Ofgem’s strict approach to the next price control for energy networks could deter investment in the energy transition and lead to potential backers looking abroad for opportunities instead.
This was the view of panellists on Utility Week’s latest #AskUsAnything show, who also said Ofgem’s stance was at odds with the government’s desire to encourage investment in a swathe of infrastructure projects as part of the economic recovery.
The regulator released its RIIO2 draft determinations for gas/electricity transmission and gas distribution companies as well as the electricity system operator yesterday (9 July). It proposed £8 billion of expenditure being disallowed while the allowed return on equity would be almost halved, to 3.95 per cent in real terms.
Dominic Nash, Barclays’ head of European utilities research, said it was still unclear whether Ofgem would be willing, or forced, to find compromises.
He said that in conversations with investors there had been a sense that the current situation was a throwback to the adversarial regulatory approach of 15 years ago – when it felt like “going through a game”.
He added: “The same investors are also asking – what if it isn’t a game this time? This might be Ofgem’s absolute position.”
He added that investors were now watching even more keenly for the decision of the Competition & Markets Authority on the cost of capital in the water sector, as part of its investigation into PR19 appeals.
Peter Antolik, of Arjun Infrastructure Partners, said that if risk was not going to be rewarded, innovation would suffer.
He said: “The returns regulators are offering are fine for day-to-day investments but if you really want companies to start to employ greater amounts of innovation, they want to know that they will have access to either certainty of funding or greater rewards for taking those risks.”
On the apparent contradiction between the messages from government and regulator, he said: “On the one hand, the government seems to want to encourage investors in, to transform the networks for the future. But then the regulator seems to be putting a brake on it because it wants to achieve a cut in bills, which doesn’t seem to match the mood music from the government.
“Investors really sense that there’s a difference in perspective between what government is saying in terms of encouraging investors and what regulators are doing in terms of actually allowing legitimate costs and legitimate expenditure and giving a reasonable return on those investments.”
His point was supported Lawrence Slade, chief executive of the Global Infrastructure Investor Association, who said there was a “curious dichotomy between where the long-term ambition of the UK government should be versus the actions of the regulator”.
He added: “I’ve never seen such a strength of response from regulated companies. I think that shows the difference in Ofgem’s response from what companies were expecting.”
All three pointed out that while investors still see the UK utilities sector as attractive, better returns are available elsewhere.
Nash said that if there is no movement from the regulator “you are going to see a natural reaction of why am I going to be making 6 per cent nominal returns in the UK when I can make 9 per cent in the US or 10 per cent in Italy”.
He added: “I think you’re going to see a natural reticence to invest in this energy transition unless you get that incentive in place.”
Slade said: “We are talking about two decades of massive disruption across every aspect of the energy sector and indeed across the country. There is a significant amount of uncertainty and therefore increased risk and Ofgem haven’t taken that into account.”