Ofgem admits price control errors leading to double-digit returns

The regulator also said underspending was a factor in the high performance of electricity transmission and gas distribution companies.

The UK’s energy regulator Ofgem has admitted the allowed equity return for its current regulatory period was set too high after half of the electricity transmission and gas distribution companies achieved double-digit returns.

Some seven of the 14 companies under its watch have recorded returns of at least 10 percent during the RIIO-1 regulatory period, it said in its annual State of the Energy Market report this week. Cadent Gas and Northern Gas Networks were the highest achievers with 13 percent returns.

The RIIO-1 price controls began in 2013 and run until 2021. Its allowed cost of equity return was between 6 and 7 percent and Ofgem said this outperformance was partly due to efficiency, good performance against targets and companies’ innovations. However, it also admitted that forecasting errors were also made by Ofgem, in addition to some budgets being set too high and some targets set too low.

“To compound this, with hindsight it now appears that the allowed return on equity was set too high in RIIO-1,” Ofgem stated in the report. “This was partly because of a failure to forecast interest rates accurately, but mainly because of a conservative approach taken to setting allowances to avoid the perceived risk of under-investment. A long price control period has meant we have had to wait several years to correct these issues.”

Ofgem added that the main driver for outperformance in both the electricity transmission and gas distribution companies was an underspend in the allowance set for each company.

“The energy networks have delivered for the bill payer while playing an integral role in the move to a low-carbon economy,” said David Smith, chief executive of trade body Energy Networks Association, in a statement. “Network costs are almost a fifth lower than they were at the time of privatisation in 1990 with costs set to fall further.

“The way we deliver energy has never been more reliable, backed by record levels of investment. Nearly £4,000 ($4,883; €4,445) has been invested in gas and electricity grid infrastructure for every household in Britain since 1990, with £1,600 invested for every household between 2013 and 2023.”

Ofgem has cut the allowed return for RIIO-2 – which will have a shorter period of five years between 2021 and 2026 – to 4.3 percent, a move which the ENA said in May would have “damaging impacts” on the energy system and the decarbonisation agenda. It declined to comment further on this week’s report when asked if it agreed with Ofgem that returns for RIIO-1 had been set too high.

Excessive profits and underinvestment have also been the basis for the UK Labour Party’s plans to nationalise the sector should it take office, under plans revealed in May this year.