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Ofgem Proposes £25 Billion to Transform Great Britain's Energy Networks

July 29, 2020
Investment program to deliver emissions-free green energy for Great Britain with world-class service and reliability.

Ofgem has unveiled proposals for a five-year investment program of around £25 billion (US$32.4 billion) to transform Britain's energy networks to deliver emissions-free green energy for Great Britain along with world-class service and reliability. Investment in the networks that transport energy round Great Britain is likely to rise to ensure they can deliver clean energy and meet government targets for a net-zero emissions Great Britain. This investment will also help generate green growth and employment.

Given the scale of green investment likely to be needed in the future, Ofgem is keeping costs as low as possible for consumers by proposing the lowest ever rate of return on capital for network companies and pushing companies to be much more efficient in how they run themselves.

Jonathan Brearley, Ofgem's chief executive, said: "Ofgem is working to deliver a greener, fairer energy system for consumers. This is why we are striking a fair deal for consumers, cutting returns to the network companies to an unprecedented low level while making room for around £25 billion (US$32.4 billion) of investment needed to drive a clean, green, and resilient recovery.

"Now more than ever, we need to make sure that every pound on consumers' bills goes further. Less of your money will go toward company shareholders and more into improving the network to power the economy and fight climate change. Ofgem's stable and predictable regulatory regime will continue to attract the investment Britain needs to go further and faster on decarbonization."

In order to further support green recovery, Ofgem has asked network companies to come forward with additional ideas on bringing forward investment plans in the current price control. Under the proposals, Ofgem is allocating £25 billion (US$32.4 billion) upfront expenditure to maintain and operate Great Britain's gas distribution and gas and electricity transmission networks as well as support the growth of green energy.

Ofgem is also proposing to unlock significant additional funding to drive green emissions-free energy and infrastructure upgrades that companies can access over the next five years as needed. This could see potentially another £10 billion (US$12.9 billion) or more of net-zero investment supported through price controls, and more if needed. Ofgem will scrutinize every investment and only give the green light to measures that deliver decarbonization at the lowest cost to consumers.

A new Strategic Innovation Fund, together with funding to individual companies for network innovations, will provide £630 million (US$817.1 million) to drive research and development (R&D) in crucial green energy projects and help expand the range of possibilities for decarbonizing the heat infrastructure, such as hydrogen, with the potential to fund more if needed.

Ofgem's proposals nearly halve network companies' allowed rate of return, so that consumers' money go less toward network companies' profits and more toward driving network improvements. This would save £3.3 billion (US$4.3 billion) over the next five years for gas and transmission sectors alone.

Additionally, Ofgem is proposing to cut over £8 billion (US$10.4 billion) from companies' spending plans by setting them stretching efficiency targets and disallowing costs that they have simply not justified as delivering value for money for consumers. It is now up to the companies to come back and provide more robust evidence on why this expenditure is needed.

Ofgem's proposals, as they stand, would lead to an expected £20 (US$25.9) fall in network charges on bills per household a year at the start of RIIO-2. This would help offset the increase in investment and charges expected later in price control.

Ofgem's analysis and experience shows that because of stable earnings and a supportive regulatory environment, Great Britain's energy networks are a low-risk and attractive sector for investors. Strong evidence from water regulation and Ofgem's offshore transmission regime shows that investors will accept lower returns and continue to invest robustly in the sector.

These proposals are part of Ofgem's draft determinations for the RIIO-2 price control for transmission and gas distribution network companies. A separate RIIO-2 price control for the electricity system operator (ESO) will boost funding and activities of the ESO to prepare to operate a zero-carbon electricity system.

The recent announcement does not apply to price control for the electricity distribution sector, which runs from 2023 and on which Ofgem is consulting separately later this summer.

Delivering value for consumers

  • Ofgem's proposals, based on current market conditions, set a cost of equity at 4.2% (in CPIH real terms) but the allowed baseline return on equity for network companies is set at 3.95% (CPIH) for a notional company with 60% gearing. The proposed gap between allowed return on equity and cost of equity represents Ofgem's judgement, based on past experience and the proposed RIIO-2 incentives, as to the minimum degree to which companies can be expected to outperform their allowed return on equity.
  • This proposed allowed return is almost 50% lower than under the previous price control (RIIO-1) and the lowest ever capital rate for energy network companies. A lower allowed return on equity of 3.95%, combined with a lower allowed return on debt, would reduce costs passed on to consumers by £3.3 billion (US$4.3 billion) over the five years of the RIIO-2 price control period (2021 to 2026) when compared with RIIO-1.
  • The savings figures include only the transmission and gas distribution networks over this five-year price control, and exclude the electricity distribution networks. The electricity distribution sector price control (ED2) runs two years behind the other sectors and decisions are still subject to further consultation. The measures differentiating allowed return on equity and cost of equity do not apply to the ESO.

Greener energy

  • Mechanisms to flex allowances to meet net-zero investment needs, with large pots of 'reopener' funding available throughout the price control for larger-scale net-zero emissions projects. Potential projects indicated by companies could include a motorway charging network for electric vehicles (EVs) and potential plans to connect renewables along the East Coast. These and other projects are costed by companies at £10 billion (US$12.9 billion), but more funding can be considered if necessary.
  • A minimum of £630 million (US$817.1 million) in innovation funding available for energy companies to do more R&D in green energy, including low-carbon alternatives to gas heating such as hydrogen.
  • £500 million (US$648.1 million) funding to reduce the networks' own impacts on the environment including visual impacts, emissions from gas transmission compressors, resource use, and waste.
  • £3 billion (US$3.9 billion) upfront funding to connect green electricity sources and transmission grid upgrades to make sure the network is resilient and copes well with rising levels of renewable power in the energy mix.
  • Increased funding for ESOs to deliver their 2025 commitment: "An electricity system that can operate carbon free."

Resilient network, better service

  • Over £6 billion (US$7.8 billion) funding to maintain, replace, and repair network assets, and funding for network resilience (including physical security, IT, and cybersecurity upgrades). More could follow in the future as needs become clearer.
  • Greater protection for consumers against poor service in gas distribution, including doubling consumer payments for failing to meet minimum standards.
  • £30 million (US$38.9 million) for gas distribution companies to spend on improving service to consumers in vulnerable situations and improve carbon monoxide awareness.

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