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Utility Week 3rd March 2017

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UtILItY WEEK | 3rd - 9th March 2017 | 15 Policy & Regulation Analysis E nergy networks enjoy a relatively shel- tered existence, but this is changing as their roles becomes more central to a changing energy system and scrutiny increases. In line with this, Ofgem recently published a new-look set of annual reports detailing how well energy networks are doing in relation to measures set out in their regulatory settlements. Overall, networks operators will be pleased with their reviews. Ofgem had rela- tively few "could do better" comments to hand down. National Grid Gas Distribution disappointed in terms of customer satisfac- tion levels and Scottish Hydro Electric Trans- mission was mildly rapped for lagging behind its classmates on SF6 leakage reduction. However, taken across the board, the RIIO annual reports say networks are driving up service levels – and earning many millions of pounds in regulated rewards – while also underspending their investment allowances. That is a nice mix for shareholders, and investors will have been particularly pleased to see Ofgem's calculations on the return on regulated equity (Rore) that networks can expect across their eight-year price controls. Rore levels vary across individual net- works and network type – gas distribution had the highest Rore (12 per cent) while power distribution included the lowest (7.2 per cent). Overall, networks are enjoying a Rore of around 10 per cent. It is not a figure that pleases everyone. On seeing the updated Rore figures, Citi- zens Advice swily concluded that networks are earning excessive profits which could be redistributed to reduce UK energy bills. In a blog, the charity's senior policy researcher, Morgan Wild, said the 10 per cent returns being reaped are "huge" for regu- lated monopoly businesses. "Given networks are a major component of energy bill costs (around a quarter), it's crucial to answer whether these profits are justified," he said. It will come as no surprise that Citizens Advice concluded they are not. The argument runs that as low risk enter- prises that are "too big to fail", networks are a safe stock for investors and their return on capital should be low compared with riskier businesses. In fact, analysis carried out by Citizens Advice shows network returns are double the UK-wide long-run average of around 5 per cent. Networks are also earning much higher returns than comparable com- panies like water networks. The nub of the problem is the generous cost of equity that Ofgem has given them, says Citizens Advice. While it looks kindly on the general prem- ise of rewarding companies for good work – and recognises the need to increase network risk appetite in order to stimulate innovation – the charity is firm that offering lavish cost of equity levels is the wrong approach. Tiny adjustments to the current cost of equity for networks could "mean hundreds of millions of pounds in difference to the amount consumers pay", said Wild's blog. For example, a 0.1 per cent reduction in the cost of equity "would reduce consumers' total networks bill by around £190 million over the course of the price controls". Ofgem cannot move to change the current cost of equity for networks until the end of the RIIO 1 cycle. But with preparations for RIIO 2 soon to begin, Citizens Advice is urg- ing the regulator to make the issue a central consideration. In reply to these concerns about network returns, Ofgem issued a statement saying it was "determined" to ensure customers got the "best possible deal" from their net- works "both in term of service and value for money". It also pointed out that, since we are only half way through even the most advanced of the RIIO cycles, any calculation of profits over the whole eight-year period is still speculative. That said, Ofgem has indicated that it is open to some substantial changes to the RIIO framework in its second iteration. The eight-year period itself is up for review and there may be tweaks coming for the innovation incentive regime to promote greater risk-taking, involvement of third par- ties and transfer to businesses as usual. Alterations to the cost of equity for net- works could easily be added to the regula- tor's to-do list. Aer all, as chief executive Dermot Nolan has said: "When you set up a new regulatory framework, you're never going to get everything right." Networks' RIIO report card Ofgem's annual reports into how well networks are measuring up under RIIO gives them the thumbs-up, but critics say they are making excessive returns. Jane Gray reports. Report highlights News about the contents of Ofgem's annual RIIO reports was dominated by the criticism of network returns by Citizens Advice. But here are a handful of other insights: • A mid-point review for gas transmission slashed National Grid Gas Transmission's spending allowance for RIIO-GT1 by £168.8 million. Consequently, it moved from a forecast out performance for the eight years (with an underspend of 0.4 per cent), to anticipating an overspend of £192 million (9 per cent). • National Grid Gas Distribution is the only gas distribution network not to meet required standards for customer satisfac- tion. It missed its target scores for customer views on planned interruptions and on con- nections. It received a £1.6 million penalty in 2016 for this failure. • In the first three years of their price control, electricity transmission owners (TOs) earned a collective £60 million in outper- formance rewards. • Scottish Hydro Electric Transmission was the only TO to underperform on SF 6 leak- age. It got a penalty of £50,000 for this for the year 2015/16 and a retrospective pen- alty of £400,000 for SF 6 leaks for the year 2014/15 because errors were discovered in its reporting. • In the first year of their price control, elec- tricity distribution companies earned a col- lective £160 million in rewards for improved customer service. The four annual RIIO performance reports can be downloaded from Ofgem's website.

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