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UW April 2021 High Res

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16 | APRIL 2021 | UTILITY WEEK Policy & Regulation Analysis Analysis of return for shareholders. Networks say the proposed returns are too low and will fail to attract the investment required to make Brit- ain net zero by 2050. In its dra• 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 adjustment of 25 basis points – the outperformance wedge – to reflect the expected outperformance of net- works 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 out- performance wedge had been applied. It said this still represented a reduction of 40 per cent when compared to the current regula- tory 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, pub- lished in September, in which the CMA (Com- petition and Markets Authority) proposed raising the cost of capital by 0.54 percentage points above Ofwat's figure. Responding to the announcements, Ofgem director Akshay Kaul, said: "Our price control drives a fair price for consumers, improves services and boosts green energy investment. "We respect the CMA 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 invest- ment for a green recovery." Alistair Cromwell, acting chief execu- tive of consumer charity Citizens Advice, said: "Networks' decision to appeal what is already a generous price control is about try- ing to go back to the days when they could make billions in excess profits at consumers' expense. There is no benefit to energy cus- tomers from this course of action. "Funding networks for the shi• 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 unneces- sary distraction." Tom Grimwood, energy editor continued from previous page by Maxine Frerk W hile the CMA is expe- rienced in manag- ing quick turn around appeals and merger decisions, the prospect of running eight parallel appeals on the RIIO2 price controls must present it with a bit of a headache. Formally the next step in the process is for Ofgem to make any comments on whether the appeals should be allowed and for the CMA then to grant per- mission (by the end of March). This is largely a formulaic pro- cess and there is no real pros- pect of the appeals not being allowed. Aside from deciding on the panel members, the CMA's next task will be to think about the logistics, timelines and how far the appeals can be run in parallel. How far is there common ground? All the appeals cover the cost of equity and the "outperformance wedge", with all of the compa- nies apart from National Grid then appealing on at least one other topic as well. On cost of equity, the compa- nies all structure their appeals around the same three key areas: errors in the calculation, including Ofgem's choice of evi- dence; errors around the cross- checks carried out; and the failure to "aim up" (that is, to use a number in the upper part of the range to avoid the risks of underinvestment). All companies argue that energy is higher risk than water and hence should have a higher cost of equity. The gas distribu- tion networks (GDNs) also argue that gas is higher risk because of the potential for stranding. Interestingly, NG Gas Transmis- sion does not make this argu- ment and has presented an identical case to NG Electricity Transmission (so at least these two appeals can be combined). On the outperformance wedge, the companies are all running similar arguments that this is unjustified and under- mines incentives. On the basis of that high-level summary, it might sound like the CMA could run the appeals together in this area. However, once you get below this initial level, the specific evidence cited by each company is different and they are using different con- sultancies to help them. Given the nature of the focused appeal in the energy sector, the CMA has to decide each case on the evidence presented – which is different in each case. This raises an interesting question (for regulatory geeks like me) as to whether you could have one network succeeding at appeal when others fail just because one has made better arguments? Or will the compa- nies' arguments evolve through the process so that by the end any "winning" arguments will be woven into everyone's narra- tive? The CMA could try to get the companies to work together but the legal framework doesn't readily accommodate that. How- ever, one has to hope that com- mon sense will prevail and they will find a way to make this a manageable process and one that provides a coherent answer at the end of the day. What else have companies appealed on? Beyond the cost of equity there are a couple of other common themes and then some com- pany-specific issues. The first additional theme is around the ongoing annual effi- ciency target applied by Ofgem on gas distribution, which all GDNs are challenging along with Scottish Power on the transmis- sion side. Ofgem came up with RIIO2 appeals are a headache for CMA "The final determination does not strike the right balance between bill reductions and necessary future investment." CHIEF STRATEGY AND REGULATORY OFFICER TONY BALLANCE "Networks are trying to go back to the days when they could make billions in excess profits at consumers' expense. ALISTAIR CROMWELL, ACTING CHIEF EXECUTIVE, CITIZENS ADVICE

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