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UTILITY WEEK | 21ST - 27TH JULY 2017 | 19 Policy & Regulation Column Networks face tougher price controls at RIIO2 Focus in the energy sector is turning to the networks as Ofgem sets out its stall for a tougher, but more adaptable, RIIO2 price control period, says Jonathan Brearley. Those that are slow-tracked are obliged to submit revised business plans and are allo- cated a sharing factor based on their diver- gence from the information quality incentives benchmark – a composite of Ofgem's own cost estimates and the aggregated business plans of the slow-tracked networks. However, Helen Poulter, a researcher from the Exeter Energy Policy Group, told Utility Week that the system does not provide sufficient incentives for networks to submit accurate business plans and has thereby enabled them to "game the system" – a view shared by Citizens Advice. Ofgem itself concedes that the current process is not perfect. "We recognise we can improve the way we evaluate the companies' business plans," wrote senior partner for networks Jonathan Brearley in Ofgem's letter to the market. "We want to set expectations up front about the economic and efficiency costs of running the networks based on pre- vious price control information and other benchmarking." According to Huggins, this suggests Ofgem believes the allowances were set too high and that "a wide range of mechanisms did not work well at RIIO1". However, he adds that this "negative interpretation of W ith all the controversy over energy in the past few years, networks have, at times, slipped below the radar, despite the fact that they are funda- mental to security of supply and connecting new low-carbon sources of energy. Networks are now coming to the fore for two reasons. First, as we make the transi- tion to a smarter, more flexible and greener energy system, the role of the UK's networks may fundamentally change. Local, distrib- uted generation may grow and new tech- nologies, such as storage and demand-side response, mean that network services may be provided in many different ways. Second, the regime we have in place will come under greater scrutiny as we pro- gress through our first RIIO network price controls, and as we start to design our price controls for next time round. Last week we set out our vision for the next RIIO and asked questions about its design. We will evaluate what has and has not worked and how the energy and finan- cial markets might change. We will then set the framework for "RIIO2", before getting into the detailed work on costs. On the day we published our open letter, Citizens Advice published its report on RIIO, which stated that companies had made £7.5 billion in "unjustified profits". We don't agree with this assessment, but we do agree the report raises some important issues which we will address next time. We want consumer groups to be more involved in the process of setting the next price controls. Network charges make up about a quarter of an average household energy bill, or £251 a year, so it is vital that the consumer's voice is heard. Regulation of monopoly assets like networks has always been about striking a balance between getting the cheapest possible deal for consumers and attracting sufficient low-cost investment to deliver the service required. We accept that investor returns for RIIO have been at the high end of our expectations, in part due to companies making efficiency savings. Given the shi in financial markets since 2008, evidence suggests that inves- tors may accept a lower cost of capital next time round. So, to keep delivering good value for consumers, RIIO2 is likely to be tougher for investors. It may also need to be more adaptable to allow networks to respond to the unfolding energy transition and meet customers' changing needs. Jonathan Brearley, senior partner, networks, Ofgem cost outperformance" is not the only way of looking at things. "There is also an alternative and plau- sible, complementary explanation for out- performance. Ofgem has put in place strong incentives to encourage cost outperformance, so perhaps shouldn't be surprised when such out- performance subsequently appears." He said the underspends achieved by networks could be "evidence of the suc- cess, not the failure, of its high-powered incentive arrangements". Maxine Frerk, director at Grid Edge Policy, says cost setting has "always been a prob- lem" for regulators. "I think what we've got now is more transparent, which is probably a good thing, but it does put things in the spot- light a bit more," she says. Frerk disputes the suggestion that some networks may have been tempted to delib- erately forgo being fast-tracked in a bid to secure higher allowances. She claims the "big rewards on the table" have been suc- cessful in luring networks down the fast- track route and ending the old "game" between the company and regulator to "see how much they could get away with". Millhouse Power director Dave Openshaw says the accelerating pace of change in the sector means forecasting costs in advance will become "ever more difficult" in future for both networks and Ofgem. "Therefore, do you need a more flexible, agile form regulation that adapts on an annual basis to what is actu- ally materialising?" Up until now, networks' profits have largely escaped the national media scru- tiny placed on the earnings of suppliers. This is unlikely to continue, given networks' growing importance to the transformation of the energy system and the increased political consciousness around liv- ing costs. If Ofgem wants to shield itself from the headaches it has faced in the retail sphere, it will have to do everything it can to reinforce the legitimacy of the RIIO2 settlement pro- cedure. What exactly this entails is open to debate, but the willingness the regulator has shown to tackle critics' concerns head on is a sign of things to come. "There is also an alternative and plau- sible complementary explanation for out- performance" MIKE HUGGINS, DIRECTOR OF FRONTIER ECONOMIC'S ENERGY PRACTICE