The Competition and Markets Authority (CMA) has found that the Gas and Electricity Markets Authority (GEMA) was wrong, or partially wrong, on a number of factors relating to the RIIO-2 price control period in its provisional decisions.
GEMA – the governing body of Ofgem – published its decisions for RIIO-2 for the electricity and gas transmission and gas distribution network companies and the Electricity System Operator in February. This modified the conditions of their respective licences to give effect to the final determinations, which were published in December.
However, in March a number of companies sought permission from the CMA to appeal this decision, including Cadent Gas, National Grid Electricity Transmission, Northern Gas Networks, Southern Gas Networks and Scotland Gas Networks, SSEN Transmission, SP Transmission and Wales & West Utilities.
This was then granted to all appellants on all grounds. Now, the CMA has given its provisional determination, finding that GEMA was wrong on a number of grounds.
The first of these was that GEMA was wrong to impose the outperformance wedge, which is a downward adjustment of 25 bps to its Capital Asset Pricing Model-based cost of equity estimate made due to the expectation that there would be outperformance in RIIO-2.
While the CMA said operational outperformance in RIIO-1 and evidence on totex outperformance in previous energy price control periods provided strong support for GEMA treating the scope for operational outperformance as an important risk area for RIIO-2, there were a number of errors in GEMA’s analysis of the extent to which operational outperformance in RIIO-2 should be viewed as probable.
It added that the outperformance wedge would be a poorly targeted way of addressing GEMA’s concerns.
The CMA also partially found in favour of Cadent, Northern Gas Networks, SP Transmission and Wales & West Utilities and found in favour of Southern Gas Networks and Scotland Gas Networks that GEMA was wrong to impose the innovation uplift, which is included within the ongoing efficiency challenge.
Ongoing efficiency is a cost reduction applied by GEMA to account for expected productivity improvements in the sector, however the CMA found that GEMA made errors in aspects of its decision to set the innovation uplift at 0.2%, stating that while innovation projects do result in cost reductions, GEMA’s approach materially over-estimated those cost reductions.
However, GEMA was not wrong in setting the core OE challenge at 0.95% for capex and repex (replacement expenditure) and 1.05% for opex.
It also partially found in favour of SP Transmission and SSEN Transmission that GEMA had acted ultra vires – meaning beyond its legal power or authority – in the manner in which it sought to use a directions process to modify certain licence conditions.
The CMA also found in favour of GEMA on certain grounds, including on grounds relating to Cost of Equity, a key element of SSEN Transmission’s appeal.
Indeed, all applicants submitted that GEMA had set the cost of equity too low, and submitted evidence that GEMA had erred in its decisions on the Risk Free Rate (RFR), Total Market Return (TMR), beta, its approach to assessment ‘in the round’, its decision not to ‘aim up’ and its assessment of the finance duty.
It also provisionally concluded that the appellants had not demonstrated that GEMA erred in estimating the TMR, which it used in coming to a view on the cost of equity, as well as that GEMA’s point estimate and range for TMR were not wrong.
Additionally, it found GEMA was not wrong in setting its cost of equity allowance in the round, its approach to estimating beta were within its regulatory margin of appreciation, that there is no compelling evidence that regulators are required to aim up and GEMA was not wrong in its assessment of financeability or its application of the finance duty.
David Smith, chief executive at Energy Networks Association, said: “These are provisional findings which we will now review in detail. It is vital that the final settlement gives network companies a robust framework to invest in a sustainable, net zero energy system in the most efficient way possible for customers.”
The CMA also found in favour of GEMA in SSEN Transmission’s appeal against the decision to to move the cash flow timing risk of Transmission Network Use of System Costs (TNUoS) from the ESO to the onshore transmission operators.
SSEN Transmission alleged that it would result in a fundamental disconnect between risk and responsibility, and that there was insufficient compensation for SSEN Transmission for the additional costs arising from the cash flow timing risk, however the CMA found that GEMA was not wrong.
This follows SSE losing an appeal in March relating to two changes to TNUoS that it said could have led to transmission charges being outside the range allowed under the relevant law.
In a statement released today, SSEN Transmission said it will “continue to engage constructively with the CMA” ahead of its final decision.
Meanwhile, Ofgem’s chief executive Jonathan Brearley, welcomed the provisional findings, stating the CMA had found in favour of Ofgem on the whole and adding the regulator will continue to engage with the CMA to finalise the price controls.
