- Publication date
- 24th May 2019
- Information types
- Policy areas
- Ofgem confirms its approach to calculating the next round of network price controls, pointing to lower company returns and cutting £6 billion from the cost of capital passed on to consumers over the course of RIIO2;
- Companies will be required to increase support to consumers in vulnerable situations, ensuring nobody is left behind by rapid changes to the energy system;
- Ofgem’s regulatory framework lays the foundations for a smarter, decarbonised energy system;
Ofgem has confirmed its methodology for calculating the next round of network price controls. The new price controls, known as RIIO-2, will deliver a smarter and more sustainable energy network that will come at a lower cost to consumers.
If applying the agreed methodology today, Ofgem would set the allowed baseline return on equity at 4.3% (CPIH) in a cost of equity range of 4.0%-5.6% - almost 50% lower than under the previous price control (RIIO-1) and the lowest ever capital rate for energy network companies.
A lower allowed return on equity of 4.3%, combined with a lower allowed return on debt, would reduce costs passed on to consumers by £6 billion over the five years of the RIIO-2 price control period (2021-2026) when compared to RIIO-1. However, the final savings figures for consumers will depend on a number of other factors like operating expenditure, which Ofgem will make a final decision on in 2020 after companies have submitted their business plans.
As part of the RIIO-2 price control framework, Ofgem will also increase the support provided by network companies to consumers in vulnerable situations, for example by strengthening licence conditions and by incentivising companies to take vulnerability into account when interacting with their customers. Ofgem will also reform current innovation funding, and provide new dedicated funding, to support projects that specifically benefit vulnerable or poorly-served consumers.
Ofgem’s regulatory framework will also facilitate the decarbonisation of power, heat and transport and the transition to a smarter energy system, enabling consumers to reap the benefits of technological change. Each company’s environmental action plan will be taken into account when funding allowances are set, and a strategic fund will be set up to support large transformational investments that improve the system as a whole.
Jonathan Brearley, executive director for systems and networks, said: “Our proposals are on track to deliver a tough, fair settlement that strikes a better deal for consumers.
“Lowering the cost of capital for network energy companies will put money back into consumers’ pockets while service standards are required to remain high.
“Our new price control for networks will pave the way for a cheaper, smarter and more sustainable energy system and is a key step in our journey to a low carbon future.”
Since 1990, network companies have invested around £100 billion in the national and local grids, operating one of the most reliable networks in Europe. Power cuts have almost halved since 2001, while customer satisfaction with local networks has improved significantly. Under our price controls, the cost of transporting a unit of electricity around Britain has fallen by 17% since the mid-1990s, relative to the retail prices index.
Notes to editors
1. The links to policy documents are here:
2. Find out more about energy networks by reading our networks fast facts.
3. Today’s announcement follows Ofgem’s consultation on the methodology of price control measures that opened in December 2018.
In the March 2018 consultation on the framework for setting the next price controls, Ofgem proposed a working assumption cost of equity range between 3% and 5% in RPI terms (4% to 6% in CPIH terms), compared with the 6%-7% in RPI terms (or 7-8% in CPIH terms) cost of equity range allowed in the 2013-2021 price control (known as RIIO-1).
In December 2018 we consulted on a methodology which indicated a baseline allowed equity return of 4% in a cost of equity range of 4%-5% CPIH. We are now indicating that, based on current market conditions, we would set the baseline-allowed equity return at 4.3% in a cost of equity range of 4%-5.6% CPIH; in other words, close to the bottom of the ranges we previously indicated. We will make a final decision on the allowed return and cost of equity for Gas Transmission & Distribution and for Electricity Transmission in late 2020.
We calculate that the projected allowed rate of equity return of 4.3% would contribute to cost of capital savings equivalent to an average of £25 per consumer per year from 2021 onwards.
4. Ofgem also published, in November 2018, proposals to introduce fixed charges to recover some electricity network charges - this would ensure that those who generate their own electricity at home or on-site pay a fair share of the charges for the grid and reduce the burden on other consumers.
These reforms could save consumers on average a further £15 per year. Combined with our RIIO-2 cost of capital reduction, this could result in cost reductions equivalent to an average of £40 per consumer per year from 2021.
5. Today’s decision relates to the price controls for gas/electricity transmission (T2) and gas distribution (GD2) from 2021 to 2026. While decisions in the methodology could, in principle, be applied we will consult separately on the electricity distribution price control (ED2). The savings figures include ED2 for completeness of the potential impact. Approximately three-quarters of the £6 billion savings noted here are due to the transmission (T2) and gas distribution (GD2) controls which begin in 2021.
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