Our views on Ofgem’s RIIO-ED2 Final Determinations (decisions) for the electricity distribution sector
Ofgem has published its final decisions on the RIIO-ED2 (ED2) price control for the 6 Distribution Network Operators (DNOs). The new price control will run from April 2023 to March 2028 and lays down how much the DNOs are able to charge on our bills, and what services they need to provide for those revenues. In this blog, we put forward our views on what has worked better compared to the ED1 price control which is due to end this month. We also highlight those areas where we felt Ofgem could have gone further for consumers to save money or raise service standards.
We will be using these lessons learnt from ED2 to feed into the latest consultation from Ofgem on Future Systems and Network Regulation.
Why does ED2 matter?
The DNOs take the high voltage electricity off the grid and deliver it to homes and businesses across Great Britain. It is essential that these companies deliver in a value for money way as their costs are added to everyone’s electricity bill. About 5% of each bill are these costs. The sums can be substantial when totalled together. In the ED2 Final Determinations, Ofgem has allowed an initial £22 billion for the 5 year price control period with more allowed if needed.
Ofgem also needs to ensure that the DNOs provide services appropriately in addition to considering the cost and value of those services. These key services include having a reliable electricity supply as well as consumers being able to connect to the network for technologies such as heat pumps, electric vehicles, and sources of generation or flexibility. The DNOs have a vital role in supporting customers during an outage, especially those in vulnerable circumstances. Net zero also means that DNOs need to better manage the energy system using so-called Distribution System Operation (DSO) services (turn up or turn down generation or demand).
Our summary view of the Ofgem ED2 Final Determinations
ED2 as a whole shows progress when compared with the ED1 price control. The new ED2 framework is more adaptive to a changing environment for electricity demand and supply. Ofgem has also tightened some elements in areas such as load-related investment (to build new infrastructure) and in the sharing factors for when there are over- and underspends of allowances. These changes should work in favour of consumers and should mean that companies are less able to pick up windfall gains or easy wins. But we still think that Ofgem should have gone further for consumers in a number of areas.
Where we believe Ofgem could have gone further
Returns to companies are still too high due to Ofgem’s cost of capital calculations. We estimate that about £1.5 billion could have been shaved off bills using Ofgem’s own cross checks.
Incentive mechanisms that are intended to drive better performance don’t reflect a competitive market and it’s generally too easy to gain rewards.
ED2 was a missed opportunity to raise standards across the sector. Ofgem did not identify best practice in areas such as Vulnerability, DSO, and in Environmental Action Plans. Best practice could have been required by all companies at the outset of ED2 rather than waiting for progress during the ED2 years.
Ongoing performance monitoring of companies is not stringent enough:
- Scrutiny of individual company performance uses successor groups to Customer Engagement Groups (CEGs). These groups are too variable, can lack independence, and don’t have a consistent and clear remit explaining how to best do the role
- Ofgem needs to have much better comparative company performance monitoring in ED2. Ofgem needs to identify the reasons for success and failure, and bring laggards up to the highest standards
Innovative elements in ED2 include uncertainty mechanisms, new incentive structures, and strategies for DSO, environmental, and vulnerability topics. While these new features are welcomed and should act in consumers’ interests, the process to review the new and untested elements of ED2 isn’t always clear and some of it is still being developed. Ofgem will need to be alive to respond to what works and doesn’t work with the new processes that have been introduced. Ofgem will need to make rapid changes, where necessary, by using the checks and balances introduced in ED2 for this purpose, so that consumers get the best services at best value.
Further reading:
Read our short report for more detail about these areas for improvement for ED2 and our recommendations to Ofgem to make it work better for the future: Our views on the Ofgem RIIO-ED2 Final Determinations for the electricity distribution sector
See also our report on Future Network Regulation where we make recommendations for improvements to overarching energy sector price control frameworks and processes.
