How we could simplify the next network price controls
Blog
James Veaney
Publication date
Industry sector
- Distribution Network
- Transmission Network
A core part of Ofgem’s role is to set price controls for energy network companies where we decide on the total amount of revenue the companies can earn over a set period.
Energy network companies are monopolies, so the price controls protect customers as they stop companies from charging unjustified prices to consumers for using the grids.
Since 1990 network companies have invested around £100 billion in the national and local grids. In the coming decades the companies will need to deliver billions more in additional investment to connect more low carbon electricity generation and adapt to changes in how energy networks are used.
A key part of each price control review are the business plans we require network companies to submit setting out how much money they need to deliver investment and services. We review these plans and decide what the costs should be for network companies to meet customers’ needs efficiently. They then recover these costs through charges on customers’ bills once the price control is underway.
Incentives for accurate business plans
The current RIIO price controls have arrangements in place to give the companies incentives to produce accurate, well-evidenced business plans. In the past it may have been in the companies’ interests to ask for higher spending allowances than they needed. Once the revenues are set, they keep a share of any savings they make by delivering investment and services for less compared with their forecasted costs. The remainder of the savings are passed back to customers. This incentive is good for customers because it helps reduce costs over time, providing the savings are down to innovation or efficiency.
It is Ofgem’s job to spot where companies’ are bidding for higher allowances than they need. The current price control has arrangements in place to help our scrutiny of business plans as the companies have incentives to produce ambitious plans that reflect great value for money for customers. We are seeking to make these incentives more effective in the next price controls from 2021 onwards.
Should the Information Quality Incentive be removed or refined?
In the current price controls the information quality incentive (IQI) allows the companies to earn extra revenue for giving us more accurate business plan forecasts. Put simply the closer their actual spending matches their forecast spending the better off they will be. By encouraging the companies to spend efficiently we can also set a lower cost allowance. However we are not sure how effective the IQI has been, as companies have generally spent well below what they forecasted. In our consultation on the framework for setting the next price controls we are asking for views on whether the IQI should be removed or refined
Fast-tracking
We also introduced ‘fast-tracking’ when setting the current price controls where companies that produced high-quality and well-justified business plans could earn additional rewards including having their settlement agreed earlier. Across all four price controls, three out of 14 companies were fast tracked. In electricity distribution we found that this resulted in better quality initial business plans as companies competed against each other to be fast tracked.
We think fast tracking works best in gas and electricity distribution where there are 10 companies carrying out similar activities that will compete against each other for the fast track reward. For this reason we are considering retaining fast tracking for gas and electricity distribution. In gas and electricity transmission, fast-tracking did not work as well and we don’t propose to use it next time. This is because there are only four companies to compare including a single gas transmission company (National Grid Gas Transmission).
Setting price controls is a complex job but we will streamline it
Simplifying the price control settlements process will make it harder for companies to ‘game’ the system by asking for higher spending allowances or lower targets for service improvements than they need. Setting price controls will always be a complex job, but we will streamline it where possible. To successfully negotiate a tougher price control which gives the companies scope to invest, deliver world-class reliability, more innovation and new services, we must be certain that they are producing more accurate business plans at the start of the process. Doing this will increase the confidence of all consumers and network users that the next price controls will meet their needs while keeping costs as low as possible. We expect the network companies to work with us to achieve that.
Your views
We’re consulting on our price control framework proposals until 2 May: Have your say
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