- Publication date
- 11th March 2021
- Information type
- Policy area
- Financial arrangements boost investment to cut polluting greenhouse gas emissions from cars and unlock more flexible local grids
- Investor returns lowered by over a third to 4.4% (CPIH real), based on working assumptions, bringing record levels of green investment at lowest cost to consumers
- Wider package will support local distribution grids to meet national and devolved governments’ climate change targets
Ofgem has confirmed ambitious plans to boost investment in local electricity grids needed to support the growth in electric cars, small scale renewables, storage and cleaner forms of heating. Surface transport and domestic heating account for 34% of the UK’s greenhouse gas emissions.
Today, Ofgem has set out its working assumptions on the financial package that will be applied for the next round of price controls for local electricity networks (DNOs) starting in April 2023.
The new price controls for the DNOs, known as RIIO-ED2, will significantly boost green investment to local networks and drive a major change in the way Britain travels, heats and powers its homes to support government climate change targets (1).
It will also enhance the role of DNOs to create more flexible local grids that can balance demand and supply for electricity more effectively by connecting more small scale renewables and storage.
To offset the increased investment and make sure that consumers pay a fair price, Ofgem has confirmed it will significantly lower the proportion of money that goes back to network company shareholders.
If applying the methodology using current market rates, Ofgem would set the allowed baseline return on equity at 4.4% CPIH (a 4.65% cost of equity, when taken together with expected 0.25% income from quality / cost incentives). This is on average a third lower than under the previous price control (which is set at 7% cost of equity when adjusted to a comparable basis) (2). This is a working assumption, and not a decision on the final allowed returns for the 2023 price control.
In line with the wider RIIO-2 aims of delivering net zero while driving better value for consumers, Ofgem has set the rates of return consistent with current market levels – in line with the average for EU regulators. This makes sure Britain’s stable and reliable sector remains highly attractive to investors (3).
Taken together with Ofgem’s other working assumptions (4), including on debt and depreciation policy, these changes would, all other thing s being equal, reduce companies’ average annual revenues compared to current levels. Such changes would lower network charges on bills by around 9%, or around £2billion, over the RIIO ED2 period compared to current arrangements. This helps ensure the networks can support the new investment needed to support net zero carbon emissions while keeping energy bills affordable for consumers (5).
Jonathan Brearley, Ofgem’s chief executive, said:
“Our price control for local electricity networks paves the way for turning Britain’s streets green, unlocking the investment needed to support the UK, Scottish and Welsh Government climate change targets, particularly around the electrification of transport.
“We’re driving local electricity networks to help make sure that every watt of energy produced from plant to plug is better used, for example by ramping up their use of battery storage, saving bills and the planet.
“At the same time, these financial arrangements will significantly cut investor returns to make sure consumers pay a fair price for energy whilst networks attract the investment they need to be safe and green.”
The Price Control drives DNOs to be proactive in ensuring the local grids are ready to cut greenhouse gas emissions, as they are best placed to know where new investment is needed to accommodate increasing demands. However, in preparing their spending plans they will be required to maximise network capacity through existing and new technologies that provide system flexibility, such as battery storage or smoothing peaks in demand, that can limit the need for expensive new network capacity.
Notes to editors
(1) Electricity distribution networks (DNOs) build and run the local infrastructure that carries electricity to homes and businesses. They are monopolies, and Ofgem regulates the rate of return they can make on investment, which ultimately is paid for through consumers’ bills.
(2) Today we have published the Finance Annex from our RIIO-ED2 Sector Specific Methodology Decision. Allowed return on equity assumes a cost of equity of 4.65% adjusted for expected outperformance of 0.25%, and assumes a notional gearing level of 60%, reduced from 65% during RIIO1. We have set a working assumption that the depreciation policy proposed during RIIO1 to move from a 20-year to a 45-year depreciation period will be implemented. However, we will consider this further following receipt of the companies’ business plans later this year. For more details on the wider policy methodology, see our December 2020 methodology announcement.
(3) We estimate the proposed cost of equity will be broadly comparable with other European regulatory regimes for the same period, based on the analysis undertaken to support the Final Determinations for the Gas Distribution & Transmission (GD&T) sector. This analysis will be updated before Draft Determinations.
(4) Working assumptions have been set according to the methodology decisions made, which is consistent with that adopted for the GD&T sector Final Determinations published in December 2020. It has been calibrated to reflect sectoral differences in cost of debt allowances and updated market information for the ED specific period.
(5) This reduction assumes that levels of investment during RIIO2 will be similar to that during RIIO-1. Higher levels of investment, for example to support Net Zero, may mitigate the impact of this reduction on consumers’ bills. It is not possible to accurately estimate the final overall revenues or average customer bill values for these financial measures at this stage of the price controls, as companies have not yet submitted their spending plans.
(6) Today Ofgem has also published energy network company annual reports for 2019-20.
For media queries, contact Ofgem’s media manager Ruth Somerville
Tel: 0207 901 7460/ 07990 139504
07928 829894 (out of hours)
For investor queries, contact Ofgem’s senior manager for investor relations Aidan Stringfellow
Tel: 07387 049 764