Ofgem “hands-on” in RIIO-2 as net zero route unfolds

During the next round of the RIIO price controls, Ofgem can be expected to take a more hands-on approach to outputs the networks are required to provide and the allowed revenues they can charge their users or consumers. This will have impacts for network development including the enabling of electric vehicle infrastructure, the electrification of heat, in the developing role of hydrogen, and also on the charges that network users and customers face.

In December, the regulator issued its final determinations for the five-year price controls for electricity and gas transmission networks, gas distribution networks and the electricity system operator (ESO). These start on 1 April. It also issued a decision on the sector-specific methodology – the approach to key decisions – it will apply to the price control for electricity distribution that starts two years later in April 2023.

The tools for this more hands-on approach are the reopeners, an element of the price control package. These are one tool in a suite of uncertainty measures that allow the price controls to flex for changes in circumstances, adding (or removing) funds from the baseline revenues initially determined. Other uncertainty mechanisms include volume drivers that adjust allowances automatically in line with actual volumes of work where the volume of work required is uncertain but the cost of each unit is stable. Reopeners, however, enable the regulator to consider and then change the outputs that the companies are allowed to deliver and, alongside that, the revenues that they are allowed to recover.

In the coming price controls, Ofgem has put in place an extensive range of reopeners and is likely to rely on them more than previously. They are particularly needed now because of the significant uncertainty in the route to achieving net zero, which the regulator is committed to support. It is not yet clear, for example, how fast and far the electrification of transport and of heat will develop, and how the role of hydrogen will evolve and what impact this will have on the use of natural gas.

The reopener with potentially the most profound impacts is the net zero reopener, and it will allow Ofgem to change the price control in response to changes related to meeting the government’s net zero targets. It has a wide scope, and will allow adjustments to be made for changes in government policy, the successful trial of new technologies or other technological advances, or changes in the pace or nature of the uptake of low-carbon technologies. It can be triggered only by Ofgem and at any time during the price control.

Not all reopeners are, like the net zero reopener, applicable to all sectors. For gas distribution, for example, reopeners include one for heat policy, which is aimed at allowing increases or decreases to allowances in response to changes to specific regulations and connection charging methodologies that support the transition to low carbon heat. There is also a smart meter rollout reopener that allows the gas networks to request funding for additional efficient costs incurred for the rollout programme. For electricity transmission, reopeners include for undertaking large and also atypical medium-sized investments, aimed at ensuring that the needs cases and costs receive regulatory scrutiny.

The greater reliance on reopeners will enable Ofgem to react with more flexibility over the RIIO-2 period and it is likely that they will continue to play a significant role beyond that, given the scale of the evolution in prospect for net zero. It also places greater importance on the regulator’s decision-making processes; this is also in transition. In its recent Energy White Paper, the government set out its intention to introduce a Strategy and Policy Statement (SPS) that will set out the strategic priorities of its energy policy and require Ofgem to carry out its duties “in a manner that is consistent with securing the government’s policy outcomes, including delivering a net zero energy system while ensuring secure supplies at lowest cost for consumers”. At the same time, Ofgem is starting to consider its own decision-making capabilities and processes, including the types of models and scenarios it might need in the light of the complex and interconnected uncertainties.

This means that even after the price controls have been determined, there will be important decisions – and development in the processes that support those decisions – that impact on network development and how the route to net zero unfolds.

We will examine the implications of these developments through Energy Spectrum and through our regulatory service. For further information, please contact v.simonds@cornwall-insight.com.

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