Ofgem publishes decision on RIIO-2 framework

Following a consultation on the RIIO-2 framework launched by Ofgem in December 2018, it has now published its findings, including some key decision for the ESO.

As a newly created Electricity System Operator (ESO) business, RIIO-2 will be the first time we have our own price control; a fantastic opportunity for us to set the direction of the business and our transforming role in the industry.

Our business plan will set out: the activities we will undertake that will drive consumer value; the investments we’ll make; how we’ll innovate to prepare for the future; and, the performance outcomes we expect to be measured against. 

In December 2018, Ofgem launched a consultation on the RIIO-2 framework, which included potential options for funding the ESO as a legally separate business. In our response, we suggested some specific changes to the proposals for the funding model, incentives and length of the price control; to ensure a model that would enable the ESO to be financeable, sustainable and appropriately incentivised to innovate and invest to deliver benefits for consumers.

Following the consultation, Ofgem recently published its decision on the RIIO-2 framework. This outlined some key decisions for the ESO, as well as further areas for consultation, summarised below:

• The ESO will have a two-year business planning cycle within a longer price control. This will be reassessed after four years.
• There will be no sharing factor1 and Ofgem will be able to disallow the ESO’s costs in the same way that it can for the other RIIO companies.
• The ESO will continue with an evaluative incentive scheme that assesses our performance retrospectively, the design of which Ofgem will consult on in the summer.
• There will be continued innovation funding, which Ofgem will consult on in the summer.
• Ofgem is exploring the role the ESO could play in facilitating competition in onshore transmission, particularly the early model. The ESO is required to submit an early competition plan in December.

Ofgem is now consulting on two alternative funding models for the ESO and has asked for views by 5 July:

1. Remunerate the ESO with a RAV-based model2 for capital expenditure (e.g. for IT) that provides money over the lifetime of the assets; and provide money upfront for operational expenditure (e.g. for people), passing through the actual costs incurred straight to consumers.
2. Remunerate both capital and operational expenditure upfront, passing through the actual costs incurred straight to consumers, thus potentially removing the need for financing.

Ofgem is also seeking stakeholder views on whether an additional return (either through a higher WACC3 or a margin on internal or external costs4) is warranted and whether there are benefits to retaining a two-sided incentive.

We will respond to this consultation and will continue to work with Ofgem and stakeholders in an effort to deliver a model that enables us to focus on unlocking benefits for consumers. If you’d like to get in contact with us to discuss any of this further, please email the team at [email protected].

1 Under the current price control, the ESO shares any under- or over-spends against its allowance with consumers through the sharing factor; this encourages efficiency.

2 A RAV-based model gives a return to the company for the equity it invests in capital assets.

3 Weighted Average Cost of Capital.

4 The ESO manages the transaction of transmission and balancing use of system charges on behalf of the industry – these are external costs.