COMMONS

Ofgem failing to keep network costs down for energy consumers

23 February 2015

Ofgem has not yet delivered value for energy consumers in its regulation of transmission and distribution networks, according to a new report. The Energy and Climate Change Select Committee raises concerns about the profits of network companies, that have been greater than expected after the first year of a new regulatory framework introduced by Ofgem to keep costs down.

Energy and Climate Change Committee Chair, Tim Yeo MP:

"The costs charged by the companies that have a near monopoly over the UK’s gas and electricity networks are often overlooked when energy bills are discussed. But network costs are one of the main reasons dual fuel bills have risen in recent years.

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

Ofgem’s Chief Executive told us that we would have to wait eight years to see whether value for money was being delivered for bill payers. This is too long for hard pressed consumers to wait."

The new regulations are an improvement on what went before, according to the report, but the MPs warn that price caps set by the regulator have been too generous and performance targets too low. The energy regulator should utilise the new RIIO price control frameworks to put more pressure on the networks to limit their costs and provide better value for consumers. Stronger incentives towards innovations in network technology are also crucial and the MPs would like to see greater incentives to connect new and smaller energy generators to the grid to increase market competition.

In the medium term, simplifications to charging methodologies would enable greater market efficiency, according to the MPs. The current system of network costs is too complex, the inquiry heard, with a combination of codes and regional charges across the country making it difficult to compare price and performance across different network companies. The complex methodologies also result in volatility in charges within regions on a year-on-year basis. This increases the costs on retail energy companies that are then passed on to consumers. The report calls for an in-depth study on the pros and cons of replacing the regional variations for network charges with a standard national tariff.

In the short term market conditions could be improved if:

  • an interim independent audit of price controls is conducted
  • the 40-day notification period network companies are required to allow for price changes is increased to 15 months
  • stronger, corrective measures are applied to network companies that have received incentive payments for reducing energy leakages when such reductions have not taken place

Tim Yeo MP concluded:

"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. Barriers preventing smaller players from entering the market must be removed to drive down costs for consumers."

Background

Network costs currently make up around 23 per cent of a dual fuel (gas and electricity) bill. These costs are passed on to consumers by gas and electricity suppliers who are charged by the network companies for using their transmission and distribution infrastructure. The network charges imposed on gas and electricity suppliers vary regionally. There are 14 regions (excluding independent Distribution Network Operators) in Great Britain for electricity transmission and distribution. Northern Ireland operates a separate wholesale electricity market, the Single Electricity Market (SEM), which is integrated with the wholesale electricity market in the Republic of Ireland.

In 2013, Ofgem replaced the price control RPI-X with RIIO (Revenue = Incentives + Innovation + Outputs) which set targets to encourage more innovation in energy networks to benefit consumers. The more innovative energy networks would receive more financial rewards, while those that failed to innovate sufficiently would face financial penalties and further regulatory scrutiny.

Ofgem also designed RIIO to attract more investment into Britain's energy infrastructure by increasing the price framework period from typically five years (under RPI-X) to eight years, the current period started in 2013 and ends in 2021. This stability over a longer period aims to increase investor confidence. Ofgem estimated that £1bn savings for consumers could be achieved through the eight-year period. The success of RIIO for the public hinges on setting targets, so that prices and profits rise no more than necessary.

Further information

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