Legal briefing | Environment & Regulatory, Infrastructure |

OFGEM delivers a shock to network operators with RIIO-2 proposals

Overview

On 9 July 2020, the Office of Gas and Electricity Markets ("Ofgem") published their consultation on the draft determinations on the RIIO-2 Framework for the setting of price controls for the gas and electricity networks in Great Britain.

The RIIO (Revenues = Incentives + Innovation + Outputs) Framework is the Ofgem regulatory approach to ensure that UK gas and electricity networks deliver consumer value for money in the absence of a competitive market, but ensuring they have the required revenue to run the networks efficient. Given that consumers do not have a choice over their transmission or distribution network provider, Ofgem implements the RIIO framework by limiting network charges using five-year price control mechanisms.

The draft determinations, which will cover the period from 2021 to 2026, unveiled an upfront funding pot of £25 billion for investments in upgrades to the UK's energy networks; the investment proposals are targeted at the delivery of emissions-free green energy in line with the UK's legally binding target to reach net zero greenhouse gas emissions by 2050. Any investment would be scrutinised by Ofgem to ensure that it delivers both decarbonisation and value for money.

The consultation announcements have pit network operators against Ofgem given that the proposals push for operators to significantly cut down on running and financing costs, and almost halving the permitted rate of return. At the same time, Ofgem challenges network operators to invest in an aging energy grid and prepare it for future demands, particularly in light of the need to electrify transport and heat (amongst other things) and be flexible enough to accommodate up to increasing proportions of renewable energy generation.

"proposals would almost halve company earnings, saving up to £3.3bn across all sectors to help fund crucial improvements, now and throughout the price control."

Ofgem, RIIO-2

The proposals have been roundly criticised by industry, being described in such unflattering terms as "half-baked" and "a massive missed opportunity". Network operators have described the curtailing of profits as short-sighted and a barrier to private sector green infrastructure investments that are needed to help achieve the transition to net zero. Ofgem's new director, Jonathan Brearley immediately responded by saying that the proposals were based on the evidence before Ofgem, which intended to "stand firm". The Competition and Markets Authority may well be the final arbiter of whether Ofgem has struck the right balance between consumer value and allowing the sector to attract the necessary investment.

An overview of Ofgem RIIO-2 plans and the response to consultation can be found here. Comments are invited until 4 September, and the final determinations are expected to be published in December before, subject to any CMA appeal, taking effect on 1 April 2021.



JJ Ball contributed to this briefing. 

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