Utility Week

UTILITY WEEK | 13TH - 19TH JULY 2018 | 21 Operations & Assets including famous household brands, are closing shops, we believe there is still huge poten- tial on Britain's high street. "Our research suggests many customers want to be able to interact with us directly rather than rely solely on the phone, email or on social media – the shop provides that option." If you have an asset or project you would like to see featured in this slot, please send details to: alicecooke@fav-house.com. O fgem's March consul- tation on the RIIO2 framework proposed "underwriting" returns in the name of financeability. The regulator's thinking was driven by its assessment that lower baseline returns envisaged at RIIO2 "may make it more chal- lenging to meet the standard financeability metrics". But before considering the merits of any mechanisms to address this, it is worth standing back and asking ourselves the question: "What is the problem we are trying to solve?" There seem to be two possibilities. First, baseline returns are simply set "too low"; or second, the range of incentive mechanisms that collectively influence over and underperformance awards are misaligned. On the first possibility, it is well understood that setting an "appropriate" return does not guarantee a regulator will meet its financeability duty (because of a mismatch in timings between allowed revenues and required cash). Accordingly, various tools have always existed to address this, including revenue smoothing. However, Ofgem now appears to be hinting at a more funda- mental tension between the baseline return at RIIO2 and the ability of companies to achieve financial ratios consist- ent with investment-grade rat- ings. But, when one considers this in terms of the notional, efficient company, such a con- cern seems unfounded. That is to say, if the other parameters of the price-setting process are set correctly, then any mate- rial incompatibility between baseline returns and achieving financeability would seem to indicate that the return has been set "too low". Turning to the second pos- sibility, perhaps the concern is instead founded in the possibil- ity that, via the various incen- tive mechanisms that apply in RIIO, companies' returns are unduly influenced by financial rewards and penalties that are not appropriately calibrated to deliver the "right" (efficient) outcomes. Take outputs. It is inherently challenging to measure the customer value or cost of delivering specific service levels. Likewise, it can be hard to know whether under or outperformance is the result of company effort or external factors outside its control. However, if concerns about the alignment of incentives are the issue, then the appropriate solution would be to look afresh at the approach and simplify – recognising that no incentives are "perfect" and focusing on using such mechanisms only when the quality of information and incentive power is sufficient to make them worthwhile. The above does not imply that "floors" would never be appropriate. They might make sense if one reached the conclu- sion that revisions to improve the design of other incentives were impractical. However, one must always be mindful that floors and caps invariably blunt overall incentive power, which is rarely a good thing. Sam Williams, director, Economic Insight. For more information, visit: www.economic-insight.com EXPERT VIEW SAM WILLIAMS, ECONOMIC INSIGHT The flaws in floors – and in caps Floors and caps invariably blunt overall incentive power, which is rarely a good thing.

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