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RIIO-2 blog series. Fair returns and financeability

RIIO-2 blog series. Fair returns and financeability

In our final blog, we review fair returns and financeability.

 RIIO-T1 and RIIO-GD1 price controls are due to end in March 2021 with RIIO-ED1 ending in March 2023. Ofgem launched the framework review for RIIO-2 earlier this year which marked the beginning of the consultation process for setting price controls for the network companies running the gas and electricity transmission and distribution networks in the UK. On the 30th June, Ofgem announced the results of the consultation which focussed on the following areas:

  • Strengthening the consumer voice
  • Responding to changes in how networks are used
  • Driving innovation and efficiency
  • Simplifying the price controls
  • Fair returns and financeability 

One of the core areas of focus in the framework decision and central to RIIO-2 is ‘Fair returns and financeability.' In this article we will explore what this means and the impact on the business planning process.

Fair returns and financeability – finding the balance

Fair returns and finaceability is one of the more complex areas of Ofgems framework decision. The chapter explores the mechanisms to ensure in the next round of price review, financial issues are reviewed.

So, what does fair returns and financeability really mean? In summary ‘The price control allows companies to recover the costs of running their networks, including the cost of financing their activities. Investors in a network company expect to receive a return on their investment. The baseline allowed return is our estimate of the return that equity and debt investors expect from an efficiently run company, i.e. a company that spends in accordance with its allowances, and performs in line with the baseline performance targets set in the price control.

A company’s actual return can be higher or lower than the baseline allowed return, depending on how well it performs against incentive mechanisms for delivering better services and/or lower costs. We want to ensure the overall returns earned are fair for both consumers and investors.’

Ofgem are clear that they will be consistent with past regulatory practices and will set the baseline to ensure that an efficient company is able to finance its regulated activities.

The framework decision confirmed that they we will use the principles set out in the March consultation. These were:

  • Consumers should pay no more than an efficient cost
  • Network companies should be incentivised to obtain lowest cost financing without incurring undue risk
  • The calculation of the allowance should be simple and transparent while providing adequate protection for consumers

Unpicking the regulatory framework, why Explain?

Explain has worked within the utilities sector for two decades, working in contracted partnerships with several of the UK’s biggest and most respected suppliers and distributors. These relationships have allowed Explain to develop an in-depth understanding of the importance of consumer and stakeholder engagement, ensuring we engage with the end user to deliver insights that support and are aligned to business planning.

Why Explain:

  1. Independent: You can be confident that our advice will be impartial, open and focused on delivering robust insight to support business planning throughout RIIO-2
  2. Bespoke solutions: Offering a range of research methodologies from the traditional to the innovative, always focussing on the best approach to deliver robust insights ensuring we engage with the end user   
  3. Business planning experience: With experience of customer and stakeholder engagement in the water and utility sector through RIIO-1, PR09, PR14, and most recently PR19 we are adept at engaging with customer and challenger groups, alongside core customer research to ensure we deliver representative results
  4. Research that unlocks insight: Delivering a range of research solutions through a mix of methodologies to deliver insights including: business planning strategic reviews, stakeholder research, customer research, vulnerable customer research, brand awareness and perceptions and public consultation.

On 4th October 2018, experts from the Explain team are presenting their findings from the Northumbrian Water Innovation Festival at the MRS Utilities Conference. The findings focus on the future of customer engagement in the utilities sector and innovation in the market research sector to future proof and provide solutions to engage with customers.

Contact the team for further information on the services we can provide.