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Controlled ambition key as Ofgem seeks industry guidance on RIIO successor

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Image: Ofgem/Twitter.

Ofgem stressed that it will need the help of industry if it is to strike the right balance between enabling the energy transition and keeping costs to within acceptable limits, as it designs the second set of network cost controls.

Today Ofgem hosted its Future of Networks event, wherein senior partner for networks Jonathan Brearley embellished on much of the regulator’s thinking on RIIO2 (Ofgem's methodology for calculating suitable returns for network companies) and the lessons it can learn from its predecessor.

Earlier this month Ofgem published its consultation on RIIO2, providing an outline on measures it would take in an attempt to save consumers £5 billion in network costs over a five-year period.

Central to that is a cap on the cost of equity to between 3-5%, and this morning Brearley discussed a wide ranging list of topics that would ultimately feed into Ofgem’s final framework, earmarked for publication this summer.

Chief among Ofgem’s considerations however is the pace of change currently being experienced within the energy sector. Brearley said the regulator would have to take a “hard look” at RIIO1, but would ultimately want its successor to be a “step forward” to adapt to an energy world that is changing fast.

“[The] energy transition has been far swifter than experts ever expected, and it will only accelerate,” he said, citing historic projections for both renewable deployment and electric vehicle adoption against what has been realised to date.

This is at least partly why Ofgem has moved to five-year accounting periods instead of eight years. Brearley added that the regulator had to be “circumspect about what we can predict”, especially a against a backdrop of rapid change.

But while Ofgem appears acutely aware that the energy transition will be one of the key contributors to its final proposals, the matter of cost has been inescapable.

Network companies stand accused of making unjust profits from network charges in recent years, with critics of the existing framework pointing towards profit margins as high as 39%, according to analysis conducted by the Energy and Climate Intelligence Unit.

The coverage has prompted something of a war of words between the two parties and has even attracted political ire, having been referenced in committee debates and oral question sessions.

This morning Brearley said that its intended cost of equity cap was a response to market suggestions that investors would accept lower returns, but readily admitted it would be Ofgem’s responsibility to ensure that returns are kept to within both consumer expectations but also enough to maintain network companies’ financeability.

Ofgem is keen to avoid the kind of runaway profits that have become politically charged of late. For that reason a number of “failsafes” are under consideration, such as a hard cap and floor on returns and the possibility of discretionary adjustment should returns appear higher than forecast. Brearley responded to a question from the audience to confirm these were not under consideration as a toolkit or suite or tools, but merely as a range of different options to be considered.

But one of the overriding messages from the regulator today remained that this is a consultation that it cannot pursue alone.

“There is a lot for us to do but we need a lot from you to get this right… this is a decision that ultimately costs tens of billions of pounds from consumers,” Brearley said.

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