Utility Week

16 | 16TH - 22ND FEBRUARY 2018 | UTILITY WEEK Policy & Regulation Analysis F or once, the big six were out of the firing line earlier this month as the energy price focus shied to whether the distribution network operators (DNOs) are making excess profits. The spat was triggered by the publication of a report by the Energy and Climate Intel- ligence Unit (ECIU) in January. According to this study, the six DNOs posted an average profit margin of 30.4 per cent in 2016, the first year aer the introduc- tion of Ofgem's RIIO price control frame- work. The same analysis showed an average dividend payout ratio of 13.3 per cent. The results backed up a study carried out last year by the ECIU, which showed that in the period 2010-15, DNOs' profits equated to 32 per cent of revenue, around half of which was paid out as dividends. "The brutal truth is that nothing has really changed," says Matt Finch, business and economics analyst at the ECIU. He insists that a vendetta against DNOs wasn't on the agenda when the ECIU kicked off its study to investigate which compa- nies are making the biggest contribution to energy bills. However, he says the networks, which account for the second-biggest component of domestic electricity bills (27 per cent), emerged head and shoulders above the rest of the industry in terms of profit margins. 'Low risk' monopolies What makes the level of the networks' prof- its even more glaring, in Finch's eyes, is that they are what he dubs "low risk" regional monopolies. Ultimately, such high dividends are not in the DNOs' own interests, he argues: "Ofgem will turn around and ask why dividends are so high. This is just going to be a stick to beat them with." The Energy Networks Association has hit back at the ECIU research, branding it "fun- damentally flawed and misleading". It insists that a more accurate picture would be gener- ated by calculating the proportion dividends make up of companies' income once costs have been taken out. This is particularly important for net- works because their capital costs are rela- tively large. This standpoint was backed up by Ofgem chief executive Dermot Nolan in a letter to MPs. A spokesman for Ofgem confirms that the regulator doesn't agree with the ECIU's analysis of DNOs' margins. He says: "Networks are very capital intensive and they have to invest an awful lot in grid infra- structure, whereas suppliers have very little need for capital investment." And the furore over price dividends should be placed in a wider context, he adds, pointing to high levels of customer satisfaction with local grids, and with power cuts down 50 per cent since 2002. Call to reopen RIIO However, these caveats haven't cut much ice with Parliament's sizeable band of energy company critics, who have seized on the ECIU's analysis with relish. John Penrose, a key ringleader of last year's House of Commons push to curb standard variable tariffs, has added a fresh approach to his campaign on energy prices. The Tory backbench MP has persuaded 33 of his fellow MPs, including a number from the opposition, to sign a letter to Ofgem, call- ing on the regulator to look again at network rates of return at its midpoint RIIO review. He has subsequently called for the energy regulator to be scrapped over its reluctance to reopen the price control framework. The ECIU's Finch argues that the scale of dividend payouts thrown up by his research justifies such a move. "If the 2016 dividend is maintained over the price control period, DNOs will pay out £5.1 billion. If you are wor- ried about costs to customers, it's hard to justify," he says, adding that there is a case for revisiting the price control framework. "Eight years is a long time and to reopen it at the halfway point makes sense because things change." Effect on consumers However, while reopening RIIO might sound like a reasonable idea to some, in practice Networks' necks on the block An ECIU study on contributions to energy bills uncovered high dividends and profit margins at DNOs, sparking calls for RIIO to be reopened and Ofgem to be scrapped. David Blackman reports. consumers would lose out from such a move, warns Ofgem. Reopening price controls will increase the networks' perceived risk in the eyes of inves- tors, which will have a knock-on effect on customers' bills, says the regulator's spokes- man. Even a 10 basis point increase in the cost of capital would add £2 to the typical customer's bill, he estimates. It would be better for the regulator to stick by the rules of the agreed framework, he argues, adding that Ofgem has secured the return of £4.5 billion to customers so far during the current price control framework. Part of this is down to companies not needing to go ahead with projects that were planned during the current price control framework, such as National Grid's proposed construction of gas transmission pipelines in Avonmouth. In addition, where companies have achieved efficiencies during the current framework, half of the savings are returned to customers. Fresh set of controls Rather than changing the rules of the exist- ing game, Ofgem is focused on drawing up a fresh set of price controls for the RIIO 2 framework, proposals for which are due to be published in the spring. Hywel Lloyd, associate director of the Institute for Public Policy Research (IPPR), suggests the new framework could include a windfall mechanism that would allow the regulator to claw back excess network profits. Both Nolan and business secretary of state Greg Clark have pledged that the new regime should be "much tougher". The Ofgem spokesman concludes: "Companies have recognised that the pres- sure is on to improve services and the costs people pay. "RIIO was set up in 2013. Since then, market evidence suggests that investors are willing to accept lower returns than what was allowed in price controls. Since the recession people have been looking for pre- dictable, safe areas to invest in: things can be tougher."

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