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Ofgem referred to CMA on networks

CMA logoWhy settle for one when you can have two?

That could be mistaken for the policy of the UK energy market following the announcement of a second Competition and Markets Authority investigation into the energy market.

This time though it isn’t Ofgem referring the suppliers to the CMA, as was the case in 2014 and which has recently released its initial findings (clearing the suppliers of much of Ofgem’s claims).

No, this time the tables have been turned, and British Gas have reported Ofgem for investigation.

This second CMA inquiry focuses on Ofgem’s latest price settlement for five of the six electricity networks that transport the energy from the generating plant to the meter.

The subject of the inquiry will be Ofgem’s RIIO-ED1 settlement, a £17bn eight-year price settlement that Ofgem had claimed provided great value for money.

The five companies Northern Powergrid, UK Power Networks, Electricity North West, SSE and Scottish Power have their budgets set by Ofgem based on claimed costs and any underspend can be retained as profit. Historically these have been seen as too generous on the cost side making underspend a matter of course. Ofgem had committed to cracking down on such constructs.

However from the off the new regime has called controversy. Northern Powergrid has already appeal against its settlement and British Gas is not the only party to criticise Ofgem’s apparent largesse in agreeing this latest settlement after the Energy and Climate Change Select Committee claimed Ofgem had been too generous in their financial awards.

A spokesman for British Gas said:

“[Ofgem’s] settlements determine network operators’ earnings for the next eight years, which are ultimately paid for by energy customers through their bills. There is evidence to suggest the settlements are too generous to the network operators and the costs to consumers are too high.”

Martin Brough, analyst at Deutsche Bank, summed up the latest blow to Ofgem’s authority saying:

“[This referral] is an unprecedented direct attack by British Gas on the network companies and means that the CMA could be reviewing all aspects of the energy industry”.

Ofgem reacted to the announcement of two appeals saying:

“We stand by our decision and will work with the Competition and Markets Authority as it considers two appeals. These appeals come from opposing directions, with one believing our decision was too tough and the other saying we could have been tougher.

“Ofgem believes our decision delivers the right balance between ensuring value for money for consumers and investment for a reliable network”

The British Gas appeal has highlighted the claimed issues of double-recovered revenues, Ofgem’s approach to asset life policy, the assumed cost of debt in the calculations as well as numerous procedural errors they believe have been committed by the regulator in determining the price control.

Tim Yeo, the Chairman of the energy and climate change select committee of MPs went further in his direct criticism of the regime:

“Ofgem has created a new regulatory framework designed to ensure that network costs are competitive and that profits are not excessive, but there is clear evidence that the companies are making higher profits than expected.

“Network costs are one of the main reasons .. fuel bills have risen in recent years.

“Ofgem must get its act together and scrutinise these near monopolies more effectively. Simpler charging methodologies are needed to strengthen the market’s ability to scrutinise costs and increase the pressure for greater cost-saving efficiencies.”

“[Ofgem have been] too generous and performance targets too low”.

“[The] barriers preventing smaller players from entering the market must be removed to drive down costs for consumers.”

Reacting to Ofgem’s chief executive Dermot Nolan’s claim that proof of the value in their settlement would take the full 8 year term to be realised was met with derision by Yeo who pointed out:

“This is too long for hard-pressed consumers to wait.”

Reacting to the three-fold attack an Ofgem spokesperson claimed:

“Our regulation has delivered value for money. Britain’s energy network is 17% cheaper in real terms than 25 years ago, £80bn of investment has been secured, and reliability has improved by 30%.

“We are in the process of implementing a number of the actions the report highlights, including introducing more competition to networks and looking to increase the notification period of network charges. Additionally, we estimate that our innovation stimulus will see companies realise around £900m of benefits to consumers in the next eight years.”

The network settlement arrangements overseen by Ofgem have long been flawed with little incentive for parties to be transparent on costs, and limited oversight from the regulator. These issues were supposed to have been addressed through the implementation of the new methodology, but given the same issues are being challenged once again this appears to be in doubt. Indeed Ofgem’s claims of needing to wait 8 years to see whether this will have been a success is typical of the sit and wait attitude of the regulator.

With network costs one of the few elements of the energy price that consistently grow, alongside social and environmental obligations (government taxes and levies, the controversy on network costs is unlikely to abate.

For their part the CMA have potentially a larger opportunity to directly impact the cost of energy through this latest investigation than through the initial one with regards supplier activity. Like the initial CMA conclusions on that first investigation, one can be assured that that was an outcome Ofgem had not expected.