biomethane and hydrogen, while retaining the ability to utilise and repurpose our existing gas network infrastructure. I do believe this approach is key to achieving all objectives.”
Those who spoke to us in the gas sector, were also growing in confidence that policy around gas decarbonisation would be forthcoming later in the year.
Explaining why gas chiefs are more accepting of their regulator, Morea says: “The gas networks were the first sector to move to an output-based regulatory regime in RIIO-GD1 and the regulatory structure has subsequently evolved through its application to the electricity and the water sectors. The RIIO framework was designed to encourage longer-term thinking, greater innovation, and more efficient delivery – all while putting customers at the heart of network companies’ plans.
“I believe RIIO-GD1 has broadly achieved these aims so far. Our investment has helped bring down bills, deliver record customer satisfaction and improved safety. It’s also brought about a network to support a sustainable future, through supporting the investment programme which in SGN alone sees around 1,000km a year of old metal pipes replaced with new plastic ones.
“Looking forward to the next price control period, my view is Ofgem’s current review of the framework – assessing performance under RIIO-GD1 and building on the lessons learnt where necessary – is the approach to best deliver the greatest customer benefits over time. A wholesale change, I believe, risks disrupting innovation and deterring investment.
“Our view is a recalibration of the existing structure will enable us to continue to support our customers’ needs while supporting innovation and investment in technologies such as hydrogen, biomethane, bioSNG and hybrid heat pumps. Having the right frameworks and policy in place will allow gas networks to develop, support and encourage the least cost, least disruptive energy solutions for the UK.
“Ofgem is consulting on RIIO-GD2 and as long as it’s given the strategic direction by government, it will be able to make decisions in the short-term, which will keep all 2050 options open, while providing enough certainty to ensure Britain’s gas network infrastructure maintains its international reputation as a top-tier investment opportunity.”