All eight of the electricity and gas transmission and gas distribution networks have now confirmed they are seeking appeals from the Competition and Markets Authority (CMA) of Ofgem’s final determinations on their RIIO2 business plans for 2021 to 2026.
The only company to accept its final determination in full is National Grid Electricity System Operator.
National Grid was the first to make an announcement on Tuesday morning (2 March). The group said the appeals it is requesting for electricity and gas transmission would be technical in nature and limited to the cost of equity and the so-called outperformance wedge.
The electricity transmission arms of Scottish and Southern Electricity Networks (SSEN) and then SP Energy Networks (SPEN) followed that afternoon. SSEN said its request would also be “narrow and technical in scope”, focussing on areas where “Ofgem’s decision does not reflect the robust evidence provided throughout the price control process, alongside material errors”. SPEN said it was “concerned at Ofgem’s approach on a number of discrete issues.”
Cadent was the first of the gas distribution networks to announce that it is seeking an appeal on Wednesday afternoon (3 March). It said its request would cover the rate of return for investors as well as total expenditure allowances and risk. Chief strategy and regulatory officer, Tony Ballance, stated: “This is because we do not believe the final determination strikes the right balance between bill reductions and future investment, that is necessary to enable us to deliver the very best service to customers and wider society.”
SGN made its announcement on Wednesday evening, explaining that it would be looking to appeal the cost of equity, the outperformance wedge and aspects of Ofgem’s efficiency methodology.
Wales and West Utilities (WWU) said it would be seeking an appeal this morning (4 March), followed shortly afterwards by Northern Gas Networks (NGN). WWU said its request would cover five areas: the cost of debt, the cost of equity, spending allowances for gas mains replacement efficiency targets and the construction of the license. NGN said theirs would cover four issues: the cost of equity, the outperformance wedge, efficiency targets and the level of incentives.
The networks covered by Ofgem’s final determinations in December had until yesterday (3 March) to decide whether or not to seek an appeal from the CMA.
As anticipated, the main point of contention is the cost of equity – the baseline rate of return for shareholders. Networks say the proposed returns are too low and will fail to attract the investment required to put Britain on course to achieve net emissions by 2050.
In its draft determinations issued in July last year, Ofgem calculated the cost of equity at 4.2 per cent based on the CPIH measure of inflation but said it would for the first time apply a downward of adjustment of 25 basis points – the outperformance wedge – to reflect the expected outperformance of networks based on past outcomes.
The regulator said it was the “lowest ever” rate and represented a reduction of almost half when compared to the current price controls.
Ofgem raised its estimate of the cost of equity by 35 basis points to 4.55 per cent in its final determinations, giving an allowed return on equity of 4.2 per cent once the outperformance wedge had been applied. It said this still represented a reduction of 40 per cent when compared to the current regulatory period.
The increase was at least partly in response to the provisional findings in the appeals of four water companies against their final determinations for PR19 published in September, in which the CMA proposed to raise the cost of capital by 0.54 percentage points above Ofwat’s figure.
The transmission and gas distribution networks have had to choose whether to request an appeal without knowing the ultimate outcome for the water sector after the CMA delayed the publication of its final redeterminations multiple times, most recently until mid-March.
Analysts at Barclays have argued that appeals are nevertheless a “low-risk” option for energy networks, given that they can be limited to specific aspects of their business plans and later withdrawn.
Responding to the announcements on Wednesday morning, Ofgem director Akshay Kaul, said: “Our price control drives a fair price for consumers, improves services and boosts green energy investment.
“We respect the Competition and Markets Authority appeal process, where we will defend robustly our decisions which are in the best interests of consumers and tackling climate change.
“While the appeals could take around six months to resolve, they will not delay any investment and we look forward to working closely with industry to accelerate investment for a green recovery.”
Alistair Cromwell, acting chief executive of consumer charity Citizens Advice, said: “Networks’ decision to appeal what is already a generous price control is about trying to go back to the days when they could make billions in excess profits at consumers’ expense. There is no benefit to energy customers from this course of action.
“Funding networks for the shift to net zero is one of the main purposes of this price control and Ofgem’s settlement allows that to happen. These appeals are an unnecessary distraction.”
Former Ofgem partner Maxine Frerk said the fact that a “full house” of networks are hoping to appeal does not mean that Ofgem is off the mark: “Following the RIIO ED1 appeal, when it became clear how the new focussed appeal arrangements worked, it always seemed likely that we would see a large number of appeals at RIIO2.
“The companies can pick the issues on which they appeal – i.e. the ones where they have the strongest case – and it’s effectively a one way bet. Unlike on the water re-hearings you can’t realistically end up worse than you went in – and who wants to be the only one not at the party if everyone else is getting a prize?”
“If the company keeps it tightly focussed on the cost of capital as National Grid have done, then they can probably avoid it being too much of a distraction and hopefully keep the heat out of the argument with Ofgem,” she added.
“Others seem to have taken the view that if they are going to the effort of appealing to the CMA on cost of equity then they might as well throw in a few other points as well.”
She said SSEN and SGN both seem to be framing their challenges as technical in nature in an effort to maintain good relations with Ofgem: “How easy that will be once they get into the heat of the debate remains to be seen but it is the right strategy.
“All the rest have gone for slightly broader appeals and without the warm words. On gas distribution there is a common theme around the efficiency targets that Ofgem set but beyond that it is a pick and mix of issues.”
Frerk described the decision to appeal as “a bit of a no brainer” but added “that doesn’t mean it’s a slam-dunk.”
“The other lesson from the ED1 appeal was that it was a relatively high bar to prove that Ofgem was ‘wrong’ which is the test for focussed appeals… Even if the CMA do finally settle on a higher cost of capital for water that doesn’t necessarily mean that they will over-turn Ofgem’s decision if it falls within what they would consider a plausible range.”