In a quiet month in terms of Ofgem consultations and decisions, one significant set of documents that may not naturally catch the eye was Ofgem’s guidance on impact assessments. Alongside the strategic narrative last year and the Decarbonisation Action Plan back in February this provides further detail on how Ofgem will weigh different considerations in taking its decisions.
How one views this guidance is a glass half-full or half-empty question. The strong emphasis that Ofgem is placing on assessing the distributional and environmental impacts of its decisions and on taking account of uncertainty are all obviously to be welcomed and go further than previous guidance has done.
However, there are weaknesses in the detail of what is proposed and there has been little debate leading up to publication. We have to hope therefore that its statement that it welcomes comments is a sign that it genuinely wants to engage on what are quite complex but far-reaching issues.
On distributional impacts Ofgem now distinguishes more clearly between those vulnerable groups that it has a statutory duty to consider (those on low incomes, the elderly, disabled and those in rural areas) and those it has placed increasing emphasis on over time as “consumers in vulnerable situations”. While that concept remains important, when it comes to quantification of impacts it rightly intends to focus on the more readily identifiable groups covered by its statutory duty.
It also ventures for the first time into applying Treasury Green Book equity weights on the gains and losses experienced by different groups. This recognises what we all know instinctively – that a £10 bill increase is more painful for someone on a low income than on a high one. It has also used the Centre for Sustainable Energy (CSE) to update work done previously on archetypes or pen portraits of different customers that can be used to test thinking around market developments – another welcome step that consumer groups had recommended.
Need for transparency
All this is positive but the risk is that it becomes a mechanistic tool that fails to provide the insights and transparency needed to inform policy making in what is a complex area. The data that Ofgem uses comes from a different source than its Typical Domestic Consumption values (used for example in the retail price cap formulae) making the numbers hard to reconcile. It has applied “equivalisation” adjustments to incomes and to energy consumption which has always been a somewhat contentious issue in fuel poverty circles and make it hard for people to understand what the impacts will be on the ground.
Another problem is the lack of information around the usage profiles of different customers which will be increasingly important with the rise of flexibility and time-of-use tariffs. Ofgem makes clear that as more granular data becomes available it will incorporate that into its impact assessments. We have to hope that behind the scenes Ofgem is stressing to BEIS the importance of it having access to such data.
Finally, there is a need to make the analysis more dynamic – looking not just at existing levels of electric vehicle ownership, for example, but at how they can be expected to change over time for different demographic groups.
A similar story applies on Ofgem’s approach to decarbonisation. The analytical framework itself is drawn from Treasury Green Book – which clearly has to be the right approach. Moreover, Ofgem acknowledges the weaknesses in the current carbon values, which have not been updated since the net-zero commitment was made – and therefore proposes where possible to incorporate sensitivity analysis for higher carbon values. It confirms it will evolve the approach to take account of the Committee on Climate Change’s sixth Carbon Budget. This is all positive.
However, what is not addressed in the guidance and is actually the harder part of any assessment is judging what the impact of its policies will be on the levels of renewable and low carbon generation. That was the battle ground in the Targeted Charging Review. These aren’t easy things to capture in guidance but acknowledgment of the need to work these questions through would help. Having a model of the commercial case for generators might be one way for Ofgem to strengthen its evidence in this space.
Assessing risk
Finally, on the third strand around handling uncertainty there is acknowledgement of the need to look at the impacts of decisions under different pathways, for example using the future energy scenarios. There is also acknowledgment of the challenges around assessing the impacts of increased competition or enabling actions to support flexibility for example. However, the main section on risk and uncertainty feels like it was written to answer a different question.
What matters for impact assessments is the tools that Ofgem will use to take account of the range of uncertainties that exist. Although not mentioned in the body of the document, the bibliography lists an Ofgem paper from 2012 looking at the option value of interruptible gas contracts which provides a model for the assessment of different options under uncertainty. What is unclear is whether that is a methodology that Ofgem would now endorse.
The whole question of how one handles investment under uncertainty is an active issue in the context of RIIO2 and one that Ofgem seems still to be grappling with. Given the uncertainties around the pace of the transition and the direction of travel on heat decarbonisation – now overlaid with the economic uncertainty created by Covid-19 – this is an important aspect of policy-making that requires more thought.
In conclusion then the Ofgem guidance is driving in the right direction but still has some way to go. Ofgem has invited comments and it must be hoped that it will be genuinely open to thoughts from others. However, ultimately the test is whether future impact assessments drive clearer thinking in Ofgem and are valuable to stakeholders seeking to engage in the policy process, or whether they are a tick box exercise to meet a statutory requirement. We wait to see.