Ofgem’s RIIO-ED1 ‘Slow Track’ Draft Determinations

Economic Consulting

August 14, 2014

On 30 July, Ofgem published Draft Determinations (DDs) for the remaining 10 electricity distribution network operators (DNOs), having already agreed a ‘fast track’ determination for the four Western Power Distribution (WPD) DNOs. Since these DDs set out Ofgem’s proposed price controls for the 2015- 23 period, they are a key determinant of investors’ expected returns and the outputs and targets the DNOs need to deliver. Moreover, as the first set of price controls (albeit draft) handed down by Ofgem’s new CEO, these DDs may provide clues as to the approach Ofgem will adopt under its new leadership.

The DDs represent a tough challenge for the DNOs, consistent with the recent trend in UK regulatory decisions targeting improved affordability for consumers and reduced returns for investors. DNO charges within customer bills will be, on average over the eight year price control period, £12 p.a. lower than presently. The DDs also incorporate a number of important – and unexpected – revisions to Ofgem’s methodology, most significantly in relation to cost assessment and financial issues. Some of the key announcements within the DDs include:

  • £1.9bn of totex requested by companies has been rejected.1 While these reductions primarily relate to RPEs and smart grids which affect all 10 of the DNOs, the modifications Ofgem has made to its benchmarking methodology may have created some winners and losers;
  • a lower cost of equity – albeit one that was flagged some months ago – of 6.0% has been imposed, meaning DNOs face one of the lowest WACCs ever set for regulated businesses in the UK;
  • a revised methodology for indexing the cost of debt which better matches DNOs’ embedded debt costs; and
  • a package of rewards, penalties and incentives that Ofgem considers will enable each DNO to earn a return on equity in a range of roughly 2 – 10% (at 65% gearing).

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