Utility Week

UTILITY WEEK | AUGUST 2022 | 9 Policy & Regulation "These are challenging times, and this is the path out of relying on expensive and polluting imported fossil fuels and moving to a home-grown energy system that exploits the best of modern technology to level out demand and reduce costs for consumers. "We're determined to get the best possible deal for consumers and the proposals we've published today will mean that substantial additional investment can be made to deliver net zero without placing any further pressure on bills. "We're confident the five-year vision we've outlined will help build the world- class energy infrastructure needed to con- nect consumers to reliable, cleaner energy at an affordable price." Analyst view The dra• determinations were described as "slightly tougher than expected" due to higher levels of assumed productivity gains and reduced scope for operational outper- formance, by ratings agency Moody's. In the case of the latter, Moody's said the potential financial rewards from output delivery incentives, which would be sig- nificantly reduced when compared to the current price controls, would be harder to achieve due to tighter targets, and would also be outweighed by potential penalties by a ratio of more than 2:1. In an update to the industry, the rat- ings agency said most of the key regulatory parameters in the dra• determinations for the RIIO-ED2 price controls were "broadly in line" with Ofgem's sector-specific meth- odology and the amended price controls for transmission and gas distribution networks following their partially successful appeal to the CMA. Speaking to Utility Week, Moody's senior analyst Phil Cope highlighted the regula- tor's approach to output delivery incentives (ODIs), noting that these have been the main driver of outperformance by DNOs against their baseline Return of Regulatory Equity (RoRE) during the RIIO-ED1 price controls. This is in contrast to other sectors, where outperformance has primarily been driven by totex underspends. However, the value of the rewards on offer from financial ODIs has been significantly reduced in the dra• determinations for ED2, dropping to a maximum of 1.95% of RoRE. Cope said that although it was not pos- sible to provide an equivalent percentage for ED1, because some incentives are expressed in terms of revenue rather than returns, the ODI for network reliability is by itself cur- rently worth plus or minus 2.5% of RoRE. He said this was previously expected to stay the same for ED2 but the maximum reward has instead been reduced by three- fi•hs to 1% of RoRE. Meanwhile, the maxi- mum penalty has been kept at 2.5% of RoRE. In general, Moody's said ODIs were heav- ily skewed towards penalties in the dra• determinations, with the maximum penalties amounting to 4% of RoRE – more than dou- ble the maximum rewards. This is in contrast to the current price controls, in which the rewards and penalties are symmetrical. What's more, the ratings agency said the targets DNOs will need to meet or exceed to secure rewards have been tightened signifi- cantly, drawing attention to the ODI for cus- tomer service. Cope said the target for ED1 is an aver- age survey score of 8.2 out of 10, with a score of 8.9 on each survey element securing the maximum reward. He said 8.9 out of 10 is instead the target score in the dra• deter- minations and Ofgem has also proposed to introduce a dead band, meaning DNOs would only start to earn rewards at a score of 9.2. He said he believed it would be "very hard" for DNOs to achieve rewards of more than 1% of RoRE across all financial ODIs. Ofgem is additionally introducing a Return Adjustment Mechanism (RAM) to limit any deviations from the baseline RoRE. Any outperformance that exceeds the baseline by more than 300 basis points will be shared equally with consumers, while consumers will receive 90% of any outper- formance that exceeds the baseline by more than 400 basis points. This mechanism will also apply to underperformance. However, Moody's said the reduction in ODI rewards, the tightening of targets and lowering of sharing factors for totex under- spends means this mechanism is "unlikely to be triggered". The sharing factors for DNOs currently range between 53% and 58%, with the exception of Western Power Distribution, which as the only company to be fast-tracked due to the quality of its ED1 business plan has a sharing factor of 70%. All DNOs are set to receive sharing factors of 49% to 50% for ED2. Said Moody's: "While we do not believe any licensee could deliver the level of opera- tional outperformance, under the dra• deter- mination, required to trigger the primary RAM threshold – Ofgem estimate this to be earning 100% of available ODI-F incentive income and delivering totex outperformance of 8% – it continues to show Ofgem is increasing focus on network legitimacy." Tom Grimwood, news editor See more of our extensive coverage on the ED2 dra determinations at https://utility- week.co.uk/tag/ed2/, including an overview of new automatic volume drivers to manage uncertainty over load-related expenditure; Ofgem's fleshed-out plans for the regulation of distribution system operator functions and a new funding mechanism to enable DNOs to act as a provider of last resort for electric vehicle chargepoints.

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