Ofgem has allocated £25 billion of upfront funding to networks as part of its draft determinations for the RIIO2 price controls for gas and electricity transmission, gas distribution and the electricity system operator beginning in April 2021.
The regulator has also identified a further £10 billion of expenditure that could be approved over the course of the five-year period to help accelerate the decarbonisation of the energy system, whilst also setting aside £630 million for a new Strategic Innovation Fund.
Based on current market conditions, Ofgem expects the cost of equity to come in at 4.2 per cent in real terms based on the newly-adopted CPIH measure of inflation. However, the regulator said it expects the allowed return on equity – the baseline return for shareholders – to be set 25 basis points lower at 3.95 per cent to reflect companies’ historical outperformance.
Ofgem said this rate would represent a reduction of nearly 50 per cent when compared to the current regulatory period, saving consumers £3.3 billion. It said the average household energy bill could be expected to fall by £20 over the first 12 months, helping to offset an increase in investment and charges during later years.
The regulator has also proposed cutting more than £8 billion from companies’ business plans by setting them stricter efficiency targets and disallowing expenditure they have been unable to justify. It said it would now be up to network companies to provide “robust evidence” that this spending is necessary.
Chief executive Jonathan Brearley said: “Ofgem is working to deliver a greener, fairer energy system for consumers. This is why we are striking a fair deal for consumers, cutting returns to the network companies to an unprecedented low level while making room for around £25 billion of investment needed to drive a clean, green and resilient recovery.
“Now more than ever, we need to make sure that every pound on consumers’ bills goes further. Less of your money will go towards company shareholders, and more into improving the network to power the economy and to fight climate change.
“Ofgem’s stable and predictable regulatory regime will continue to attract the investment Britain needs to go further and faster on decarbonisation.”
Reaction
Responding to the announcement, Energy Networks Association chief executive David Smith said: “While the proposals outlined today will take some time to review in detail, we are concerned that they don’t go far enough to encourage the investment needed to achieve net zero emissions and support the UK’s economic recovery.
“While network companies have historically been able to raise billions of pounds to invest in the networks and support the transition to a sustainable future at low cost to the customer, the proposals set out by Ofgem could significantly inhibit their ability to do so.
“Network companies listened to their customers and stakeholders and put forward plans informed and influenced by their extensive engagement through focus groups and events held around the country. The plans put forward by network companies would make this possible with little to no impact on the average energy bill.”
He continued: “We will work with Ofgem over the coming months to highlight these concerns ahead of the final settlement being published in December.”
National Grid said it was “extremely disappointed” in the decision, adding: “This proposal leaves us concerned as to our ability to deliver resilient and reliable networks and jeopardises the delivery of the energy transition and the green recovery.”
Scottish and Southern Electricity Networks (SSEN) said it “fundamentally fails to deliver on net zero, inadequately reflects stakeholder and customer needs, and falls short in seeking to attract the significant investment required”.
“Whilst our stakeholder-endorsed and evidence-based business plan was in step with the government’s low carbon investment ambition, Ofgem’s first pass at a settlement resembles a worrying return to austerity,” remarked SSEN managing director of transmission Rob McDonald.
“Ofgem’s draft determination is a barrier towards achieving net zero and damaging to the green economic recovery.”
By contrast, the decision was warmly welcomed by consumer advocate Citizens Advice.
“Today’s announcement is another step closer to a price control that stops network companies from overcharging energy customers by billions of pounds,” said chief executive Gillian Guy.
“These decisions are extremely technical, but they matter. Ofgem has struck the right balance between shareholder returns and value for money for energy customers, while making sure networks can continue to attract investment.
“Energy networks are key to meeting net zero, but future demands on the energy system are hard to predict. Decarbonising heat, electric vehicles and increased use of smart products in the home will pose different challenges. But measures outlined today should protect consumers by ensuring the transition to net zero is done at a lower cost.”