With most of the networks now more than half way through their RIIO settlements, attention is beginning to turn towards the next period of the new price control regime.
The dramatic changes the energy system has already undergone during the first chapter will no doubt be surpassed by those of the second. So, in what ways will the framework need to be altered to ensure that it helps rather than hinders this transformation?
There is a broad consensus that on a fundamental level RIIO has worked as intended, pushing networks to innovate while further honing their existing operations.
Writing in Utility Week recently, former Ofgem senior partner for networks Maxine Frerk described how RIIO had become an international “role model” and warned the regulator not to “throw the baby out with bath water” when deciding where next.
There was agreement on this at Utility Week Live 2017 last month, where a succession of conference speakers presented the case for tweaks rather than an overhaul. “Evolution” not “revolution”, said UK Power Networks (UKPN) director of strategy and regulation Suleman Alli. “I think RIIO has provided a good, strong foundation.”
At the same time, all had plenty of ideas on how to improve the framework.
Simon Harrison, group strategic development manager at consultancy Mott MacDonald, said it needed to be “flexible” and “agile” to reflect increased uncertainty. He warned that rigid price controls would leave networks “straight-jacketed” and unable to adapt to a fast-changing environment.
“Under the current set of RIIO price controls every network has been able to outperform the baseline level set by Ofgem.”
Andrew Manning, head of network regulation at British Gas
Stephen Hall from the University of Leeds agreed. Presenting findings from the Energy Research Partnership’s Utility 2050 project, he told delegates that innovative products and services could account for up to 30 per cent of the value of the energy market by the middle of the century.
The project examined possible futures for the UK’s energy system and concluded that the financial opportunities created by electric vehicles, flexibility and low-carbon generation were “massively volatile across scenarios”. He said: “We know there’s going to be a lot of business model churn… Different futures mean different pools of value.”
The research showed that opportunities to create value from flexibility will be especially volatile. So much so that “only small start-ups” will be interested in taking a dip, and even they may need to be enticed with the offer of a risk premium, said Hall. “We’d need to be looking at higher rates of return than are currently available in the sector without someone saying: ‘We need to put a cap on tariffs because someone is earning more than 6 per cent.’
“To try new things, to experiment with new things and to ultimately grow them into the market, I think a more sophisticated appreciation of risk and company failure is necessary.”
However, British Gas head of network regulation Andrew Manning warned that this must not translate into largesse.
Although he agreed that RIIO had been successful in encouraging innovation, Manning said it was “less clear” that it had delivered value for consumers: “Under the current set of RIIO price controls every network has been able to outperform the baseline level set by Ofgem.”
He said the electricity distribution networks are set to receive rewards totalling £647 million during the current period for merely maintaining the initial level of reliability, and he questioned why.
In March 2015, British Gas appealed against the settlement for electricity distribution, partly on the basis that it was too generous. The CMA eventually dismissed the appeal on four out of five grounds, but it also told Ofgem it needed to “engage stakeholders who criticised the process when developing future target-setting approaches”.
“That’s what we feel is the missing part,” Manning said, recalling the episode. “There has to be a degree of rigour in the process. As stakeholders engage and make their points, there needs to be an obligation to either accept those points or explain why not.”
Manning said Ofgem should take a more proactive approach to engagement – seeking out the diverse range of stakeholders and educating them about key issues.
He said the problem was exemplified by a recent consultation to which British Gas owner Centrica was the only one to reply: “Something is not right there if on fundamental issues for price controls only one industry party is responding.”
“For the regulator to try and predict the future in a regulatory regime – I think it is an unreasonable ask.”
Basil Scarsella, chief executive of UK Power Networks
UKPN’s Alli said the next settlement needed to be flexible about timing as well as returns. He explained that his firm is holding tenders this year for “up to a dozen sites where, rather than reinforcing, we want to buy a service contract”.
“If I underspend in year one, a proportion of that underspend is passed back to customers,” he added. “Within period my revenues drop.” He urged debate over how the deferral of investment is treated in following periods.
Furthermore, Alli said RIIO2 offered an excellent opportunity to develop incentives for whole-system solutions, “whether that be transmission investment, distribution investment or flexible solutions”.
Frerk has suggested that this may require the alignment the RIIO settlement periods. The electricity distribution settlement currently runs two years behind the others.
UKPN chief executive Basil Scarsella also said that in the face of great uncertainty the settlement periods should probably be shorter: “For the regulator to try and predict the future in a regulatory regime – I think it is an unreasonable ask.”
He claimed that unless the duration of the next electricity distribution was reduced, there would be “so many re-openers and uncertainty mechanisms that it will be difficult to manage”.
Ofgem will need to walk a careful balancing act as it formulates the second round of the RIIO price controls. The regulations clearly need to be more flexible and adaptable to reflect the growing uncertainty and the accelerating pace of change. But they need to do so while continuing to put pressure on networks to be efficient and demonstrate customer value for money. Finding this equilibrium will be no easy task.