Utility Week

UTILITY WEEK | 17TH - 23RD MAY 2019 | 15 Policy & Regulation regulators since privatisation," it added. "However, we do not share a belief that indexation is by de nition a better substitute for this established practice. The fact that the risk-free rate has turned out to be lower than predicted in RIIO1 does not in itself warrant a transition to mechanistic indexation." Return adjustment mechanisms To provide further "failsafe" protection against windfall gains, Ofgem is planning to introduce "return adjustment mechanisms" to limit the amount by which network returns can exceed expectations. For transmission networks, they would take the form of "sculpted sharing", whereby deviations from a set threshold would be reduced to bring returns closer to this point. The regulator said "anchoring" is the pre- ferred option for gas distribution networks. Under this mechanism, companies' returns would be adjusted only if the sector average moved too far from a set threshold – Ofgem has suggested a collar of 3 per cent above or below the average allowed return for the sec- tor. Returns would be adjusted downwards proportionally to bring the sector average within this range. While protesting against the reduction in the allowed cost of equity, National Grid reluctantly accepted these measures: "While ideally these would not be required, we rec- ognise that they may be needed in the short term to maintain legitimacy and allow other areas of the framework to be developed unfettered by concerns of excessive returns." Cadent was supportive of return adjust- ment mechanisms as a "backstop to address any structural errors that lead to windfall under-performance or outperformance". But it also urged Ofgem not to adopt anchoring for gas distribution, arguing that adjust- ments should be applied on an individual basis, not to the sector as a whole. It said the market would be "heavily distorted" by the proposed measure given Cadent's sizeableŒshare. SP Energy Networks opposed the propos- als in any form. It said the introduction of return adjustment mechanisms would rep- resent a "material departure from the long- standing and highly successful regulatory framework for electricity networks in Great Britain". "Even the mere possibility that the mech- anism could apply may reduce companies' ambitions and attempts to be more innova- tive and e" cient." It said this issue could become ampli ed as the price controls pro- gress and some companies realise they are on course to breach the thresholds. continued overleaf RETURN ON REGULATORY EQUITY BASED ON NOTIONAL GEARING RIIO-ED1 PERIOD RETURN ON REGULATORY EQUITY BASED ON NOTIONAL GEARING RIIO-GDI PERIOD 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% Allowed equity return Broad measure of customer service Time to connect incentive Network Innovation Competition Company compulsory contribution Tax performance – at notional gearing Totex outperformance Interruptions-related quality of service Losses discretionary reward scheme Penalties and fi nes RoRE – operational performance IQI reward Incentive on connections engagement Network innovation unrecoverable expenditure Debt performance – at notional gearing RoRE – including fi nancing and tax Tax performance – at notional gearing Debt performance – at notional gearing Penalties and fi nes Network Innovation Competition Company compulsory contribution Network innovation unrecoverable expenditure NTS exit capacity Discretionary reward scheme Environment emissions incentive Shrinkage allowance revenue adjustment Broad measure of customer service IQI reward Totex outperformance Allowed equity return RoRE – operational performance RoRE – including fi nancing and tax ENWL Cadent NGN SGN WWU NPG SP SSE UKPN WPD 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% Source: Ofgem Source: Ofgem

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