Utility Week

8 | AUGUST 2022 | UTILITY WEEK Policy & Regulation Analysis Price control updates signal 'stretching' targets Over the past month the energy and water regulators have made significant pronouncements on upcoming price reviews. Here Tom Grimwood summarises the key points from Ofgem's ED2 draft determinations, while overleaf he reviews Ofwat's draft methodology for PR24. O fgem's initial response to the busi- ness plans submitted by distribu- tion network operators (DNOs) for 2023 to 2028 were described as "tough and stretching". That particular verdict came from Scottish and Southern Electricity Networks (SSEN) a‚er it saw the largest proportional decrease in its total expenditure (totex) allowances. In its business plan, the company requested around £4,232 million of totex allowances for the five-year price controls beginning in April 2023, which the regulator reduced by around £946 million – or 22.4% – to £3,286 million. DNOs collectively requested £25.2 billion of totex allowances in their business plans, submitted to Ofgem in December. The regu- lator said its own modelling of the plans put the figure at £23.2 billion, representing an 8% reduction. Ofgem then applied demand-driven reductions of roughly £700 million (3%) to align the plans with its common scenario for meeting the 2050 net-zero target. It said the decision to base funding on a central- ised scenario reflected concerns over insuf- ficient justification for DNOs' scenarios and assumed levels of demand. The regulator said this would ensure consumers are not exposed to unneces- sary costs, noting that DNOs will be able to unlock extra funding through uncertainty mechanisms if further needs materialise dur- ing the course of the price controls. It additionally applied downward adjust- ments of £300 million (1%) and £1.3 billion (5%) to reflect the catch-up and ongoing efficiency challenges to give a final totex fig- ure of £20.9 billion. This equates to a 14% increase in annual expenditure when com- pared to the current price controls. Ofgem said it included £2.7 billion of upfront net-zero investment, representing a 90% increase in annual load-related expend- iture compared with the current regulatory period. Although SSEN saw the largest reduction in totex on a proportional basis, the greatest absolute decrease was that applied to West- ern Power Distribution's totex allowance, which fell by around £1,327 million – or 19.2% – to £5,581 million. The smallest proportional reduction was to UK Power Networks' totex allowances, which dropped by £609 million – or 11.1% – to £4,854 million. (See table). Cost of capital Ofgem has set the allowed return on equity – the baseline rate of return for investors – at 4.75% in real terms based on the CPIH meas- ure of inflation. The regulator said this is down roughly 30% when compared with the equivalent rate for the current price control period of 6.8%. In line with the ruling of the Competi- tion and Markets Authority (CMA) in the appeal of transmission and gas distribution networks against their final determinations, the rate does not include the outperformance wedge proposed by the regulator in its sec- tor-specific methodology for the RIIO-ED2 price controls. The outperformance wedge – a down- ward adjustment to the cost of equity of 0.25% – was intended to counteract infor- mation asymmetry between Ofgem and net- works, reflecting investors' expectations that companies would outperform the baseline on average. Although the CMA recognised Ofgem's concerns over information asymmetry, the body removed the measure from the price controls for transmission and gas distribu- tion, leaving the appellants with an allowed return on equity of 4.55%. The regulator's chief executive, Jonathan Brearley, said: "Ofgem's job is to ensure energy networks have achievable and afford- able plans that will attract the investment needed for a more resilient energy network and achieve the government's net-zero ambi- tion at the least cost to the consumer. TOTEX: WHAT WAS ASKED FOR AND WHAT WAS OFFERED Distribution network operator Submitted Totex Proposed Totex Difference Difference (%) Electricity North West £2,015m £1,640m £375m 18.6% Northern Powergrid £3,229m £2,650m £580m 18.0% Western Power Distribution £6,907m £5,581m £1,327m 19.2% UK Power Networks £5,462m £4,854m £609m 11.1% SP Energy Networks £3,397m £2,928m £469m 13.8% SSEN £4,232m £3,286m £946m 22.4% Total £25,244m £20,939m £4,305m 17.1% Source: Ofgem

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