Utility Week

UTILITY WEEK | DECEMBER 2021 | 25 Policy & Regulation Analysis CMA makes fi nal RIIO2 call After a lengthy appeals process, the CMA has issued it's fi nal verdict on transmission and gas distribution – and as predicted conceded little ground on its original decision. T owards the end of October, the Com- petition and Markets Authority (CMA) issued its nal determination on the RIIO2 appeals by brought by all of the trans- mission and gas distribution networks. As widely expected, it made no signi - cant changes from its provisional decision in August, upholding Ofgem's drastic reduction to the cost of equity but removing the out- performance wedge introduced by the regu- lator to counteract information asymmetry between itself and the networks. With regards to the cost of equity, the CMA noted networks' complaints that it had not considered the merits of the appeals, that it had "failed to grapple properly with the evidence", and that it had deferred to Ofgem's judgement too much. "We disagree," the CMA declared. "We have carefully scrutinised the evidence as well as the substance of Ofgem's decision- making in line with the grounds of the appeal advanced before us and are satis ed that we have correctly applied the standard of review in our assessment." The outperformance wedge On the outperformance wedge, the CMA once again acknowledged that "regulators inevita- bly face information asymmetries, and that those asymmetries can make the setting of appropriately stringent and robust price con- trols challenging", particularly in relation to totex allowances. A† er Ofgem concluded that this had allowed networks to pull the wool over its eyes during the rst set of RIIO price controls and rake in much higher pro ts than was justi ed, e‡ orts to prevent it from happening again have permeated the second set. The outperformance wedge – its ‰ agship mecha- nism to o‡ set the imbalance – had been a particular bone of contention for networks, who had described it as arbitrary in nature and without precedent. The CMA said Ofgem had not demon- strated suŠ ciently why "the extensive set of tools it used for RIIO2 should be regarded as providing insuŠ cient protection for customers". "We have ordered that the decision to introduce the outperformance wedge should be quashed and substituted with our deci- sion to remove the outperformance wedge and associated backstop," it stated. The removal of the outperformance wedge – a downward adjustment to the cost of equity worth 25 basis points – will leave the appellants with a nal gure of 4.55% based on the CPIH measure of in‰ ation. The CMA additionally maintained its pro- visional decision to remove Ofgem's upli† to required improvements in cost eŠ ciency to re‰ ect the bene ts of past innovation projects. Recognising that past innovation is likely to have resulted in cost reductions, the CMA said it had since considered whether the upli† could be set at a more appropriate level than the 0.2% chosen by Ofgem but ultimately decided to remove it entirely. The CMA did retract its provisional nd- ing that Ofgem was wrong to adopt a gure of 0.5% for Cadent's embedded ongoing eŠ ciency challenge based on subsequent responses and additional evidence. It also upheld its decision that Ofgem had acted beyond its legal authority – "ultra vires" – in introducing special licence con- ditions that could be modi ed during the price control to manage uncertainty and contingency allowances – a process Ofgem described as "self-modi cation". The body said it had quashed such licence conditions for the transmission arms of SP Energy Networks and Scottish and Southern Electricity Networks and directed Ofgem to use the "standard licence modi cation pro- cess by which any modi cations to the rel- evant licence conditions can be appealed to the CMA". Ofgem director of networks Akshay Kaul welcomed the CMA's nal ruling, saying it achieves "the right balance between a‡ ord- ability, sustainability, and practicality, while broadly supporting and reaŠ rming Ofgem's decisions on setting price controls". None of the appellants have so far indi- cated their intention to take things further, suggesting they have likely come to terms with the outcome. 'Good news for customers' Andy Manning, principal economic regula- tion specialist at Citizens Advice, described the CMA's nal determination as "good news for customers". Writing in a blog, Manning said: "The CMA's decision to con rm lower returns on investment is a signi cant step forward in tackling the excessive pro ts made by network companies at the expense of their customers. Our evidence showed that, if suc- cessful, the appeals by networks could cost consumers an additional £1.5 billion." But he said the RIIO2 price controls are still "naturally skewed" towards energy net- works. "As is o† en the case, the price con- trol settlement falls between the companies' and Ofgem's starting positions. This means returns are higher than necessary," he said. Manning said the process is further skewed by the appeals process, which allows network companies to "cherry-pick" issues they can easily a‡ ord to challenge and o‡ er a "good bet" given the amounts of money at stake. He said it is much harder for organisa- tions like Citizens Advice to justify the legal costs of mounting an appeal in instances where the price control is too generous . Focus will now switch to the RIIO2 price controls for electricity distribution, which will start two years later than the rest in April 2023. The distribution network operators are due to submit their business plans to Ofgem on 1 December. Tom Grimwood, news editor

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