A Question of Balance

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Ofgem's Latest RIIO Consultation.

Ofgem recently published its consultation on the framework for the next round of RIIO price controls and yesterday hosted a well-attended event to present its thinking.

Reading the consultation document you could be forgiven for thinking that Ofgem was pre-occupied with a single question - how to ensure that companies do not earn such high returns in future. In the 153 pages of the document there were 125 references to returns but only 2 references to vulnerable customers and 1 to affordability. It didn’t feel like Ofgem were really focussed on the full range of consumer outcomes. Every discussion whether on the structure of incentives or the length of the price control was couched in terms of which option would best enable them to limit returns.

At the event yesterday Ofgem presented a more balanced picture. The top team (Dermot and Jonathan) publicly acknowledged that they needed to put more focus on vulnerable customers going forward. There was a lot of talk about the energy transition and the need for whole system thinking. There was a recognition that incentive-based regulation had been key in driving the major improvements in performance that we have seen on the networks in recent years and an acknowledgment that there is a balance to be struck between providing strong incentives and keeping a tight cap on returns. There is a tension here and it was good to see that Ofgem understands that.

However that still leaves some big gaps in Ofgem’s thinking to date which has focussed on strengthening the consumer voice and on the financial elements of the review. The big questions about what outcomes Ofgem wants to see, how to drive whole systems thinking, how to cope with the uncertainties around the future of gas and the move to a more flexible energy system are touched on in the consultation but only as questions, with little evidence that Ofgem has yet done much thinking on these difficult issues.

Ofgem’s answer, no doubt, is that these will be dealt with in the sector specific strategies (or other parts of its work programme) but many of these issues are cross sector and have deep implications for the RIIO framework itself.

One way of dealing with whole system issues might be to redefine what falls within the bounds of the price control and whether there are categories of spend that companies are expected to undertake at their own risk but where their returns are not constrained in the same way. Or indeed categories of spend such as on connections that are currently outside the price control but should perhaps be within it. Dealing with uncertainty may mean revisiting thinking on real options with implications for how you benchmark costs or reviewing the approach to depreciation which Ofgem appear to have rejected out of hand. Similarly allowing for more regional variations in outcomes (giving consumers a stronger voice) must have implications for its thinking on fair returns. A carbon reduction incentive as floated by Sustainability First could provide a single cross sector incentive that could drive behaviour in a number of areas but needs working through.

None of these are easy issues and if Ofgem is going to have a chance of reshaping RIIO to respond to these wider challenges and the full set of consumer outcomes then it needs to be moving forward on all these fronts in the coming months. The level of returns is important but it’s only a piece of the jigsaw.