Utility Week

26 | SEPTEMBER 2022 | UTILITY WEEK Regulation ED2 draft determinations: where's the vision? Maxine Frerk sifts through Ofgem's recent draft determinations for the RIIO-ED2 price controls – and wishes there were more of a driving purpose. Comment O fgem recently published its dra determinations on the RIIO-ED2 price control. This comes at a challenging time with an understandable focus on rising energy costs and the wider cost-of-living crisis – but also a growing recognition of the threat posed by climate change. The headline messages from Ofgem therefore empha- sise both the signi• cant investment being made in net zero and the cuts that Ofgem has made to what the com- panies asked for. At an average of 17%, the "haircut" for ED2 sits midway between that for gas distribution (12- 13%) and that for transmission (20-23%). And, as with transmission, this is not all about e‰ ciency but also about pushing more funding out of baseline allowances into uncertainty mechanisms. In ED2 there is scope for revenues to be higher if demand for EVs [electric vehi- cles] and heat pumps really takes oŽ through what looks like a workable – though not very transparent – volume driver that will support timely investment if it turns out to be needed. Overall, the general sense is that Ofgem is happier with the quality of the business plans this time than for gas distribution and gas/electricity transmission, with the companies having had a chance to learn from the earlier controls as to what was expected. Ofgem too will have learned from the process – including the Competi- tion and Markets Authority (CMA) appeal – and there seem to be fewer howls of outrage from the companies this time round. That said, inevitably the companies will not be happy with what has come out. UK Power Networks will no doubt be disappointed that despite having tried hard to impress there were no bouquets from Ofgem. Others will be frustrated at Ofgem's rejec- tion of areas of spend they considered justi• ed through stakeholder engagement and the tough e‰ ciency targets imposed to try to keep bills down. All the companies will now be picking over Ofgem's benchmarking and the adjustments they have made – and we can expect some move- ment at • nal determinations. On cost of capital there is an interesting twist where Ofgem questions whether high inœ ation bene• ts the companies who largely have • xed rate debt – and whether Ofgem should be clawing some of this bene• t back for con- sumers. This suggestion was clearly a big worry on the investor call and Ofgem couldn't provide any reassurance because its thinking remains at an early stage. Having come out of le • eld, late in the day, it is hard to see how Ofgem could actually do the necessary thinking and consultation on such a major shi before • nal determinations. Indeed, it has said that if it were to conclude action was needed, it would apply to the other sectors as well. It would be an unprecedented step to change such a core part of the methodology mid-period but there is understandable public and political concern about prices that are pegged to inœ ation. But that's all standard price control stuŽ . In its press release Ofgem called this a "landmark • ve-year vision" which feels like a bit of an oversell. What is it that Ofgem is expecting the companies to actually deliver? Does it have any sense of what "good" looks like? Ofgem has acknowledged the crucial role the net- works have to play in facilitating the connection of EVs and heat pumps and supporting the move to net zero. But the scenario Ofgem has chosen is the most conserva- tive of the net-zero compliant Future Energy Scenarios, sending a very downbeat signal to distribution network operators (DNOs) and others. Companies will be able to secure additional allowances through the automatic volume driver around load-related expenditure. But there remains a diŽ erence of view across the DNOs as to how far you can use œ exibility as a short-term solu- tion or whether it is more e‰ cient to move ahead with reinforcement now to get ahead of the game. Ofgem says those looking to undertake more strategic invest- ment haven't made the case – but it remains open to argument. And in its latest Net Zero Britain discussion document it highlights this tension as one that needs to be resolved. But Ofgem itself isn't presenting a vision of what good looks like in this space. And more generally on distribution system operators (DSOs) and the market for œ exibility, again, the compa- nies all have diŽ erent commercial strategies and models (including on the degree of separation for the DSO). Ofgem seems happy to let these diŽ erent approaches run. There may be learning to be gained from trying diŽ erent approaches and Ofgem has metrics for check- ing on speci• c DSO outcomes (which are what matter). This will no doubt be an area that Ofgem will continue to scrutinise and it has a DSO reopener if it considers in future that roles need to be reassigned, for example. But at this stage there isn't a clear or common DSO vision. tried hard to impress there were no bouquets from Ofgem. Others will be frustrated at Ofgem's rejec- tion of areas of spend they considered justi• ed through stakeholder engagement and the tough e‰ ciency targets imposed to try to keep bills down. All the companies will now be picking over Ofgem's benchmarking and the adjustments they have made – and we can expect some move- ment at • nal determinations. On cost of capital there is an interesting twist where Ofgem questions whether high inœ ation bene• ts the companies who largely have • xed rate debt – and whether Ofgem should be clawing some of this bene• t back for con- sumers. This suggestion was clearly a big "There remains a difference of view across the DNOs as to how far you can use fl exibility as a short-term solution."

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