Consumers are paying over the odds for energy networks, with their exposure to excess charges determined by a “postcode lottery”, Citizens Advice has claimed in a report.
Following Ofgem’s pledge to rein in profits during future price controls, the charity has urged the regulator to “hold its nerve” as it comes up against “strong and sustained” resistance from network operators.
Analysis published by Citizens Advice last year concluded network companies are set to receive £7.5 billion of “unjustified profits” over the current RIIO price controls. This equates to an average of £285 per household.
However, further research has highlighted regional disparities in consumers’ contributions towards these “missing billions”.
A new report by the charity has found households in South West England will bear the greatest burden (£315), whilst those in the south of Scotland will be least affected (£225).
Excess profit per household by region
Source: Citizens Advice
The report says these disparities are the result of regional differences in network charging, which are present for a reason: “It costs more to build energy infrastructure and transport energy in some parts of the country than others. Making bills reflect these differences in cost can improve efficiency and encourage better investment decisions.”
“But,” it adds, “the excessive profits we’ve identified are not reflective of the underlying network costs – it’s money that consumers shouldn’t be paying in the first place.
“This is a regional inequality that we could fix without any cost to the overall economic efficiency of energy networks.”
Citizens Advice chief executive Gillian Guy said: “People across the country are overpaying on their energy bills, because some network companies are making unjustified profits.
“Ofgem has signalled its intention to deliver a tougher settlement on the network companies and a better deal for consumers. The regulator will undoubtedly face strong and sustained opposition as the networks try to protect the status quo.
“Ofgem must hold its nerve and make sure that the next price control delivers much better value for consumers.”
Over the past year, National Grid Electricity Transmission, Cadent, Scottish and Southern Electricity Networks and SGN have all voluntarily relinquished part of their spending allowances. Citizens Advice said the other networks should follow their lead.
If they don’t, the government should step in and implement a mandatory rebate through legislation.
The charity also recommended a series of reforms to the RIIO framework to prevent networks from receiving further unjustified profits during the second round of price controls.
These include: indexing costs to real-world benchmarks; lowering the equity beta, a measure of financial risk that influences returns; and toughening up the incentive regime by introducing penalties for poor performers.
The response from networks
The Energy Networks Association (ENA) has hit back at the new report, saying both it and the original analysis from which it is derived are “flawed”.
“The calculations underpinning this analysis are plucked out of thin air and run directly counter to the conclusions of the independent regulator and the Competition and Markets Authority,” said a spokesman.
“Network costs are down 17 per cent under the current ownership model, delivering £9 billion of savings for consumers by running a world-class system of energy networks more efficiently”.
The original report by Citizens Advice argued errors in forecasting capital costs will cost consumers £3 billion over the current price controls. It said indexation should be introduced for the risk-free rate – one half of the equity beta – and the cost of debt index should be made more responsive to changes in financial markets.
The ENA said the Competition and Markets Authority has already ruled that Ofgem’s method for assessing the cost of debt is not overly generous, as Citizens Advice claims. It criticised the charity’s proposal to introduce indexation for the risk-free rate but not the second half of the equity beta – the risk premium. The trade body said a reduction in the former is usually accompanied by a rise in the latter.
Regardless of forecasting errors, the report said Ofgem had overestimated the capital risks for networks and set the equity beta too high, costing consumers a further £3 billion. Citizens Advice called for the equity beta to be brought in line with those for other utilities such as water companies.
But, the ENA believes it is a mistake to view energy networks as presenting the same risks to investors as water companies. They face a much greater degree of uncertainty due to the transformation of the energy system and investors should be compensated accordingly.
Lastly, the report from Citizens Advice said excessive spending allowances and incentives had cost consumers £1.1 billion and petitioned Ofgem to introduce penalties for poor performers against targets.
The ENA disputed the charity’s suggestion that networks may have submitted inflated costs in their business plans, arguing the underspends they are forecast to achieve against their allowances reflect improvements in efficiency. The association said introducing penalties as well as rewards would increase the risk to returns, undermining the argument that networks are a low-risk investment.
Ofgem launched a consultation on the second round of RIIO price controls at the beginning of March. The deadline for responses in 2 May.