Energy networks should prepare for tougher price controls
- Distribution Network
- Supply and Retail Market
- Transmission Network
- Generation and Wholesale Market
- Energy system is going through unprecedented change and next price controls will be more adaptable so companies can better meet customers’ needs
- Ofgem’s price controls have driven significant improvements in reliability and customer service at reduced costs
- Investors need to prepare for lower returns from 2021 with tougher price controls to maintain good value for customers
Ofgem has today made the first steps towards setting tougher price controls from 2021 for the companies that run Britain’s energy networks.
Britain’s energy system is evolving at an unprecedented pace and the scale of this investment challenge is significant. Over one million kilometres of pipes and wires need to be updated and maintained to deliver reliable energy supplies for consumers. By 2020, our price controls will have enabled around £80 billion of investment in transmission and distribution infrastructure since privatisation, while reducing network costs by 17 per cent over the same period.
Price controls need to evolve to meet the rapidly changing and uncertain needs of an energy system where, for example, renewable generation has gone from 5 per cent of capacity to 24 per cent in 10 years. There is great deal of uncertainty about the speed and direction of change: for example, the uptake of electric vehicles and the electrification of heating could have a profound impact on the power network.
Ofgem needs to set price controls that will attract global investment, while ensuring consumers get value for money. Ofgem believes there is strong evidence that investors are increasingly willing to accept lower returns for investing in the very stable regulatory framework that Britain offers.
Ofgem is signalling today that companies need to prepare themselves for a tougher round of price controls from 2021. This is in line with other utility regulators, as there is clear evidence pointing towards the cost of investment required for networks (cost of capital) being significantly lower.
Jonathan Brearley, Senior Partner, Networks, said: “Ofgem is working to ensure that customers pay no more than they need to for energy networks while still benefiting from improvements in reliability and service. That is why in launching the new round of price controls, we are looking at what lessons we can learn to improve further the RIIO framework for consumers.
“Our stable regulatory regime appeals to investors. We believe current market evidence suggests that they may be willing to accept lower returns for regulated assets. Setting tougher controls will ensure that Britain’s energy networks deliver even better value for customers.”
Company performance in the first four years of the existing price control has been towards the higher end of expectations, although consumers have benefited as efficiency gains have been shared with consumers in the form of lower charges – down 6 per cent since the start of the control.
Ofgem is continually driving further savings and has so far secured an additional saving of over £4.5 billion for consumers by a combination of reduced revenues or voluntary contributions from companies. Ofgem is continuing to engage with network companies to drive further savings.
Notes to editors
1. Ofgem has published a letter today explaining its thinking for the next controls and asking for stakeholder input into the framework for setting them. The letter shows the timeline for publishing the final framework in May 2018. See today’s Open letter on the RIIO-2 Framework
2. Under Ofgem’s regulation;
- network costs on bills have fallen by 17% over the last 30 years.
- the number and length of power cuts on local electricity networks has also almost halved since 2002; and
- customer satisfaction is at record highs for the local networks that serve consumers.
3. How do price controls work?
Energy networks are monopolies so Ofgem sets controls for the maximum amount the companies can recover to fund the operation and investment in their networks. There are four RIIO price controls - for gas distribution, electricity distribution, gas transmission and electricity transmission (for the high voltage electricity grid and the high-pressure gas main). The current gas distribution and transmission price controls run from 2013-2021. The electricity distribution price control is from 2015-2023.
Other elements of the price control include a range of financial incentives that reward improvement and penalise poor performance in customer service, connections, reliability and other areas. Ofgem also sets the cost of capital – the rate of return that companies can pay investors for providing finance. Since the 2008 financial crisis, after which Ofgem started to develop RIIO, there has been a continued shift in financial markets. Interest rates have fallen to record lows. At the same time, investors have been more willing to accept lower returns from longer-term investments in regulated infrastructure. The current cost of equity for gas distribution, electricity distribution and energy transmission ranges from 6 per cent to 7 per cent. Other regulators such as Ofwat have recently noted that current market evidence shows that the cost of equity is likely to be lower in future price controls.
The overall return that the companies make depends on a range of factors including how they perform against their incentives and how efficiently they spend compared with what Ofgem has allowed. The current forecast rate of return for energy distribution and transmission companies in 2013-2021 controls ranges from 7 per cent to 12 per cent. Their earnings across the full control are not certain as they are only around half way through it.
Ofgem will ensure that returns in the next price controls will allow companies to finance their investments efficiently. However, market conditions continue to indicate that returns in the next price controls should be lower.
4. Breakdown of the over £4.5 billion savings
Ofgem is working hard to ensure that consumers get a good deal out of the current price control. First of all, Ofgem secured a reduction of £10.6 billion in allowances (compared to company business plans) at the time the price controls were set.
Secondly, Ofgem interventions (and the price control by design) are already expected to secure an overall saving of over £4.5 billion for consumers in terms of reduced revenues or voluntary contributions from companies. This consists of:
RIIO savings summary table (£m)
|Allowance impact (15/16 prices)||Revenue/cash impact (15/16 prices)|
|Reductions to actual and bid allowances (to date)||1,294||911|
|Automatic volume driver reductions (8 year forecast)||1,165||628|
|Automatic sharing factor savings (8 year forecast)||N/A||1,636|
|Automatic Cost of debt savings (conservative 8 year projection)||N/A||1,200|
|Voluntary reductions (NGET and Cadent)||641||373|
|Voluntary rebate outside price control (Cadent)||N/A||150|
Going forward, Ofgem will continue to monitor outperformance by network companies. If companies are able to deliver the outputs set for them for less money in RIIO1, we will take this into account in setting the allowances for RIIO and ensure consumers see 100 per cent of the benefit in the next price control period. This is a normal part of the way in which incentives encourage companies to be efficient, and the benefits of this efficiency are passed on to consumers partly within the current price control period, and fully from the next price control period.
Further information for media
For further information, contact:
Tim Webb: 0207 901 7179
Mark Wiltsher: 0207 901 7006
Media out of hours mobile: 07766 511470 (media calls only)
Further information for investors
Martin Young, head of investor relations: 0207 901 7114
Ofgem is the independent energy regulator for Great Britain. Its priority is to make a positive difference for consumers by promoting competition in the energy markets and regulating networks.
For facts, figures and information about Ofgem’s work, see Energy facts and figures or visit the Ofgem Data Portal.