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Ofgem pushes forward with plans to slash RIIO-2 network returns

Image: Getty.

Image: Getty.

Energy regulator Ofgem has pushed ahead with plans to slash the cost of equity for networks under RIIO-2, confirming a methodology which, if applied today, would cut the baseline return on equity to 4.3%.

The response from the networks has been swift and strong, insisting that the current proposals would have “damaging impacts” on their ability to deliver on clean growth plans.

Ofgem confirmed its intent in a consultation response this morning, stating that by capping the cost of equity using its favoured methodology and enacting a lower allowed return on debt, it would reduce network costs passed onto consumers by £6 billion over the five-year price control compared to RIIO-1.

It did, however, stress that final savings would depend on a number of other factors including operating expenditure allowances, which Ofgem is to make a decision on next year, after network companies have submitted their business plans for approval.

Jonathan Brearley, executive director for systems and networks, said that the proposals were on track to deliver a “tough, fair settlement” that promised a “better deal for our consumers”.

“Lowering the cost of capital for network energy companies will put money back into consumers’ pockets while service standards are required to remain high.

“Our new price control for networks will pave the way for a cheaper, smarter and more sustainable energy system and is a key step in our journey to a low carbon future,” he said.

Ofgem has moved to further justify the decision by stating that its evidence base includes views that investor expectation on returns has declined since RIIO-1.

The policy decision follows a consultation in December last year, within which the regulator confirmed its intent to slash its cost of equity and set baseline returns at just 4%, equivalent to a 50% reduction on the existing RIIO-1 framework.

That consultation prompted a strong response from the country’s networks. National Grid, whose stock slid 3% following the announcement, said that cost of equity range did not “appropriately reflect the level of risk borne by transmission networks”.

The Energy Networks Association also issued a strong rebuke. The trade body’s chief executive David Smith said Ofgem needed to do much more work to understand the pace of change sweeping the UK’s energy system.

Smith followed up on those comments this morning, insisting that if today’s proposals are implemented they would have damaging impacts on the networks’ ability to adhere to the government’s plans for decarbonisation.

“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.

“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,” he said.

Citizens Advice meanwhile, a long-time critic of profits made by the country’s energy networks, has encouraged Ofgem to hold its nerve.

“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.

“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,” Gillian Guy, chief executive at Citizens Advice, said.

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