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Ofgem RIIO-2 – what are the key takeaways from the sector specific methodology consultation?

Ofgem RIIO-2 – what are the key takeaways from the sector specific methodology consultation?

Ofgem (the Office of Gas and Electricity Markets) set price controls for the monopoly companies operating the gas and electricity networks in Great Britain using the RIIO framework, where Revenues = Incentives + Innovation + Outputs. The framework is in place to ensure these companies have enough revenue to run an efficient network that delivers what customers need.

In December 2018, Ofgem published their consultation on the sector specific methodologies for the transmission companies, and gas distribution networks (GDNs).

Here, we summarise some of the core areas of Ofgem’s proposals.

An output-based framework

Central to the methodology is Ofgem’s intention to establish an output-based framework, simpler in its approach than previous price controls. These are outputs which are focused on the consumer, and will sit in three categories:

  1. Network companies must deliver a high quality and reliable service to network users and consumers (including a focus on those living in vulnerable circumstances)
  2. Network companies must deliver a safe and resilient network that is efficient and responsive to change
  3. Network companies must enable the transition towards a smart, flexible, low cost and low carbon energy system for all consumers and network users.

It is anticipated that in creating a simplified, output-based framework this will enable to Ofgem to set outputs and incentives that reflect what consumers really value.

Ofgem are proposing to implement three different output types:

  • Licence obligations - minimum standards companies must deliver to avoid penalty
  • Price control deliverables (PCDs) - outputs directly funded through price control settlement
  • Output delivery incentives (ODIs) - incentivised service level improvements 

Companies will also have the opportunity to propose bespoke outputs, however these will need to be strongly evidenced and well justified. Robust evidence must be provided to demonstrate that these outputs will deliver value for money for consumers, and that they have strong support from consumers themselves.

Giving consumers a stronger voice

It is the intention that RIIO-2 will deliver enhanced customer engagement, with consumers being given a stronger voice, not just in the price control settlement process, but also within the day-to-day business of network companies. Ofgem are also exploring the possibility of incentives for stakeholder engagement.

In gas distribution, companies have set up Customer Engagement Groups and in transmission, companies have established User Groups to provide input and challenge to their Business Plan.

The quality of stakeholder engagement will be a key consideration for Ofgem when they review final business plans. They set an expectation that whilst engagement must inform business planning, they want to see robust and high quality engagement on an ongoing basis. It is therefore essential that robust and meaningful engagement becomes ingrained in everything companies do, with a clear long term strategy being developed as part of RIIO-2. Understanding the needs of consumers in vulnerable circumstances will also be of particular importance, given the focus on companies consumer vulnerability strategies.

Preparing for the future

Decentralisation, decarbonisation and digitalisation are resulting in significant changes in the energy industry, and therefore Ofgem want to design a framework that is flexible and responsive to the future possibilities, whilst also encouraging companies to invest in delivery of their own efficiency and innovation projects for networks.

Ofgem propose that a reformed innovation stimulus will fund solutions to facilitate greater joined up working with the government and third-party innovators.

Learning from previous price controls

Ofgem state that they want to achieve a better balance between risk and reward in RIIO-2. They will set the returns that companies earn to reflect the risks that they face in the stable, predictable regulatory environment.

Ofgem also want to reward strong service improvement and performance, with companies being able to earn higher returns if they are able to improve the quality of the service they provide and lower their costs.

Next steps

We are waiting to hear from Ofgem on their sector specific methodology for the electricity distribution network operators (DNOs), but the core areas summarised here provides clues as to key areas of focus.

Having worked with the utilities sector for two decades, Explain is strongly placed to help organisations across the sector embed best practice engagement as part of your business planning and business as usual, to give your consumers a stronger voice.

Why Explain?

Explain works in contracted partnerships with several of the UK’s biggest and most respected transmission and distribution companies across all networks. These relationships have allowed us to develop an in-depth understanding of the importance of customer and stakeholder engagement, and business planning, which remains unmatched by other providers.

Working with Explain ensures:

  • Quality – everything we do is underpinned by the highest levels of quality ensuring the approach you take and the data we produce stands up to the highest levels of scrutiny from challenge groups and the regulator
  • Experience – over 20 years of experience in the utilities sector and in business planning research ensures we know what the regulator is looking for in terms of good quality engagement and robust data and will guide you accordingly
  • Integrity – we will challenge you to ensure that what you submit to the regulator stands up to scrutiny. For example, avoiding bias, ensuring robustness and operating with integrity
  • Effective and efficient delivery – we pride ourselves on our project management and communication – we will be clear on what is required to deliver the project on time and meet deadlines. This is of key importance considering the hard deadlines involved in business plan submission

If you would like to have a further discussion about how Explain can support you with customer or stakeholder engagement during RIIO-2, please contact Kim Davis, Managing Director, at kim@explainresearch.co.uk.