Navigating the uncharted waters of the UK’s latest utility business model evolution
August 7, 2020

Graeme Hutchison

Changes to industry regulation pose challenges for utilities in the best of times. In a rapidly evolving business environment like today’s electricity sector, anticipating changes and maintaining regulatory alignment to current policy can have a significant impact on a business.

When Ofgem issued its latest proposed settlements (“RIIO-2” draft determinations) for the next five-year price control period, it exposed transmission companies to a higher level of risk than ever before. Some companies have responded publically with their concerns.[i] [ii] [iii]

RIIO

In 2008, UK’s gas and electricity regulator, Ofgem, introduced RIIO (Revenue= Incentives + Innovation + Outputs.). Ofgem’s RIIO framework is aimed at rewarding utilities for achieving desired outcomes and minimizing costs. Specifically, those related to greener networks, better value for money, better customer service, and safer and more reliable networks.[iv]

With Ofgem’s recent RIIO T2 draft determination, the UK electric and gas utility network companies were exposed to CAPEX allowances far lower than under the previous price controls (RIIO 1), with rates of return (RoR) more closely aligned to Offshore Transmission Operators (OFTO’s).

One of the main aims of RIIO T2 is to prepare the regulated companies to deliver ‘Net Zero’ at the lowest cost to the consumer while maintaining system reliability. Ofgem highlight that load-related and non-load-related reinforcement may rise significantly to accommodate this change; however, to balance this, they are seeking adjusted RoR and CAPEX allowances to decrease perceived inefficiencies. As a result, it is paramount that business planning, and particularly network planning strategy, is appropriately considered within this context. Network companies will be challenged to be as efficient as possible in how they run and finance themselves to help offset the need for additional investment.

As such, it is critical that Operators have a robust and coherent approach on how to present their associated business plan for RIIO going forward. Investment appraisal and network planning must evolve from the submissions within RIIO-1 to consider the use of innovation elements as ‘business as usual’ and must consider other forms of innovative solutions in the context of Distributed Energy Resources (DER) and Demand Side Management (DSM).

Rates of Return

One of the key areas of discussion within the T2 draft determinations is around the comparatively low RoR. Utilities have always been perceived as a safe investment with a consistent RoR, thus they have always been able to gain financing (and shareholders) without difficulty. This is especially the case during periods of economic strife. Ofgem believes that setting the RoRs at these historic low values will not dissuade investors. With such regular and significant regulatory changes to the determinations within the sector, time will tell if this is the case.

PSC is here to help

PSC is positioned to actively support UK utilities to limit their risk through appropriate review and to shape their CAPEX programs according to this ever-changing landscape. PSC has worked on RIIO-2 investment challenges and is well equipped to help develop business plans for submission or support utilities in responding to determinations.

Find out more about our global energy regulation and strategic advisory capabilities and contact us to continue the conversation.

 

[i] https://news.energynetworks.org/news/response-to-proposed-settlements-for-riio-2

[ii] https://www.spenergynetworks.co.uk/news/pages/sp_energy_networks_responds_to_ofgems_proposed_settlements_for_riio_t2.aspx

[iii] https://www.nasdaq.com/articles/national-grid-extremely-disappointed-with-ofgems-draft-determination-for-riio-t2-2020-07

[iv] https://www.ofgem.gov.uk/system/files/docs/2020/07/riio-2_draft_determinations_overview.pdf

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