Ofgem’s senior partner for networks, Jonathan Brearley, looked out over the banks of the Rubicon – and thought better of it.
This week’s announcement that there will be no mid-period review of RIIO-ED1 for power networks shows Ofgem listened carefully when networks and their investors warned that to change the financial terms of the regulatory settlement halfway through the period would be disastrous for investor confidence and hence the cost of capital.
Indeed, Ofgem even put a number on it – a change to the terms now could put an extra £3.1 billion on the cost of capital in the next regulatory period. That’s a sobering thought for any regulator. A cut to network returns would certainly play well in the media – but not at the expense of higher bills in just a few years’ time.
So why the false alarm? Perhaps Ofgem was testing the market with its now notorious option three – the option of the mid-period review consultation that raised the prospect of reviewing “financial and incentive performance and design”. If so, it may have been shaken by the strength of reaction from investors.
Numbers don’t lie, and as Western Power Distribution’s (WPD) chief executive Robert Symons told Utility Week earlier this year, the very prospect of the mid-period change wiped one-fifth off the share price of the network’s parent company in the US. There will have been numerous private conversations in a similar vein between networks, investors, and Ofgem’s chairman David Gray, chief executive Dermot Nolan and Brearley.
Ofgem may also have been showing its strength. Certainly, the prospect of a mandatory change to the regulatory settlement may have been on networks’ minds as they agreed a number of voluntary returns. WPD has agreed to return £77 million relating to changes to the government’s rail electrification programme, bringing the total voluntary returns by gas and power transmission and distribution networks over the RIIO1 settlement to more than £700 million. Ofgem also retains the option of clawing back allowance underspends at the end of the price control period.
It was a wise move on Ofgem’s part to stand down, and one that will serve the regulator well as it moves on to the next battle: the cost of capital in RIIO2. Investors will look more kindly on a lower – even a much lower – cost of capital, if they can be confident in the integrity of the regulatory deal. As of this week, they can be.