Network operators have defended the RIIO framework from criticism over excessive profits, saying the price controls have driven a marked improvement in performance since their introduction in 2013.
However, they also called for tweaks to the regulatory regime to sharpen financial incentives and account for uncertainty.
The comments came during a discussion of the second round of RIIO price controls at Utility Week Live at the NEC in Birmingham.
“If you were a customer of ours in 2010 you’d be interrupted on average once every one and a half years,” said UK Power Networks (UKPN) director of strategy Suleman Alli. “That’s now once every two and a half years.
“In 2010, if you had the misfortune of having a power cut it would last over an hour. It’s now half an hour.”
Alli said this improvement is the result of the regulatory framework and its focus on operational performance: “It’s made that performance absolutely transparent and comparable between companies, and it’s given management the tools and the incentives to absolutely nail it.”
He recounted how, when joining UKPN, he had met with an engineer to discuss the introduction of a new self-healing grid technology called APRS – short for automatic power restoration system.
“As an engineer, he opened up his spreadsheet and showed me what our customer minutes lost would have been under the old system, what it is now as a result of the investments we’ve made given the incentive frameworks of RIIO, and most importantly for an engineer showed me how much incentive revenue we’d earned as a business.
“That, ladies and gentlemen, is the power of incentive-based regulation… And we should not lose sight of that.”
Wales and West Utilities director of regulation, Steven Edwards, concurred, saying networks have changed “massively for the better” since RIIO came into effect. He said the best scoring networks at the beginning of the price controls would now rank lowest if judged by the same performance.
Excessive profits
However, Alli also said that networks need to tackle “head-on” the criticisms which have been lodged against RIIO, whether “perceived or real”.
In July last year, Citizens Advice released a report claiming that energy networks were on course to earn £7.5 billion of “unjustified profits” over the current price controls. The findings were disputed by the Energy Networks Association.
Nevertheless, a cross-party group of MPs wrote a letter to the head of Ofgem in January urging the regulator to bring electricity network profits under “tighter control”.
Reacting in parliament, business and energy secretary Greg Clark agreed. He told lead signatory John Penrose that distribution network operators had grown “fat and lazy” at the expense of customers.
In March, Ofgem published a consultation on its plans for the RIIO2 price controls. It included proposals to cut the length of the price controls from eight years to five, drastically reduce of the cost of equity and alter the way it calculates the cost of debt.
The response from networks
Speaking at Utility Week Live, Alli implied that financial incentives should be sharpened to exert greater competitive pressure on networks and penalise those that underperform: “If a company is high-performing and deliver what its customers want, it should be able to deliver higher than average returns.
“Conversely, in a competitive market, if you don’t deliver what your customers want you go out of business. So, we need to think what that means for a regulated monopoly.
“Do we want regulated networks to go out of business? Or should we say actually, you can earn enough to service your debt and no more?”
Edwards was more explicit: “Some returns are too high. I think some networks are earning their returns… where they are showing exemplar performance.
“What we need to make sure is that RIIO2 addresses the networks that are not delivering and not earning those returns.”
Alli also called for greater use of uncertainty mechanisms and cost indexation to prevent networks resting on their laurels or profiting from developments outside their control.
“I think it’s impossible to know when you set targets eight years in advance or five years in advance what the performance is going to be,” he explained. “I think we can offer very practical solutions on that.
“Reset the targets within-period based on the revealed performance. It encourages management to go even further to earn the incentives, as long as powerful incentives exist.”
Again, Edwards agreed: “If there are things that are very hard to forecast, like for example real price effects, we think they should be indexed.”
He said the cost of debt, however, should not be indexed as it is currently. Debt costs, he argued, should instead be passed straight through to consumers: “When you have an average index there will be windfall gains and there will be windfall loses”.
Edwards said the impact on individual networks was dependent on when exactly they needed to raise debt.
“Our view is the customer should not have that risk,” he added. “There should be an efficiency test but there should be pass through of actual debt costs.”
This was one of the three options proposed by Ofgem in its March consultation.
The regulator also revealed it was exploring options for “failsafe mechanisms” to prevent networks from earning excessive returns. Edwards said he was opposed to such measures: “You don’t need failsafe mechanisms if you get the process right”.