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When regulators strike back

After years of being criticised for allowing bills to rocket and returns to increase, UK regulators are finally striking back. First came the water watchdog Ofwat in December, demanding UK water companies be at the heart of “profound change” in the sector and promising a “tough price review”. Last month was the turn of Ofgem, the energy regulator.

Ofgem promised a “tougher regulatory framework” and warned investors in the sector to expect a “significantly lower range of return”. The barb was aimed specifically at those owning the gas and electricity transmission and distribution networks ahead of the new pricing review from 2021. Somewhat extraordinarily for a body decried as a “toothless tiger” a few years ago, the proposals were accompanied by public criticism of one specific company – Hong Kong-based investor Cheung Kong Infrastructure.

CKI, the owner of Northern Gas Networks and Wales and West Utilities – the latter held alongside Australia’s State Super – was told by Dermot Nolan, chief executive of Ofgem, in an op-ed for the Financial Times, that it was “yet to step up” where its counterparts had done so in returning some of its profits to consumers. Barring CKI, a total of £650 million ($900.3 million; €731.5 million) has been passed on by investors to consumers, Ofgem says.

It is in the interests of all the gas and electricity distribution companies, according to Nolan, to maintain the “social contract and public trust” they have with the British public. The two networks maintained their silence in response.


CKI is one of several infrastructure investors that have been attracted to the UK’s gas distribution sector since 2005 following the break-up of the National Grid subsidiary Transco, creating the eight networks that exist today. CKI followed its initial investment in Northern Gas Networks from 2005 with its £645 million acquisition of Wales and West in 2012.

Scottish utility SSE has in recent years attracted the likes of Ontario Municipal Employees Retirement System, Ontario Teachers’ Pension Plan and Abu Dhabi Investment Authority, the latter of which paid £621 million in 2016 for 16.7 percent ownership.

The sector’s most recent investment was completed last year when the Quad Gas consortium (Macquarie Infrastructure and Real Assets , China Investment Corporation, Allianz CP, Qatar Investment Authority, Hermes Investment Management, Amber Infrastructure and Dalmore Capital) bought 61 percent of National Grid-owned pipelines, valuing the now-renamed Cadent Gas group at £13.8 billion.

Setting out the new price controls, Ofgem’s Jonathan Brearley, senior partner for networks, lapped up the plaudits by stating that it was “Ofgem’s stable regulatory regime [which] allows companies to attract investment from around the world”.

Clearly, the sector has a gravitational pull for traditional infrastructure investors. However, Ofgem’s worry is that these investments are turning out to be too much of a good thing.

“Returns across companies have been higher than we expected and do not reflect the low level of risk these companies face,” said Nolan in his opening remarks to the consultation. “We have sought to maintain an attractive environment for investors, but investors should prepare for returns that properly reflect the low level of risk that they face because of our stable, predictable regulatory framework.”

In short, Ofgem wants the above owners to accept lower returns, but to have an industry that continues to attract the same levels of investment. Ofgem said “most companies are making double-digit, or close to double-digit returns in real terms” – particularly in gas distribution – and while some of that originates from greater efficiency and good performance, it also, according to Nolan, results from changes in global financial trends; namely, lower interest rates.

This investment should not be taken for granted, however, came the warning from SP Energy Networks, which transmits electricity to about 3.5 million British consumers across 4,000km.

“Ofgem will need to think very carefully about whether their proposals encourage the necessary investment in critical infrastructure that ensures resilience of the nation’s energy supplies and that the UK also realises its low-carbon future in transport and heat,” cautioned Frank Mitchell, chief executive of SP Energy Networks.


Ofgem is indeed thinking carefully. Stakeholders have until 2 May to respond to the regulator’s consultation before it finalises the new framework in the summer. Ofgem, though, has provisionally set a cost-of-equity range for the new so-called RIIO-2 era of between 3 percent and 5 percent. This contrasts with the 6 percent to 7.2 percent range set in the previous price framework and will represent savings to British consumers of between £15 and £25 per year, the lowest ever rate proposed, according to Ofgem. Changes to the cost of debt remain under consideration.

RIIO-2 will also be set across a five-year period instead of the current eight-year one, with Ofgem wary of the rapid changes in the energy transition taking place. The new framework is also set to analyse ways in which underspending is only rewarded where companies have been proved to have discovered performance efficiencies and driven innovation.

When approached for comment, most of the network operators pointed to comments from the Energy Networks Association, which urged “balanced regulation” from RIIO-2 based “on the principles of transparency and stability to provide predictability for investors, innovators and consumers alike”.

Investors will initially be wary of the most immediate impacts, with rating agency Moody’s changing the UK water sector’s outlook to negative following Ofwat’s vow to curb returns in its own pricing review.

They will also do well to consider the current macro environment in which they are operating. Rising bills have been partially responsible for allowing UK opposition leader Jeremy Corbyn to tap into sentiments against privately owned infrastructure, promising to nationalise such assets should he and his Labour Party attain power.

Martin Stanley, global head of MIRA and the leader of the Quad Gas consortium, told us last month he believes such a scenario to actually take place is unlikely but acknowledged that shouldn’t mean business as usual.

“At the heart of it is the question of whether private ownership has delivered real value to the ultimate customers of those assets. That is a legitimate question that we should not be afraid of answering,” he said.

Ofgem awaits the response.