Utility Week

16 | 17TH - 23RD MAY 2019 | UTILITY WEEK Policy & Regulation Analysis It said return adjustment mechanisms would bring additional uncertainty for inves- tors, adding to financing costs, but welcomed Ofgem's decision to steer clear of discretion- ary adjustments, which it said would make this problem even worse. Northern Gas Networks was similarly opposed to return adjustment mechanisms in general but was particularly worried about the anchoring method being proposed for gas distribution, warning: "Proposals for cross-sector averages put licensees at the mercy of other players, without the informa- tion to be able to make informed decisions." Scoring system Another major change for RIIO2 is to the pro- cedure for assessing business plans. For the first set price controls, these business plans were subjected to an initial assessment by Ofgem. Any that were good enough to be approved at this stage would be fast-tracked and thus receive a higher sharing factor, allowing the authors to keep more of any underspends against their allowances. The rest would be required to resubmit theirs, which in combination with Ofgem's own cost estimates would be used to calcu- late the information quality incentive (IQI) benchmark. The benchmark was weighted towards the regulator's view. These slow-tracked companies would then be assigned sharing factors based on the difference between their cost forecasts and the benchmark. For RIIO2, Ofgem plans to remove both fast-tracking and the IQI. It said IQI has failed to prevent networks submitting excessive cost forecasts and takes no account of the qualitative aspects of their business plans. It instead intends to score the business plans on both cost and quality and then apply rewards and penalties on this basis. There would be a maximum overall loss or gain of 2 per cent of totex allowances (see chart, above). Rewards would come from a shared pot, meaning the more companies were scored highly, "the more the reward for individual companies is diluted". Sharing factors Ofgem has additionally proposed to intro- duce "blended" sharing factors. This would see the regulator initially apply different sharing factors to different parts of networks' spending allowances, depending on its level of confidence in the accuracy of the corre- sponding forecasts. Those cost items in which the regulator has a high level of confidence would be allo- cated a higher sharing factor, and vice versa. Ofgem would then calculate an overall sharing factor for the total allowances based on a weighted average of the constituent parts (see chart p17 for example). "This could incentivise companies to pro- vide us with information that would allow us to set allowances with higher levels of confi- dence," the regulator explained. Citizens Advice gave its backing to the removal of the IQI: "The intentions behind the IQI were sound, but it's ability to deliver didn't materialise, so it's good that Ofgem is reworking the method this time around." It was also welcomed by the University of Exeter's Energy Policy Group (EPG) which has previously claimed the IQI allowed DNOs to "game the system" by submitting inflated cost forecasts. The academic body said it would also be "happy for penalties to be more than the plus/minus 2 per cent" sug- gested by Ofgem. Network reaction Network companies thought differently. Northern Gas Networks said Ofgem's pro- posal to include quality and ambition in its assessment of business plans would make it "highly subjective". It lamented the lack of clear guidance on the exact criteria by which they will be judged and warned there were some ele- ments of the proposed methodology that could actually discourage networks from stretching themselves. "Including ambition in the plan which is not accepted may attract a financial penalty but submitting a less ambitious plan will attract no reward or pen- alty – seemingly providing an incentive for a conservative approach." SP Energy Networks accepted that the IQI mechanism is not without flaws but said it is better than the alternative and should be improved upon rather than abolished entirely. It said removing the network com- panies' own forecasts from Ofgem's assess- ment of costs could create "inequity" due to the "greater potential for unintended differ- ences in allowances between companies". Meanwhile, blended sharing factors would introduce "a new degree of complex- ity which requires consistency checks across price controls and sectors". UK Power Networks agreed on the lat- ter point but argued Ofgem should apply "a single, common, totex sharing factor to all network companies". This, it said, would encourage whole-system thinking by provid- ing a level playing field between companies that could potentially deliver the same out- puts for customers. Outputs On the subject of outputs, Ofgem is planning to consolidate the six previous categories into just three, namely: meet needs of con- sumers and network users; maintain a safe and reliable network; and deliver an environ- mentally sustainable network. It also plans to distinguish between three types: licence obligations; price control deliverables (PCDs); and output delivery incentives (ODIs). Licence obligations will cover minimum standards that networks must meet or face penalties or enforcement actions. PCDs will refer to outputs that are directly funded through the price control settlement. Examples include large one-off capital pro- jects, such as the strategic wider works from RIIO1, or activities that are tied to changes in government policy. These will be consid- ered on a case-by-case basis. Some may be funded upfront, with Ofgem clawing back money if they fail to materialise. Others will only be allocated funding once work has actually begun. And ODIs will describe "service level" outputs for which networks can be both rewarded and penalised. Ofgem said some could be a mixture of all three types and that networks could propose bespoke outputs within their business plans. Some targets and incentives could pos- sibly be relative and dynamic in nature. Networks could be granted rewards from a shared pot for the sector or judged based continued from previous page RIIO2 BUSINESS PLANS INCENTIVE Quality/cost Good Average Poor Good Good value Max +2% totex equivalent Value Max +1% totex equivalent Standard Average Value +1% totex equivalent Standard Low value -1% totex equivalent (fixed) Poor Standard Low value -1% totex equivalent (fixed) Poor value -2% totex equivalent (fixed) Source: Ofgem

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