For decarbonisation’s sake, drop the shareholders-vs-customers rhetoric

Ofgem’s RIIO-2 framework provides few benefits to investors, consumers or the system itself. It’s time for regulators to think beyond the status quo.

When Jonathan Brearley took over as chief executive of Ofgem on 1 February, he had little idea of the turbulent opening to his tenure that would ensue – a dramatic event that probably expedited several of the plans he had outlined to the bosses of the UK energy regulator in order to win the job.

Predictions of global pandemics aside, Brearley would have known he was likely to receive a backlash from industry in its response to last month’s release of the RIIO-2 price control framework. In it, Ofgem has proposed to nearly halve the allowed returns for electricity, gas transmission and gas distribution companies between 2021 and 2026. Ofgem has proposed an allowed cost of equity return of 3.9-4.2 percent, down from RIIO-1’s 6-7 percent.

In an interview with The Times this week, Brearley confessed to being an “energy geek” when revealing his favourite TV show to be Chernobyl, the series depicting what led to the destruction of the Soviet nuclear reactor and its aftermath. Industry critics might also accuse him of leaving a trail of destruction with RIIO-2.

The price review “fails on net zero”, according to SSE. It “jeopardises the energy transition”, added National Grid. Scottish Power, for its part, went personal: “This was Jonathan Brearley’s first big test as the new Ofgem chief executive and he’s flunked it.”

Although Ofgem said its proposals would generate about £25 billion ($31.3 billion; €27.7 billion) of investment to deliver an emissions-free network, critics argued they did not provide companies with sufficient incentives to make these investments. Worse, the proposals could even prevent companies from doing so.

This is, in part, a situation of Ofgem’s own making. A day after announcing Brearley’s appointment in October, the regulator released its State of the Energy Market report in which it admitted its own past errors, such as “a conservative approach taken to setting allowances to avoid the perceived risk of under-investment”.

Ofgem has tried to address this and the need to reduce consumer bills with RIIO-2. Unfortunately, the new proposals, coming with the self-congratulatory announcement that customers would save £20 per year on bills, do little to address either issue.

Investors’ interest in such assets has waned in recent years under the twin threats of regulation and nationalisation. However, with other sectors facing uncertain times, the price review could have been an opportunity to reawaken interest in what are truly secure and stable assets.

“The problem with regulated assets in the past few years has been the regulation of those assets,” remarked Spence Clunie, managing partner at Ancala Partners, in our mid-market roundtable, to be published next month. “These assets tend to trade when the regulatory period resets and trade on that cost of capital.”

Few regulatory reviews will lead to market participants jumping for joy – that is par for the course. Yet it feels as though Ofgem’s proposals provide few benefits to investors, consumers or the system itself. Perhaps there is a case for wider regulatory change, and the balancing of shareholder returns against customer bills is perhaps not the best way to move forward with decarbonisation.

A similar view is held by UK lawmakers with respect to water regulator Ofwat and its own measures. The House of Commons’ cross-party public accounts committee told the UK government this week that “the regulatory regime does not adequately recognise the urgent need for long-term infrastructure investment to improve resilience and the emphasis on price is overplayed”.

In his interview with The Times, Brearley hinted that some changes may be closer than they currently appear. He highlighted new power lines to cope with an increased offshore wind capacity as projects of £100 million or more, which Ofgem could be allowed to tender to outside bidders if network incumbents do not want to build them.

Brearley, though, will be hoping those potential investors still perceive the UK as the ‘gold standard’ for such assets.

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