An ECIU study on contributions to energy bills has uncovered high dividends and profit margins at DNOs, sparking calls for RIIO to be reopened and Ofgem to be scrapped. David Blackman reports.

For once the big six were out of the firing line last week as the energy price focus shifted to whether the district network operators were making excess profits.

The spat was triggered by the publication of a report by the Energy and Climate Intelligence Unit (ECIU) in January.

According to this study, the six DNOs posted an average profit margin of 30.4 per cent in 2016, the first year after the introduction of Ofgem’s RIIO price control framework. The same analysis showed an average dividend pay-out ratio of 13.3 per cent.

The results backed up a study carried out last year by ECIU, which showed that in the period 2010-2015, DNOs’ profits equated to 32 per cent of revenue, around half of which was paid out as dividends.

“The brutal truth is that nothing has really changed,” says Matt Finch, business and economics analyst at the ECIU.

He insists that a vendetta against the network wasn’t on the agenda when ECIU kicked off its study to investigate which companies were making the biggest contribution to energy bills.

However, he says that the networks, which account for the second-biggest component of domestic electricity bills (27 per cent), emerged head and shoulders above the rest of the industry in terms of profit margins.

Low risk

What makes the level of the networks’ profits even more glaring, in Finch’s eyes, is that they are what he dubs “low risk” regional monopolies.

Ultimately such high dividends are not in the DNOs’ own interests, he argues: “Ofgem will turn around and ask why dividends are so high. This is just going to be a stick to beat them with.”

The Energy Networks Association has hit back at the ECIU research, branding it “fundamentally flawed and misleading”. It insists that a more accurate picture would be generated by calculating the proportion dividends make up of companies’ income once costs have been taken out.

This is particularly important for networks because their capital costs are relatively large. This standpoint was backed up by Ofgem chief executive Dermot Nolan in a letter to MPs last week.

Capital intensive

A spokesman for Ofgem confirms that the regulator doesn’t agree with the ECIU’s analysis of DNOs’ margins. He says: “Networks are very capital intensive and they have to invest an awful lot in grid infrastructure whereas suppliers have very little need for capital investment.”

And the furore over price dividends should be placed in a wider context, he adds, pointing to high levels of customer satisfaction with local grids, and with power cuts down 50 per cent since 2002.

However, these caveats haven’t cut much ice with Parliament’s sizable band of energy company critics who have seized on the ECIU’s analysis with relish.

John Penrose, a key ringleader of last year’s House of Commons push to curb standard variable tariffs, has opened up a fresh front in his campaign on energy prices.

The Tory backbench MP has persuaded 33 of his fellow MPs, including a number from the opposition, to sign a letter to Ofgem, calling on the regulator to re-open the RIIO at its midway mark. He has subsequently called for the energy regulator to be scrapped over its reluctance to reopen the price control framework.

Reopening RIIO

ECIU’s Finch argues that the scale of dividend pay-outs thrown up by his research justifies such a move. “If the 2016 dividend is maintained over the price control period, DNOs will pay out £5.1 billion. If you are worried about costs to customers, it’s hard to justify,” he says, adding that there is a case for revisiting the price control framework. “Eight years is a long time and to reopen it at the half way point makes sense because things change.”

However, while reopening RIIO might sound like a reasonable idea, in practice consumers will lose out from such a move, warns Ofgem. Reopening price controls will increase the networks’ perceived risk in the eyes of investors which will have a knock-on impact on customers’ bills, says the regulator’s spokesman. Even a 10 basis point increase in the cost of capital would add £2 onto the typical customer’s bill, he estimates

Better for the regulator to stick by the rules of the agreed framework, he argues, adding that Ofgem has secured the return of £4.5 billion to customers so far during the current price control framework.

Part of this is down to companies not needing to go ahead with projects that were planned during the current price control framework, such as National Grid’s proposed construction of gas transmission pipelines in Avonmouth. In addition, where companies have achieved efficiencies during the current framework, half of the savings are returned to customers.

Rather than changing the rules of the existing game, Ofgem is focused on drawing up a fresh set of price controls for the RIIO 2 framework, proposals for which are due to be published in the spring.

Excess profits

Hywel Lloyd, associate director of the Institute for Public Policy and Research (IPPR), suggests that the new framework could include a windfall mechanism which would allow the regulator to claw back excess network profits.

Both Nolan and business secretary of state Greg Clark have pledged that the new regime should be “much tougher”.

The Ofgem spokesman says: “Companies have recognised that the pressure is on to improve services and the costs people pay.

“RIIO was set up in 2013. Since then market evidence suggests that investors are willing to accept lower returns than what was allowed in price controls. Since the recession people have been looking for predictable, safe areas to invest in: things can be tougher.”

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