Why we don’t agree with Citizens Advice

Citizens Advice has today published their latest report on the profits that energy network companies make. The underlying research for today’s claims is not, in fact, new – it is a regional breakdown of the ‘Missing Billions’ report, published in July 2017, which Energy Networks Association said at the time was misleading. We did so because we believed the report was claiming that consumers were definitively missing out on money on the basis of what is a best a hypothetical and at worst discredited methodology.

The fact is that the current system of regulating energy networks is bringing cost reductions to consumers whilst providing the investment to deliver the new technologies needed to support communities and keep our energy system running safely and reliably.

The calculations underpinning this analysis are plucked out of thin air and run directly counter to the conclusions of the independent regulator and the Competition and Markets Authority. Network costs are down 17% under the current ownership model, delivering £9bn of savings for consumers by running a world-class system of energy networks more efficiently."  - Energy Networks Association

Ofgem's RIIO-1 framework is on track to save energy consumers £9billion during the 8 year period it applies, through reductions in the return on capital employed that network operators can earn compared to under the previous framework.

Specifically, we feel that the Citizens Advice research, which claims that consumers are ‘missing out’ £7.5bn, is flawed for the following reasons:

1. Because of the way capital costs for network companies are forecast (accounting for £3.4bn of the £7.5bn)

• The research doesn’t fully capture the cost of debt incurred by network companies. Ofgem has acknowledged that their own methodology doesn’t do this, as part of a 2015 Competition & Markets Authority ruling. That ruling also rejected the claim that Ofgem’s method of indexing debt was overgenerous.
• The saving attributed by Citizens Advice to its proposal to change the way the cost of equity is calculated selectively uses historical data in a period of exceptionally low interest rates - which only this month were forecast to increase by the Bank of England.
• To create the ‘missing’ amount, Citizens Advice proposes an index for just one part of the cost of equity (called the risk free rate) however doing so will produce large errors because evidence shows that as this one part of the cost of equity decreases other parts (the equity risk premium) rises.

2. Because it underestimates the risks that network companies have to take (accounting for £3bn of the £7.5.bn)

• The research assumes network companies are the same as other utility companies (such as water companies like United Utilities and Severn Trent) in terms of risk profile. But they’re not – those companies have to borrow less than energy networks to maintain investment needed.
• At the same time, energy networks are also accommodating a period of rapid technological change (renewables generation, electric vehicles, storage etc), which will create uncertainty around how network companies will make money the future.  This risk will be borne by equity that is issued.

3. Because it misunderstands the way the price control system works (accounting for £1.1bn of the £7.5bn) 

• The ‘Totex’ incentive payments that network companies receive under the price control are a ‘win-win’ mechanism - any savings made resulting in lower bills for consumers will lead to better returns for networks. That's because if a project comes in under budget then the difference between the planned cost and the actual cost is shared with consumers.
• Adopting the risk-based approach to incentives as Citizens Advice propose (with penalties as well as rewards) would increase the risk profile of network companies for investors and so the cost of capital delivered. This would then undermine Citizens Advice's argument around network companies being low risk and so the 'saving' made under their calculations.
• Finally, network companies do not have the power to request a review at any time as claimed – this was removed from the current RIIO price control system.