Ofgem publishes RIIO-ED1 final determination

Transcription

1 November 2014 Frontier Economics 1 Ofgem publishes RIIO-ED1 final determination FRONTIER CLIENT BRIEFING NOTE Ofgem today published its consultation on its final determination for the slowtracked GB electricity DNOs in the RIIO-ED1 price control. This follows on from Ofgem s February 2014 decision to fast-track WPD (concluding WPD s price control review early) and its July 2014 draft determination for the slowtracked DNOs. The five remaining slow-tracked companies are UK Power Networks (UKPN), Northern Powergrid (NPg), Electricity North West (ENW), Scottish Power (SP) and Scottish and Southern Energy (SSE). The RIIO-ED1 period covers 8 years from 2015/16 to 2022/23. The full suite of Ofgem documents can be found here: The briefing below provides a summary of key points of the final determination. WACC Allowed cost of equity has remained at 6.0% (post-tax real) for slow-tracked DNOs. Allowed cost of debt based on index of comparable companies debt costs (i.e. iboxx index), using the same policy as at draft determination. As in the draft determination Ofgem applies a trombone-like trailing average (meaning the trailing average will extend from a 10-year to a 20-year trailing average over the ED1 period, with the start year anchored at 2004). The notional gearing assumed is 65%. With a provisional cost of debt estimate of 2.55% 1, Ofgem s vanilla (real) WACC is 3.76% (vanilla real). This is the allowed WACC for 2015/16, but WACC thereafter depends on movements in cost of debt index. 1 Based on Ofgem s latest cost of debt indexation model published here:

2 2 Frontier Economics November 2014 Confidential Ofgem has not provided any further detail on its view of the underlying cost of equity parameter estimates. Cost allowances Total reduction relative to the revised business plan requests totalling 1.3bn (or 7.1% of revised submissions) over ED1 period. This compares to total cost reductions of 1.4bn (or 7.5% of revised submissions) at draft determination. The total cost reductions are driven by the following: Ofgem s efficiency analysis reduces expenditure allowances by 728m (3.9%), which compares to 650m at draft determination. Revised approach for RPEs reduces allowances by a further 728m (3.9%), which compares to 850m at draft determination. Further potential savings resulting from smart grids of 322m (1.7%), which compares to 400m at draft determination. Reductions are offset by increase in allowance after IQI is applied of + 445m (+2.4%), which compares to + 480m at draft determination. Impact of final determination on revenues industry-wide is a reduction of around 4.7%, compared to 5.5% at draft determination. Translates into reduction of approximately 11 in typical household bill. Benchmarking Combination of totex and disaggregated analysis continues to be used, and the weights remain the same as those used at draft determination (50% totex, 50% disaggregated). Two totex models continue to be used, based on the same cost drivers as in the Draft Determination: MEAV and customer numbers used for top-down totex model; Combination of drivers from disaggregated model used in bottom-up totex model. 2014?utm_medium= &utm_source&utm_campaign= _Daily-Alert_ &utm_content=Cost+of+debt+indexation+model+31+October+2014

3 Confidential November 2014 Frontier Economics 3 Fewer cost items excluded from benchmarking than at draft determination, and some data corrections (e.g. normalisation of MEAV data). As in the draft determination there are some specific adjustments made to account for unique features of regional networks, e.g. the specific design of the SP Manweb network. RPEs and Productivity Productivity adjustments of between 0.8 and 1.1% per annum across DNOs based on DNO submissions, which represents no change since draft determination. RPEs allowances 728m lower than DNO plans. No RPE for 2013/14 due to having outturn data; No specialist labour premium in early years but premium included in later years; Small uplift in allowances to account for private sector premium over general wages; Retain adjustment to reflect change in ONS RPI methodology, reducing RPE allowance by 0.4% per annum. Figure 1 shows Ofgem s RPE forecasts for totex (excluding productivity). Figure 1. Ofgem s RPEs calculations Following its consultation, Ofgem has decided not to introduce an uncertainty mechanism for RPEs. Incentives Ofgem s RoRE analysis shown in Figure 2.

4 4 Frontier Economics November 2014 Confidential Figure 2. Ofgem RoRE analysis Source: RIIO-ED1 Final Determination Analysis suggests all DNOs could have a potential to earn RORE above 10%, and poor-performing companies could earn very low (less than 2%) returns. No substantive change to outputs framework or targets. Primary outputs specified in 6 categories: safety; environment; customer service; connections; social obligations; and reliability and availability. The IQI policy has remained the same as at draft determination, with the break-even point being 102.9%. However, all components in the calculation are now calculated post-tax. This increases both rewards and penalties versus draft determination. Final IQI results are shown in Figure 3. These compare to fast-tracked DNO efficiency incentive rate of 70%, and ex ante reward of 2.5% of totex.

5 Confidential November 2014 Frontier Economics 5 Figure 3. IQI results The resulting efficiency incentive rate for each DNO is shown in Table 1. Table 1. RIIO-ED1 Efficiency Incentive Rates ENWL 58% NPg 55% UKPN 53% SPEN 54% SSEPD 56% WPD 70% Uncertainty mechanisms Figure 4 shows the full set of RIIO-ED1 uncertainty mechanisms. Two new mechanisms have been introduced at the Final Determination: reopeners for exploding link boxes and burying subsea cables (SSEH only).

6 6 Frontier Economics November 2014 Confidential Figure 4. RIIO-ED1 uncertainty mechanisms Frontier Economics Limited in Europe is a member of the Frontier Economics network, which consists of separate companies based in Europe (Brussels, Cologne, London & Madrid) and Australia (Melbourne & Sydney). The companies are independently owned, and legal commitments entered into by any one company do not impose any obligations on other companies in the network. All views expressed in this document are the views of Frontier Economics Limited.