Ofgem announces RIIO-2 methodology amidst strong reactions from energy industry

Regulator cuts the cost of equity of networks to reduce costs to consumer by £6bn over five years.

After a consultation announced last year and amid ongoing nervousness from many industry players including National Grid, Energy Regulator announced its response to the consultation and revealed its sector-specific decisions on methodology for the RIIO-2 price controls from April 2021.

The biggest headline was the cut in the allowed return on equity for energy providers to an average of 4.3% over five years, based on current working assumptions.  Ofgem had previously stated, when the consultation process started in December 2018, that it intended to significantly reduce the cost of equity, using its favoured methodology, to a four percent baseline - 50% lower than the existing RIIO-1 framework.

The core decision document released by Ofgem also revealed a consolidation of the six key outputs from RIIO-2 to just three:

  1. Network companies must deliver a high quality and reliable service to all network users and consumers, including those in vulnerable situations.
  2. Network companies must deliver a safe and resilient network that is efficient and responsive to change.
  3. Network companies must enable the transition towards a smart, flexible, low cost and low carbon energy system for all consumers and network users.

The consolidated outputs and the cost of equity decision - which effectively reduces network costs passed on to consumers over the period by £6bn compared with the RIIO-1 figures - was met with strong reaction from the industry. 

In a statement from The Energy Networks Association, CEO David Smith commented: “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. 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.

He added: “The approach needs to evolve in response to experience and the lessons learnt under the RIIO-1 price control. Central to this is ensuring that Britain’s energy networks are able to continue to attract significant levels of investment over the next decade and beyond, at lowest cost to the consumer.”

Scottish and Southern Electricity Networks (SSEN) also reacted strongly, stating: “Although Ofgem has revised its position in some areas, SSEN retains its concern, as set out in its response to Ofgem’s consultation, that the proposed framework fails to fully balance stakeholder and consumer needs with the requirement to provide investor confidence and attract the significant investment needed to enable the clean energy transition.

“In particular, SSEN remains very disappointed with the proposed Cost of Equity range which runs contrary to the independent analysis provided to Ofgem on the level of risk inherent in the delivery of critical electricity transmission infrastructure.”

However, Citizens Advice CEO, Gillian Guy, rallied to Ofgem’s defence: “Energy networks have been able to overcharge customers by £7.5 billion under the current price control. This announcement takes us another step towards a settlement that prevents this from happening again.”

She continued: “Ofgem has made significant progress so far, but the acid test will be the final outcome. The regulator will face intense industry pressure to water down these measures in the coming months. It must hold its nerve and deliver a price control which is good value for consumers.”