Electricity network companies have provided a good service under Ofgem’s regulation. However, the cost to consumers has been greater than it should have been.
Today’s report by the National Audit Office (NAO) finds that strong price controls and greater coordination across the energy system are needed to ensure electricity networks transform to support a low-carbon energy system at the least cost to consumers.
Each year around 20% (£130 on average) of the typical household’s annual electricity bill goes towards running, maintaining and upgrading the networks which take electricity from power plants into homes and businesses.1
These networks are privately owned, and their earnings are regulated by Ofgem through price controls, which provide networks with budgets and performance targets. Since 2013, a price control framework known as RIIO2 has aimed to ensure consumers are provided with a reliable service, prevent them from being overcharged and encourage networks to innovate and enable the transition to low-carbon energy.
The NAO has found that networks provide a good service. Consumers in Great Britain experience fewer power cuts than in most other EU countries, and networks have met almost all their RIIO-1 targets, which cover safety, environment, reliability, providing timely connections, customer services, and assisting vulnerable consumers.
However, consumers have paid more than they should have under RIIO-1. This is because:
- networks’ performance targets were set too low;
- their cost budgets were set too high;
- Ofgem overestimated how much money shareholders would need to incentivise them to invest in network companies; and
- Ofgem set a regulatory period of eight years instead of the usual five, delaying the opportunity for improvements.
Networks expect to deliver shareholder returns of 9% in real terms, compared to a UK company average of around 5%-6%. This is higher than Ofgem anticipated and has increased consumer costs. Of the 9% returns, 1.5% points came from rewards for exceeding performance targets, including a scheme to prevent power cuts. Targets for this scheme were fixed too far in advance, meaning networks were already exceeding their targets before RIIO-1 started. The NAO estimates that if Ofgem had placed greater weight on the most up-to-date evidence on network company risk, consumers could have paid at least £800 million less in total.
Ofgem has highlighted concerns about the legitimacy of network companies making such high returns. Four out of the nine network companies have voluntarily returned some money to consumers.
By setting price controls for eight years rather than the usual five years, Ofgem has locked consumers into paying higher costs for longer. Ofgem expected this to encourage innovation and better outcomes for consumers and the environment, but has concluded that it didn’t provide this additional benefit.
Ofgem is currently designing the next set of price controls (RIIO-2), which will start to apply from 2021. It is making changes which are aimed at ensuring network companies only earn a fair return. These include reducing its estimate of the money shareholders require to incentivise them to invest in network companies. It is also proposing to adjust networks’ returns if they vary greatly from its expectations.
Ofgem’s regulation also aims to encourage networks to innovate. By 2050, the amount of electricity flowing through networks may need to double to support electric vehicles and electric heating. If networks do not transform their businesses in an intelligent way, this expansion in the electricity system could add significantly to network costs. Strong pressure from government and Ofgem is needed to encourage this because these changes will not necessarily be in networks’ financial interests.
The Department for Business, Energy and Industrial Strategy (BEIS) and other government departments have important roles to play in ensuring networks support the achievement of net zero emissions. BEIS has not yet introduced a fully-fledged strategy for low-carbon heat. Policy uncertainty creates a risk of too little network infrastructure being built, endangering the net zero target, or too much being built, at added cost to consumers.
The NAO recommends that BEIS consider the benefits of more strategic coordination in the energy system; keeping network costs to a minimum while the wider economy undergoes a mass transition to low-carbon power may necessitate more joined up thinking than the current system allows. Ofgem must also do more work to show in clear and simple terms that network regulation is working for consumers.
“Ofgem’s regulation of electricity networks has delivered good service performance but higher than necessary costs for consumers. Its approach to price controls used insufficiently demanding targets and the eight-year price control period meant a longer wait before these targets could be reset.
“While Ofgem has encouraged networks’ innovative efforts to reduce carbon emissions, more needs to be done across government if the UK is going to reach net zero emissions at least cost to consumers. Tougher regulation of networks is part of the picture, but so is greater policy certainty and better coordination between the energy system’s many players.”
Gareth Davies, the head of the NAO
Read the full report
Notes for editors
Key facts
£8bn
Total regulated revenues of electricity transmission and distribution companies (electricity network companies)
9%
Average return on regulatory equity electricity network companies expect to make for their shareholders in the current regulatory period. This compares with historical returns of 5%-6% for UK companies on average (figures in RPI-real terms)
£17bn to £40bn
The cumulative amount of expenditure across the electricity system, including networks, that could be avoided by 2050 by using sources of flexibility like batteries, according to research for BEIS
29 million
Number of homes and businesses connected to the electricity networks
£40 billion
Estimated value of electricity network assets such as cables and substations
£70 billion
Ofgem’s estimate of the capital investment in electricity networks that has taken place since privatisation in 1990
Around 50%
Reduction in the frequency of power cuts since Ofgem introduced incentives for companies to improve reliability in 2002.
£130
The amount households pay each year, on average, for electricity transmission and distribution networks. A further £10 is spent on the costs of balancing the electricity system. These payments are made via consumer energy bills.
£800 million
Amount we estimate consumers could have saved in the current eight-year regulatory period if Ofgem had used up-to-date evidence to set network companies’ returns.
- The physical assets making up the networks, which have an estimated value of about £40 billion, include over 800,000 km of overhead and underground cables. Electricity networks comprise transmission networks, which carry electricity nationwide at high voltage, and distribution networks, which carry electricity at lower voltages and distribute it locally.
- RIIO is an acronym for ‘Revenue = Incentives + Innovation + Outputs’. For transmission networks, the first set of RIIO price controls (RIIO-1) applies from 2013 to 2021, and for distribution networks, the first set of RIIO price controls applies from 2015 to 2023.
- Press notices and reports are available from the date of publication on the NAO website. Hard copies can be obtained by using the relevant links on our website.
- The National Audit Office (NAO) helps Parliament hold government to account for the way it spends public money. It is independent of government and the civil service. The Comptroller and Auditor General (C&AG), Gareth Davies, is an Officer of the House of Commons and leads the NAO. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether government is delivering value for money on behalf of the public, concluding on whether resources have been used efficiently, effectively and with economy. The NAO identifies ways that government can make better use of public money to improve people's lives. It measures this impact annually. In 2018 the NAO's work led to a positive financial impact through reduced costs, improved service delivery, or other benefits to citizens, of £539 million.