The imminent announcement of the next round of regulatory spending control for the UK’s energy networks, RIIO-2, will tell us whether the regulator, Ofgem, has any real regard for the consumer interest. Two resignations reported in the last week, of Ofgem’s Executive Director for Consumers and Markets, as well as the Chief Economist, suggest the worst.
The British electricity industry regulator, Ofgem, is on the verge of publishing details of the next round of spending controls for the electricity and gas industry transmission, distribution and system operation companies, which comes into effect in April next year. These controls are known under the term RIIO (Revenue = Incentives + Innovation + Outputs), which boils down to the prosaic reality of:
a) How much the regulator will allow the regulated energy industries to spend on capital investment and system operation
b) How large a return on this expenditure the regulated industries will be allowed to derive from consumer bills.
This second round of spending control, RIIO-2, will endure for five years, and forms the first major test of the new Chief Executive at Ofgem, Jonathan Brearley, a former civil servant at the Department of Energy and Climate Change and personally responsible for the design of some of policies that he now oversees on behalf of consumers. By any standard he was a very odd choice to run the regulator (see my earlier comments: “The Decline and Fall of Britain’s Energy Regulator, Ofgem”, and we shall soon find out whether he has changed his spots, or caved in to industry pressure to permit them more generous terms in order to deliver the Net Zero target.
The early signs are not particularly encouraging. In an Op-Ed on RIIO-2 published in the Sunday Times on the 5th of July (“Energy firms need to take the public with them to build a greener future“) Mr Brearley remarked that:
Companies are also invited to bid for additional funding as new technologies emerge so that we can get to net zero in the most efficient, smartest way. In return, companies will have to reduce their ongoing costs significantly and accept much lower returns.
Mr Brearley is saying that while he is unable to permit the 6.5% return the industry claims to want, as opposed to the 4.3% that Ofgem thinks reasonable, there will be an opportunity to enlarge capital spending very significantly, meaning that the asset base and hence the valuation of these companies will grow, making up for the lower returns, and implying a major wealth transfer to shareholders in the regulated energy companies.
Of course, a truly consumer-oriented regulator would be very reluctant to allow either increased capex or high rates of return, but Mr Brearley does not look like a consumer-oriented regulator. This, after all, is a man who resigned very publicly and noisily from his position in the Department of Energy in 2013 because the Treasury had moved to prevent him from offering lucrative incentives to investors in the low carbon policies.
Given that background it is a matter of particular concern that Mr Brearley is now engaged in a reorganisation at Ofgem that seems set to consolidate his power and reduce internal opposition. The industry journal Utility Week has reported in the last few days that both Mary Starks, Ofgem’s Executive Director for Consumers & Markets, and Joe Perkins the Chief Economist, have resigned. Mary Starks was formerly at the Office of Fair Trading, the Financial Conduct Authority, and the Bank of England, while Joe Perkins was formerly at Her Majesty’s Treasury and the National Audit Office. Neither has been at Ofgem long, and their resignations are a surprise.
Utility Week quotes Mr Brearley as explaining that an internal consultation was taking place on a new “flatter and broader leadership”, a phrase that he doubtless hopes will suggest egalitarian openness. However, it seems as likely that such a reform would in fact have the consequence of weakening the authority of the Directorships, Consumers and Markets, and Systems and Networks for example, as well as the Office for Research and Economics, while leaving the Chief Executive himself as the sole power in the land. A “flatter” leadership could easily mean that there is no effective challenge within the organisation to Mr Brearley’s own position. Is that why Mary Starks and Joe Perkins are leaving?
Whatever the explanation for their departure, the consumer has much to fear from any concentration of power in Mr Brearley’s hands. Electricity demand has been falling in the UK since 2005, and the public health measures to address the pandemic have deepened the trend. Whether demand will recover soon or indeed ever is very unclear. This has important implications for electricity prices. The very large costs entailed by the current renewables policies (£10 billion a year in subsidies alone), as well as the consumer charges required to pay for all the Net Zero capital expenditure that will be allowed by RIIO-2, must now be recovered from a much smaller volume of electricity sales. This is a sure and certain recipe for higher prices. Will Mr Brearley do anything to put a brake on this, or will he allow it to accelerate, pleading the overwhelming imperative of meeting climate change targets and safe in the knowledge that the grim political impact will fall on Boris Johnson’s government while Ofgem escapes unscathed?