Ofgem caps equity returns at 4.3%

UK energy regulator Ofgem has ended its consultation on price controls for network operators, confirming a methodology that would result in an allowed return on equity of 4.3 percent.

The “tough, fair settlement” ends a consultation period from December, when the regulator announced it was looking to impose a 4 percent return on companies running the gas and electricity distribution networks in the country. The proposed range for the regulatory regime – dubbed RIIO-2 – is set to come into effect from 2021.

The controls are almost 50 percent lower than the current regime and the lowest-ever capital rate for energy network companies. Ofgem said the allowed baseline return on equity of 4.3 percent in a cost of equity range of 4.0 percent to 5.6 percent, combined with a lower allowed return on debt, would reduce costs passed on to consumers by £6 billion ($7.5 billion; €6.7 billion), over the five years of the RIIO-2 price control period (2021-26) compared with RIIO-1. December’s proposals would have cut the costs by £6.5 billion.

However, the final savings for consumers will depend on other factors, such as operating expenditure. Ofgem will make a final decision on these aspects in 2020 after companies have submitted their business plans, the regulator said.

Ofgem added that a “strategic fund” will be set up to support “large transformational investments” to improve the system. It also said it will increase support to companies helping “vulnerable” consumers, by providing incentives for companies to take such vulnerability into account, without providing further details. Ofgem had not responded to a request for comment by the time of publication.

“Our proposals are on track to deliver a tough, fair settlement that strikes a better deal for consumers,” said Jonathan Brearley, executive director for systems and networks at Ofgem.  “Lowering the cost of capital for network energy companies will put money back into consumers’ pockets while service standards are required to remain high.”

He added: “Under our price controls, the cost of transporting a unit of electricity around Britain has fallen by 17 percent since the mid-1990s, relative to the retail prices index.”

‘Damaging impacts’

The proposals have failed to convince the industry, despite the marginal increase in the cost of equity return from the December consultations, according to a statement from industry group Energy Networks Association.

“These proposals, if implemented, will have damaging impacts on the energy networks’ ability to deliver the government’s plans for clean growth and the wider economy, undermining efforts to build a smarter, more efficient energy system for the public,” said David Smith, chief executive of the ENA. “Costs are down, power cuts are at record lows and the amount of renewable energy connected to the grid is at an all-time high. Ofgem needs to build on this track record.”

The industry was the subject of scrutiny following the release of the UK’s opposition Labour Party’s policy to nationalise the companies operating in the space earlier this month, with the party criticising what it sees as the companies’ excessive profits and under-investment in decarbonising the network.

One such company, Cadent Gas, last week reached a £44 million settlement with Ofgem, comprising a £24 million payment to Ofgem and the establishment of a £20 million fund to help consumers in vulnerable circumstances.

The fine was imposed for the company’s past failures, which included leaving customers without gas longer than they should have been; missing records of 775 high-rise blocks of flats, which meant they were not part of its regular inspection or maintenance programme; and failing to pay compensation over a six-year period to roughly 12,000 affected residents left without gas for over 24 hours as required.

The fine relates to events that occurred when the company was owned by National Grid as well as under its current owners, a consortium comprising Macquarie Infrastructure and Real Assets, China Investment Corporation, Allianz Capital Partners, the Qatar Investment Authority, Hermes Investment Management, Dalmore Capital and Amber Infrastructure. The consortium acquired a 61 percent stake in the company in March 2017.